Thursday, June 21, 2012

The Federal Reserve: The Cause That Cannot be Named

In the last several years, there is an ever-increasing amount of diagnosis of the current economic calamity approaching the Austrian, free-market tradition.  Not that the analysts are Austrian, claim to be Austrian, or even mention the school.  Nevertheless, the analysis is almost Austrian.  I emphasize “almost.”

However, when it comes to recommending a treatment few if any in the mainstream world suggest a path that is even remotely Austrian.  Inevitably, the proposed cure is one of a different statist cure – “don’t do what the current guy is doing, instead implement my idea.”  In other words, substitute one centrally plan solution for another centrally planned solution.

Bloomberg offers an editorial entitled “Dear Mr. Dimon, Is Your Bank Getting Corporate Welfare?”  This editorial is attributed to “The Editors,” and it follows precisely this formula.  The editorial rightly points out the massive subsidies received by the large money center banks – subsidies equal to the annual profits of these same banks.  The subsidies allow the payment of bonuses, provide a backstop to risky bets, and in other ways significantly distort the market.  The occasion of this editorial was in regards to Jamie Dimon’s recent visit to Washington:

When JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon testifies in the U.S. House today, he will present himself as a champion of free-market capitalism in opposition to an overweening government. His position would be more convincing if his bank weren’t such a beneficiary of corporate welfare.

To be precise, JPMorgan receives a government subsidy worth about $14 billion a year, according to research published by the International Monetary Fund and our own analysis of bank balance sheets. The money helps the bank pay big salaries and bonuses. More important, it distorts markets, fueling crises such as the recent subprime-lending disaster and the sovereign-debt debacle that is now threatening to destroy the euro and sink the global economy.

In recent decades, governments and central banks around the world have developed a consistent pattern of behavior when trouble strikes banks that are large or interconnected enough to threaten the broader economy: They step in to ensure that all the bank’s creditors, not just depositors, are paid in full. Although typically necessary to prevent permanent economic damage, such bailouts encourage a reckless confidence among creditors. They assume the government will always make them whole, so they become willing to lend at lower rates, particularly to systemically important banks.

The editorial points out that just the subsidy provided by lower interest rates is equal to the profits of the large money-center banks over the last twelve months, and in JP Morgan’s case, equal to 77% of its profits.

The editorial additionally points out other government programs that induce a bubble: various subsidized lending including in real estate, farm subsidies, etc., all of which distort the economy and especially distort pricing.  These subsidies in all forms lead to inordinate debt in the economy, debt which eventually becomes unsustainable:

Inevitably, the debt burden becomes overwhelming, precipitating crises in which banks suffer losses, private credit dries up, and people cut back on spending to pay down their debts.

Bloomberg has identified the boom, and the inevitable bust.  However, not one mention is made of the Federal Reserve as the prime facilitator in this dance.  Bloomberg offers its own solution:

The solution: Minimize the subsidy. Require banks’ shareholders to put up enough capital to make bailouts highly unlikely (we advocate 20 percent of assets). Allow some creditors to take losses when a bank gets into trouble, so they won’t assume they’re safe (an approach regulators in the U.S. and Europe are considering). Cut off subsidies to traders, such as the folks in London who lost billions for JPMorgan, by forbidding speculative trading activity at banks (the goal of the Volcker rule in the U.S. and financial ring-fencing in the U.K.).

There it is.  A different set of rules, and an insistence that “next time, we promise, we will know how to let some banks fail.”  We need better and smarter government, and these problems will disappear.  Faith in centralized power is faith in centralized planning.  How about just allowing markets to works, without the government interfering in any way?

It is almost as if the editors at Bloomberg want to tell us, need to tell us, would love to tell us…but aren’t allowed to tell us.  Editorials such as these are written to sound convincing, with the purpose being to distract attention from the prime culprit – the Federal Reserve.  Bloomberg: just another con man with the three walnut shells, always getting the audience to follow the wrong shell.

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