Don't Buy the Fed's New "Bribe-a-Bank" Interest Rate Policy

Editor's Note: No one understands the complex, unhealthy relationship between the Federal Reserve, Wall Street, and the economy better than Lee Adler at the Wall Street Examiner. He just caught The New York Times trying to put a positive spin on the Fed's terrifying post-ZIRP plans. You need to know what's really coming next...  

After seven long, strange years, we're now looking at the end of ZIRP as we know it.

And good riddance, too. It's been a disaster for the U.S. economy, the middle class, the housing market - just about every facet of American economic life has suffered from this fiscal disaster masquerading as coherent monetary policy.

But what's coming next has the potential to be even worse, though you'd never know it if you read the paper...

You see, the Fed counts on a corps of enthusiastic financial media cheerleaders to parrot its company line. In fact, The New York Times just published one of their explainers discussing just how the Fed would raise interest rates should it decide to do so.

Of course, like everyone in the Fed's "Amen Corner," the author carefully avoids the subject of just how the Fed would raise rates when there's $2.6 trillion in excess cash parked in the banking system - if there's a reason why rates are zero and borrowing money is virtually free, that is it.

Never mind that common sense (not to mention the Law of Supply) suggests that, when there's too much of a good, the supplier of that good loses the ability to raise its price without a massive increase in demand for the same.

But when did common sense ever stop the Fed or its slavish propaganda wing? It would be funny - if the consequences for every American's money weren't so dire.

Here's what I mean...

Welcome to the "Bribe-a-Bank" Interest Rate Policy

In this excerpt, the Times relates a key component of the Fed's post-ZIRP plans with a straight face, utterly failing to call the new policy being mooted what it really is: simple bribery.

It says...

"For the last seven years, the Fed has encouraged financial risk-taking in the service of its campaign to increase employment and economic growth. By starting to raise interest rates, the Fed intends to gradually discourage risk-taking.

"The straightforward part of the plan is persuading banks not to make loans.

"In a serendipitous stroke, Congress passed a law shortly before the financial crisis that let the Fed pay interest on the reserves that banks kept at the Fed. Written as a sop to the banking industry, it has since become the new linchpin of monetary policy."

The Fed will "pay banks not to lend." This is the essence of why it is akin to bribery.

Of course, the Fed has no realistic alternative here, because it has made the markets completely dependent on zero interest rates and quantitative easing.

Nobody can reasonably claim to know what will happen when the Fed takes away the easy money because it's never been done before under similar circumstances.

The Fed, and Wall Street, too, are terrified of the unknown. So they're averse, even afraid, to do what is absolutely right and indeed essential for restoring sanity in incentives for rational investment decisions - rather than the rank speculation and financial market distortion we've endured for the last seven years.

But the economy's long, dark night isn't over yet...

The Taxpayers' High Costs Could Get Even Worse

The Times comes perilously close to calling out their pals at the Fed here, but they come up just short:

"More than seven years ago the Federal Reserve put its benchmark interest rate close to zero, as a way to bolster the economy. But that policy is about to change.

"Say the Fed wanted to raise short-term interest rates to 1%, meaning that it did not want banks to lend at lower rates. Because the glut of reserves is so great, the Fed could not easily raise rates by reducing the availability of money. Instead, the Fed plans to pre-empt the market, paying banks 1% interest on reserves in their Fed accounts, so banks have little reason to lend at lower rates. 'Why would you lend to anyone else when you can lend to the Fed?' Kevin Logan, chief United States economist at HSBC, asked rhetorically."

"Why would they not?" I would ask Kevin.

They still have all of the funds. The Fed increasing the rate on reserves would not restrict the banks from lending money in any way. The reserve exists as a liability account at the Fed. But it is still a cash asset to the banking system as a whole.

The banks could make trillions in loans at whatever rate they want to without running into any constraints whatsoever as long as those excess reserves exist. In fact, if the Fed increased its subsidy, the banks could lend at even lower rates and still be just as profitable as before.

In fact, if the Fed wants to raise rates, it would need to charge the banks interest on those reserves, not pay interest. In charging the banks interest, it would increase their cost of funds, forcing them to raise rates. This is exactly the opposite of what the Fed is proposing.

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Instead, the Fed will ask the American taxpayer to pay the banks an increased subsidy. Here again, the Times ignores the big, noisy rampaging elephant in the room:

"(Paying banks interest) is not a cheap trick. Since the crisis, the Fed has paid banks a token annual rate of 0.25% on reserves. Last year alone, that cost $6.7 billion that the Fed would have otherwise handed over to the Treasury."

Now, the author says "Treasury" here, but he means "the American people," who are going to end up paying even more for the privilege of having the Fed and Wall Street destroy their wealth, like so...

"Paying 1% interest would cost four times as much. The Fed has sent roughly $500 billion to the Treasury since 2008. As the Fed raises rates, some projections show that it may not transfer a single dollar in some years. Instead, the Fed will pay banks tens of billions of dollars not to use the trillions it paid them previously."

Since the Times won't say it, I have to: This comes straight out of taxpayers' pockets.

I dare say that it won't go over well when taxpayers figure out that they are paying an even larger subsidy to keep banks' profits high. That is, if anybody in Big Media bothers to inform them.

On the other hand, the Times' mention of this in passing - buried in the bowels of this piece - is one of the very few times I have seen even a slight allusion to this issue by the Fed's adoring media chorus.

You see, the Fed and Wall Street will have a harder time wrecking the economy when their plans are exposed to the cold light of day. Just don't count on the media to drag them into the open.

Read Lee Adler every day at The Wall Street Examiner.