Sunday, April 15, 2012

Econ 201: I Think I'm Starting To Get It

My economic education has proceeded apace these years since the housing market collapsed where I live in Florida in 2005 (well before everywhere else) and then the full economic collapse in 2008. I understood what the banks were doing regarding the mortgage bubble while it was happening, since that's the business I'm in, but it's taken me some time to wrap my head around some of the policy moves made since the collapse. But I had an epiphany the other day which, if I'm correct, may go a long way to explaining why the bailout and the ongoing Quantitative Easing (QE) measures (a fancy way of saying the Fed has printed a LOT of money) have been rigged the way that they were rigged.

The Fed has the task of maintaining control over the US banking system, keeping it solvent and stable, while balancing inflation and employment rates. This I learned long ago but understanding how it works in a time of extreme, almost catastrophic crisis, was new on me, as I guess it's been for pretty much everyone, including the folks in charge of the system, the Bernanke, the Timmy, et al.

Basically what has been done since the crisis began is pretty simple: throw lots and lots of cash at the problems. The problems have been caused almost exclusively by insanely abusive banking practices that utterly confounded the purposes for a banking system. But that's another discussion which has been oft-discussed. Let me just get to my epiphany.

So lots of money has been given to the banks, essentially free of charge -- no short-term interest rates for practical purposes. That means ANYthing the banks did with that money would be profitable as long as it didn't become a loss (like all of those criminally fraudulent mortgages they gave to borrowers). Of course, the banks were and are carrying enormous losses for the foreseeable future because of the mortgage mess. If the totality of the losses were tallied, it's pretty well certain that most if not all of the biggest banks in the country would collapse immediately. But with a massive infusion of cash, a lot of that damage can be masked. As long as that cash stays on hand, it remains an asset rather than as a liability. In other words, if the money isn't loaned out, then it stays in the positive column of the bank balance sheet. Additionally, if all that money were loaned out, another bubble could be triggered as people start buying stuff with it. THAT could (and because of the gigantic sums of fresh cash printed up) probably would also trigger some pretty massive inflation, devaluing the dollar overnight.

Of course, we've heard a lot of noise about hyperinflation because of all the money printing, and we've also heard a lot of noise about how the banks are sitting on the money instead of loaning it out to the public. And often, it's been portrayed as an oops that strings weren't attached to the bailouts and QE requiring that the money be loaned out to the public. But my epiphany is that it wasn't a mistake at all. It was intentional from the start.

Free money to bad banks prevents their collapse and keep them profitable, thereby meeting the first major requirement that the Fed has. Allowing them to hold onto the money contributes to their stability and prevents inflation even though so much more cash is theoretically out there. But it's all fake because it isn't out there at all -- it's completely locked up, hoarded, on banking balance sheets as unreachable as the gold in Fort Knox. So inflation is kept at bay, fulfilling another of the Fed's obligations. Finally, nominal stability in finance has allowed the economy in general to more or less stabilize as well and perhaps slowly start to creep into something that can be described as a recovery even though unemployment, the final obligation of the Fed, remains well over 8%. The argument here is that the monetary policies of the government and the Fed prevented unemployment from being much much worse. While that may be true, had it not been for the irresponsible Fed policies through the 90s and especially the early aughts, together with the longterm and successful efforts of every congress and administration since late Carter to chip away at the regulatory foundation of post-Depression Era finance, the madness that caused the crisis would never have happened.

There's no oops here. The stability of the banks is false but will stay as is unless another outside crisis knocks them over. A European crisis, major war, major oil shock, or some other like big event could do the trick. We are still living in a house of cards and there's no telling if or when an ill wind will rise on the horizon.