Friday, February 21, 2014

Mike Gongloff — The Fed Was Hopelessly 'Behind The Curve' During The Financial Crisis, New Transcripts Show

Federal Reserve policy makers were repeatedly caught by surprise as the economy and financial markets collapsed around them in 2008, according to newly released transcripts of their meetings from that year.

If you believe, for some reason, that the Fed has special fortune-telling abilities, these records should disabuse you of that notion pretty quickly.

Repeatedly throughout that crisis year, the Fed took relatively hopeful views of the economy's fate, only to play catch-up when the situation got much worse than they expected, sometimes in a matter of just weeks or days.

To be fair to the Fed, the unfolding economic collapse took a lot of people by surprise. And the Fed did act fairly aggressively when it got around to acting. But these records are reminders that the human beings pulling the strings of the world's largest economy are no better than most other economists at predicting the future.


Ralph Musgrave said...

It should be blindingly obvious that a system in which banks can 1, accept deposits, 2 lend on or invest that money, and 3, promise to return money to depositors (or bond-holders) is inherently fragile: the value of the investments or loans can easily fall below the value of the deposits. At which point a bank is insolvent. Doh!

The 1930s demonstrated that fragility. But the human race never learns. The solution is to outlaw the above promise. That is, as suggested by Milton Friedman, banks should offer depositors two options. First have your money lodged in a 100% safe manner, in which case it earns no interest. Second, have your money invested or loaned on, but you foot the bill when it goes wrong. If I invest in the stock exchange and my investments go wrong, I foot the bill. Anything wrong with that?

Matt Franko said...


to me its worse than even this...

If you break it down, what happens is that banks create loans whereby huge portions of the loan balances are used to pay taxes when the deals close... so the funds to pay the loan back is eliminated from the system with the deal closing via these taxes...

then it is up to the govt to create additional future flows of currency balances to the non-govt that are adequate for the net-liability cohort in the non-govt to be able to pay the loan back, which often does not happen and then the system has to end up with defaults... this does not look like a good business to be in to me... or at least one would have to be "in paradigm" and even then VERY careful to be in the banking business... you could easily lose all or your capital at any time...


Ralph Musgrave said...


I don’t think there are too many cases of banks lending to idiots who simply use the money to pay taxes and then remain permanently in debt to the bank. But certainly private banks make silly loans (e.g. NINJA mortgages) in the knowledge that come the crash, the government (i.e. taxpayer) will clean up the mess.

That problem would be solved by the system advocated by Milton Friedman (and Lawrence Kotlikoff, who advocates much the same idea). That is, if those depositing money in banks WANT TO have their money loaned to NINJA mortgagors, they can. But anyone taking a risk like that with a view to making a fast buck deserves to lose their money when it goes wrong.

In contrast under the MF/LK system, anyone who wanted a modest rate of interest and 99.9% safety for their money would opt to have their money loaned just to safe mortgagors: e.g. those who had a minimum 20% or so equity stake in their house.

Brian Romanchuk said...

I am unconvinced that anything would need to be done, other than regulating banks properly. The economic damage of leaving the non-guaranteed depositors to eat defaults would be such that no government will let that happen. We ended up with a central bank system precisely because governments were unwilling to let the private sector liquidate itself.

What we saw ithe crisis is that no-one was willing to let non-guaranteed creditors eat losses. This was true even in the private sector, where banks bailed out their "off balance sheet" SPVs that theoreticallly had no guarantee from their parent.

Tom Hickey said...

Brian, I assume that as a given. Governments will not, cannot, let the private sector liquidate itself without provoking regime change. Politicians are not willing to commit suicide.

However, the question then becomes who is going to bear the pain and that's were power and influence comes in, unless politicians strongly believe that voters will throw them out if they reduce the powerful in order to "save the system."

In the US there is enough of a safety net to prevent voter pain from becoming too great to prevent rescuing the powerful and privileged. That was not the case at the time of the Great Depression, which led to the Pecora Commission and the New Deal.

It seems that just as the abolition of the draft has allowed the US elite to pursue the aggressive foreign policy it desires, so too the safety net blunts voter outrage at financial and economic excesses that lead to dysfunction.

Ralph Musgrave said...


Re the idea that we should “regulate banks properly”, Dodd-Frank, Basel and others have been trying to do that for the last few years and have so far just made a huge mess. For some details, see:

Re the alleged impossibility of “non-guaranteed depositors eating defaults” they ate them in Cyprus, and New Zealand’s depositors have no state back up. Also, whenever there is a stock market setback (e.g. 1987 and early 2000s) investors “eat” billions worth of losses, and no recession ensued on those two occasions.

If bank capital ratios were 100% or at least vastly higher than at present, banks couldn’t suddenly fail. In the event of bank/s having problems, their shares would just fall in value. They wouldn’t face insolvency. The private sector “liquidating itself” just wouldn’t happen.

Kyle said...

I like Mosler's approach to the issue of bank regulation:
Stop telling banks what they CAN'T do; start telling them what they CAN do.