Ask Bullwinkle J. Moose about the Federal Reserve’s recently disclosed $7.7 trillion in emergency loans to banks, and he would observe that sum is “antihistamine money. It ain’t nothing to sneeze at.” He would be right; $7.7 trillion is a lot of money.
However, much of the story is overblown. Moreover, most commentators skirt the crucial question: If there are financial institutions so large that their failure would throw the economy into chaos, why don’t we simply break them up?
Start with the simplest issue, which is the overall quantity of loans. The Fed is less secretive than people think. It has long disclosed, on a weekly basis, the sum of all of its lending in various categories.
It also publishes its own detailed balance sheet weekly. So during the crisis, anyone, including Congress and the media, could have followed the Fed’s emergency lending on a week-to-week basis. And, since it also publishes an updated historical file each week, anyone with access to the Web can look at this data from 1975 on. (The data is summarized here.)
Looking at that data puts the $7.7 trillion in perspective. Yes, the lending increase was spectacular. As late as Feb. 28, 2007, all Fed loans totaled only $30 million, of which $22 million went to small farm banks, primarily in North Dakota. But when the financial crisis began to unfold in mid-August that year, loans quickly ballooned to $2.2 billion.
Totals then ebbed and flowed for months, spiking after Bear Stearns failed in March 2008, but then receding until Lehman Brothers and AIG went to the wall in September. By mid-November that year, average weekly Fed loans outstanding surged past $725 billion.
They stayed above $500 billion until the end of May 2009. Since then, they’ve declined steadily and are now down to $10.6 billion, less than 2 percent of the peak but at least 50 times as large as the average for 2006, the last year before the crisis. Virtually all the money loaned out at one time has since been repaid.
How can the Fed have loaned $7.7 trillion if its loans outstanding never exceeded $726 billion in any one week? The answer is that the $7.7 trillion is the sum of all loans made, but not all were at the same time.
Suppose my colleague Joe and I go out for lunch on Monday and he leaves his wallet on his desk. I lend him $30 and he repays me that afternoon. Mary unexpectedly needs to fly to Omaha yet today and her cash card won’t work, so I lend her $100 for cab fares. She pays me Wednesday. That day, Frank wants to put $40 into an office collection for a colleague’s child who has cancer, but he is out of cash, so I lend him the money and he pays me on Thursday. Then Ann needs cash, but the ATM is down so I lend her $50 and she pays me Friday.
I have made $220 in loans that week but never had more than $100 due me at any one time. The average over four days was only $55. And that is how the Fed lent a total of $7.7 trillion over three years, but never was owed even 10 percent of that amount over any one week.
However, that the Fed does not disclose exactly to whom it is lending, nor the amounts of individual loans, raises legitimate questions.
Doesn’t democracy demand that Congress and citizens themselves be informed when an institution created to serve the public takes actions of this size? Is secrecy necessary?
The answer is yes, secrecy is essential and details should not be disclosed, at least until the crisis is well past. The reason is a pragmatic one: The system won’t work without it.
The whole point of such last-resort lending is to quell panic in financial markets by providing money so that otherwise-solvent financial institutions can meet any demands for cash placed on them. Telling the world that specific firms needed large amounts of cash would increase fears rather than diminish them.
Lender-of-last-resort interventions are not pretty and not necessarily fair. But they are necessary. We could stand on democratic principle and go through a depression or we can hold our noses, avert our eyes and step back from the brink of an abyss.
The whole kerfuffle raises other important issues. Should the Fed lend at low interest rates? Should banks that borrow be allowed to lie to their own shareholders about their true financial state? Should banks that probably would have failed without such intervention be allowed to pay high salaries and bonuses? And where in the world does the Fed get $725 billion, much less $7.7 trillion? I’ll address those soon.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.