US Fed Responsible for the Credit Crisis

There has been a lot of talk in the news recently about the Federal Reserve and the actions it has taken over the past few months. Many media pundits have been bending over backwards to praise the Fed for supposedly restoring stability to the market. This interpretation of the Fed’s actions couldn’t be further from the truth.

The current market crisis began because of Federal Reserve monetary policy during the early 2000s in which the Fed lowered the interest rate to a below-market rate. The artificially low rates led to over investment in housing and other malinvestments. When the first indications of market trouble began back in August of 2007, instead of holding back and allowing bad decision-makers to suffer the consequences of their actions, the Federal Reserve took aggressive, inflationary action to ensure that large Wall Street firms would not lose money. It began by lowering the discount rates, the rates of interest charged to banks who borrow directly from the Fed, and lengthening the terms of such loans. This eliminated much of the stigma from discount window borrowing and enabled troubled banks to come to the Fed directly for funding, pay only a slightly higher interest rate but also secure these loans for a period longer than just overnight.

After the massive increase in discount window lending proved to be ineffective, the Fed became more and more creative with its funding arrangements. It has since created the Term Auction Facility (TAF), the Primary Dealer Credit Facility (PDCF), and the Term Securities Lending Facility (TSLF). The upshot of all of these new programs is that through auctions of securities or through deposits of collateral, the Fed is pushing hundreds of billions of dollars of funding into the financial system in a misguided attempt to shore up the stability of the system.

The PDCF in particular is a departure from the established pattern of Fed intervention because it targets the primary dealers, the largest investment banks who purchase government securities directly from the New York Fed. These banks have never before been allowed to borrow from the Fed, but thanks to the Fed Board of Governors, these investment banks can now receive loans from the Fed in exchange for securities which will in all likelihood soon lose much of their value.

The net effect of all this new funding has been to pump hundreds of billions of dollars into the financial system and bail out banks whose poor decision making should have caused them to go out of business. Instead of being forced to learn their lesson, these poor-performing banks are being rewarded for their financial mismanagement, and the ultimate cost of this bailout will fall on the American taxpayers. Already this new money flowing into the system is spurring talk of the next speculative bubble, possibly this time in commodities.

Worst of all, the Treasury Department has recently proposed that the Federal Reserve, which was responsible for the housing bubble and subprime crisis in the first place, be rewarded for all its intervention by being turned into a super-regulator. The Treasury foresees the Fed as the guarantor of market stability, with oversight over any financial institution that could pose a threat to the financial system. Rewarding poor performing financial institutions is bad enough, but rewarding the institution that enabled the current economic crisis is unconscionable.

Dr. Ron Paul
Project Freedom

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  1. scratchatary

    You know what half of that stuff was above my head in my article. But I did get the part about the banks not being held accountable for bad lending practices. I agree that this baby sitting from the federal reserve is a terrible idea and it is costing the American taxpayer. Plus if you add rising gas costs this is truly becoming a nightmare. I don’t know to much about bubbles, but I do know that eventually somebody has to pay the bill and that is not happening. My concern is simple I think we are going to have a violent economic reaction to all of this stuff and we will all suffer in the end.

  2. This is why I love searching around on this site…so I can learn. The article above makes me so angry because although I have not known exactly how it all occured, I knew the crisis happened in the first place because of our government and because of the banks and other large institutions/companies. Where does this vicious cycle end? How is throwing more money at these banks going to help anything. It just puts this country further into debt and further reduces the value of our dollar. Below is a question I posted to another article I just read. If anyone can help me out with an answer, I would appreciate it…

    Even if the Fed buys the debt of companies as far as the “commercial paper” goes and takes “direct investments in banks” how is that really going to help? These institutions already have debts unpaid and the Fed’s plan may help that for the moment, but everyday, their debt is growing and the Fed doesn’t have unlimited money to keep pumping into them. It would be a long time to pay that back, much longer than 85 days. Plus, helping companies cover payroll and keep inventory on their shelves is all well and good, but if the American people keep suffering financially, they will be out buying less and less. I as an American wouldn’t want to go apply for a loan of any kind to help cover the debt I am falling into due to the economy. If I can barely pay my bills and keep food on the table now, why would I want to put myself into more debt so why do I care if banks have stopped lending. Know what I’m getting at? Companies are in trouble so it make sense for them to go borrow more money?? If the Fed bails out banks so they can now buy commercial paper or issue loans to businesses, again, that is short term and what happens when the companies still can’t pay the banks back because the “people” still don’t have money to spend? Seems to me this is just going to be a vicious cycle and the only thing it is going to do is put America further into debt. Either way, this 700 billion dollars has to be paid back sooner or later and there is just something I am not getting here in this whole bailout plan. I’ll keep trying to understand though!




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