Federal Reserve policy is getting crazier and crazier

Apparently, after hours yesterday, the Federal Reserve made a major policy shift: It allowed US banks to assume colossal amounts of risk.

From the Financial Times:

The Federal Reserve has eased a capital rule for large banks in a move to encourage leading financial groups to increase lending and play a bigger role in the market for US Treasuries.

The “supplementary leverage ratio”, a rule adopted in 2013, required large banks with international portfolios to hold capital — equal to 3 per cent of their total assets — to absorb losses. On Wednesday the US central bank said banks could exclude Treasuries and cash reserves held at the Fed from these calculations for a year.

The decision means that as the Fed pushes more cash reserves into the banking system, the banks will be able to take those reserves on to their balance sheets without having to increase capital at the same time.

“If [the capital rule] was a binding constraint to banks, we just created capacity to lend money,” said Peter Fisher, former head of the Fed’s market desk, now at Dartmouth’s Tuck School of Business. Banks should “no longer be bound and therefore have latitude to lend’’.

Priya Misra, global head of rates strategy at TD Securities, said with the new rule, banks would be more likely to buy Treasuries if they cheapen sufficiently, helping to ensure the smooth functioning of the world’s largest debt market.

“This is a very big deal,” she said. “Now we don’t have to rely on just the Fed to bring normalcy back to the Treasury market . . . There’s an additional player that can restore normalcy.”

I have been asking over and over how the US was going to continue to finance the deficit given the increasingly extreme measures that have already been enacted and will yet be enacted because the shutdowns are becoming more extensive and longer.

This is the answer: The Federal Reserve is temporarily suspending regulatory measures put in place after the last financial crisis to keep the financial system stable.

Our country has finally come full circle: The financial industry broke the global economy in 2008, resulting in new government regulations restricting the amount of risk banks can assume. Then the government broke the economy in 2020, resulting in the government allowing banks to go wild with risk-taking to pay for the government’s losses.

This is on top of allowing state and local governments access to the Fed’s commercial paper (short-term lending) facilities – something that did not even occur in the last financial crisis, because the Fed is usually averse to assuming the credit risk of municipal governments (many of which were in bad shape – by choice – before this hit).

2 thoughts on “Federal Reserve policy is getting crazier and crazier

  1. The virus is probably a legitimate emergency.

    The financial crisis was a failure of government to enforce rules that needed to be in place and that the government actors involved by the time of the crisis really didn’t understand. They allowed dark pools that were believed to average risks but also incentivized enormous fraud.

    This throwing money at people may be necessary in these circumstances, but it also incentivizes fraud. And expectations that government will support everyone financially. Terrible moral hazard.

    Like

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