Volcker And Bernanke: So Close And Yet So Far

By Simon Johnson

In case you were wondering, Paul Volcker is still pressing hard for the Senate (and Congress, at the end of the day) to adopt some version of both “Volcker Rules”.  It’s an uphill struggle – the proposed ban on proprietary trading (i.e., excessive risk-taking by government-backed banks) is holding on by its fingernails in the Dodd bill and the prospective cap on bank size is completely missing.  But Mr. Volcker does not give up so easily – expect a firm yet polite diplomatic offensive from his side (although the extent of White House support remains unclear), including some hallmark tough public statements.  It’s all or nothing now for both Volcker and the rest of us.

But at the same time as the legislative prospects look bleak (although not impossible), we should recognize that Paul Volcker has already won important adherents to his general philosophy on big banks, including – most amazingly of late – Ben Bernanke, at least in part.  In a speech Saturday, Bernanke was blunt,

“It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms. If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation [like fall 2008].”

You may dismiss this as empty rhetoric, but there is a definite shift in emphasis here for Bernanke – months of pressure from the outside, the clear drop in prestige of the Fed on Capitol Hill, and the pressure from Paul Volcker is definitely having an impact.

Bernanke finally understands the “doom loop” – in fact, he provides a nice succinct summary:

“The costs to all of us of having firms deemed too big to fail were stunningly evident during the days in which the financial system teetered near collapse. But the existence of too-big-to-fail firms also imposes heavy costs on our financial system even in more placid times. Perhaps most important, if a firm is publicly perceived as too big, or interconnected, or systemically critical for the authorities to permit its failure, its creditors and counterparties have less incentive to evaluate the quality of the firm’s business model, its management, and its risk-taking behavior. As a result, such firms face limited market discipline, allowing them to obtain funding on better terms than the quality or riskiness of their business would merit and giving them incentives to take on excessive risks.”

He also expands on an important, related point – that the presence of “too big to fail” is simply unfair and really should be opposed by all clear thinking businesspeople who don’t run massive banks (aside: someone kindly point this out to the Chamber of Commerce – they are undermining their people),

“Having institutions that are too big to fail also creates competitive inequities that may prevent our most productive and innovative firms from prospering. In an environment of fair competition, smaller firms should have a chance to outperform larger companies. By the same token, firms that do not make the grade should exit, freeing up resources for other uses…. In short, to have a competitive, vital, and innovative financial system in which market discipline encourages efficiency and controls risk, including risks to the system as a whole, we have to end the too-big-to-fail problem once and for all.”

Bernanke now endorses the first Volcker Rule, “Some proposals have been made to limit the scope and activities of financial institutions, and I think a number of those ideas are worth careful consideration. Certainly, supervisors should be empowered to limit the involvement of firms in inappropriately risky activities.”

But he is still hampered by the illusion that there is any evidence we need megabanks in their current form – let alone in their likely, much larger, future form.  Let me be blunt here, as the legislative agenda presses itself upon us.

I’ve discussed this issue – in public where possible and in private when there was no other option – with top finance experts, leading lawyers, preeminent bankers (including from TBTF institutions), and our country’s most prominent policymakers.  And I have testified on this question before Congress, including to the Joint Economic Committee, the House Financial Services Committee, and – most recently – the Senate Banking Committee, where leading spokesmen for big banks were also present.

Mr. Bernanke, with all due respect: there is simply no evidence to support the assertion that, “our technologically sophisticated and globalized economy will still need large, complex, and internationally active financial firms to meet the needs of multinational firms, to facilitate international flows of goods and capital, and to take advantage of economies of scale and scope,” at least if this implies – as it appeared to on Saturday – we need banks at or close to their current size.

We can settle this in a simple and professional manner.  Ask your staff to contact me with the evidence – or, if you prefer, simply have a Fed governor provide the compelling facts in a speech and/or have a staff member put out the technical details in a working paper.

There is no compelling case for today’s massive banks, yet the downside to having institutions with their current incentives and beliefs is clear and awful.  Think hard: what has so far changed for the better in the system that brought us to the brink of global collapse in September 2008?  In this context, Mr. Bernanke’s three part proposal for dealing with these huge banks should leave us all quite queasy:

  1. He wants tighter regulation.  Fine, but what happens next time there is “let it all go free” president again – a Reagan or a Bush?  Regulation cannot be the answer; there must be legislation.
  2. Improving the clearing and settlement of derivatives is also fine.  But why not also make the banks involved smaller – given that a bankruptcy of a future megabank could easily involve millions of open derivative positions?  This would also make complete sense as a complementary measure – unless you think society would lose greatly from the absence of megabanks.  Again, show us the evidence.
  3. A resolution authority is not a bad idea.  But everyone involved in rescuing the big banks with unconditional guarantees in spring 2009 insists on one point – if they had run any kind of FDIC-type resolution process, this would have been prohibitively expensive to the taxpayer.  You simply cannot have this both ways – either resolution/bankruptcy was a real option in early 2009 (as we argued) or it was not (as Mr. Geithner argues), but in that case the resolution authority (and also living wills, by the way) would change precisely nothing. 

Mr. Bernanke needs to face some unpleasant realities.  Because of the various actions – some unavoidable and some not – it took in saving Too Big To Fail financial institutions during 2008-09, the Federal Reserve is now looked up with grave suspicion by a growing number of people on Capitol Hill. 

The cherished independence of the Fed is now called into question – and losing this could end up being a huge consequence of the irresponsible behavior and effective blackmail exercised by megabanks – who still say, implicitly, “bail us all out, personally and generously, or the world economy will suffer”.

Mr. Volcker sees all this and wants to move preemptively to cap the size of our largest banks.  Mr. Bernanke has one last window in which to follow suit (e.g., lobbying Barney Frank could still be effective).  In a month it could be too late – the legislative cards are now being dealt.

Mr. Bernanke is a brilliant academic and, at this stage, a most experienced policymaker.  What is holding him back?

37 thoughts on “Volcker And Bernanke: So Close And Yet So Far

  1. It’s not just that government backed banks are taking too much risks. And can take too much risks because they are government backed.

    Those banks actually create the money everybody uses. Such is the fractional reserve system with a high multiplier we have now. But, of course the big bankers create that money first for themselves, their friends, their servants, and their own dark purposes.

    Once they have created most of the world’s capital, the big bankers divert it towards the derivative universe, 800 trillion dollars strong, or so. Nothing much is left for the real universe, and the real economy. This allows them to claim big (imaginary) profits, and thus all too real bonuses (a gigantic 145 billion dollars in 2009 alone, in the USA alone; basically all this money was stolen from the taxpayers, because the banks would have stopped existing without the taxpayers.)

    Thus what are these big bankers, except the biggest, most corrupt “civil servants” who ever were? It would not be the first time that civil “servants” would have become the masters, because people were looking somewhere else.

    A partial solution: put a 95% tax on the property of all big bankers, their families and associates. It goes without saying that most derivatives ought to be outlawed, to force capital back in the real universe.


  2. “Chris Dodd’s wife and derivatives trading
    March 19, 2010 | 2:14 pm
    In the middle of a blog item about credit default swaps, Felix Salmon of Reuters drops the following nugget about Sen. Chris Dodd and the CME Group, which owns the Chicago Mercantile Exchange and the New York Mercantile Exchange.

    “Dodd’s wife, Jackie Clegg, is a director of the CME, which paid her $153,219 in 2009; she also owns shares in the company worth about $235,000. (The CME makes no mention of her husband on its website or in its SEC filings, despite the fact that he’s surely a big part of the reason why she has the position.)”


  3. All that means is that he feels enough pressure that he feels the need to talk a better game.

    Weeks before Obama called the banksters “savvy businessmen” he called them “fat cats”. His actions prove which one really reflects his loyalties.

    Aren’t we finally, irrevocably past the point where we would ever believe anything anyone says?

    Where we would ever believe in anything but actions?

  4. Here’s one: (The Man Who Sold the World:Ronald Reagan and the Betrayal of Main Street America-William Kleinknecht)

    The McFadden Act of 1927, ‘a law aimed at preserving community banking by restricting the ability of financial institutions to operate in more than one state. The law was all that stood in the way of national companies’ swallowing up independently owned banks across the country. Reagan was even more disdainful of the Banking Act of 1933, better known as Glass Steagall Act. …enacted to break up the unethical collusion between banks and brokerage houses in the years preceding the Depression. Many depositers lost their life savings because commercial banks had invested money in stocks during the speculative frenzy leading up to the Great Crash. Some banks had engaged in a practice known as self-dealing-the loaning of money to hollow companies to make their books look attractive to investors. The bank was then repaid from the company’s artifically inlfated stock market capitlization.”

    Great book, highly recommend. Reagan got rid of the McFadden act, then began the weakening of Glass-Steagall. By the time Clinton repealled it, it had become nearly useless. Obviously with deriviatives these criminals have up the ante to ‘nth degree.

    The only solution might be State Banks, and all that implies for that struggle…

  5. This “relatively small number of giant financial firms” is not only too big to fail. It is also too big to regulate, too big to investigate, too big to prosecute. It has become a virtual sovereignty unto itself. Further, its global scope and reach isn’t well known. It will be interesting to see if any significant regulation is legislated and, if legislated, how long it stands.

  6. Agree.

    But I do not think the argument is still about whether the banking system is too big to fail but rather what is the best approach going forward.

    Even though at times we’re prone to believe in what we read and hear, to Mr. Bernanke and Treasury Secretary Geithner, we’re not all dummies!)

  7. “[If] a firm is publicly perceived as too big, or interconnected, or systemically critical for the authorities to permit its failure [it receives even more] incentives to take on excessive risks.”
    Setting aside Bernanke blaming the markets as the prime mover for a distortion amplified beyond comprehension by himself, the corollary here is that the most “important” institutions are also bound to be the most dysfunctional. That should have anti-trust and Too Big implications all by itself, especially as the cause-effect relationship here is dramatically nonlinear – there are thresholds (defined by presence or absence of peer competitors and market share).

    Market efficiency is fundamentally incompatible with market dominance, even as it produces it.

  8. Or maybe the “succint” summary is more sublte than I give Bernanke credit for: He might just see the Fed as another “creditor” or “counterparty” who had decreased “incentive” to “evaluate […] management and risk-taking behavior” – and provided the “funding” to fuel even more “excessive risks”.

    Bernanke himself certainly demonstrated he suffered no “incentive” whatsoever to evaluate during his decade-long bubble bath.

    I do not think he understands the doom loop. He is busy rewriting the past, that is no foundation for anybody attempting to write the future.

  9. All that means is that he feels enough pressure that he feels the need to talk a better game.

    But his re-appointment already got confirmed, so he is all set for the next four years.

    That he waited until after his confirmation might mean he is speaking his mind. Not that I really expect anything to come of it.

  10. @Patrice Ayme

    I just posted a rather long comment that I think got eaten because it was too long. I’m going to break it down into two parts and see if it comes up. I apologize if this ends of being double posted.


    While I agree with the thrust of your argument that the size of the nation’s largest banks constitute an implicit tax on the American people that can/should be recouped by moving toward a more progressive tax system, I think your characterization of fractional reserve banking as the source of the financial industry’s power to extract economic rent is flawed. The necessity for banks to maintain some fraction of the amount of money they lend out is an artifact of the days when the U.S. was still on the Gold Standard. This requirement is no longer necessary in the fiat currency world we live in today. Several countries, including Canada and Australia, that have fared quite well in the current financial crisis actually have no reserve requirements at all. Here in the U.S. Chairman Bernake has recently proposed doing away with minimum reserve requirements, stating:

    “The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.”

    While many individuals of the libertarian persuasion view this proposition as akin to the end of civilization as we know it, I would submit that it is merely a recognition of the way our modern fiat currency system operates. The standard textbook interpretation of money multiplier theory is highly misleading. For those interested in learning about money multiplier theory I recommend looking through the Federal Reserve Board of New York’s educational material posted on their “about,” web-page. You can find relevant information here:


    I want to quote a paragraph from the above web-page here because it does an excellent job of showing how money multiplier theory is presented to credulous undergraduate students (like I was not too long ago) who go on to uncritically accept what they are taught even though the theory is deeply flawed:

    “If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100 + $90 + $81 + $72.90 +… = $1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+ $80 + $64 + $51.20 + … = $500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.”

    However, later on in the educational material it is acknowledged that:

    “…the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.”

  11. *Continued from above:

    A “relatively limited role,” should probably read “almost no role.” In our modern banking system banks will offer a loan to any credit-worthy customer that walks in the door. The constraints on bank lending are the number of credit-worthy customers on the demand side and the amount of liquid capital available on the supply side. FDIC insured deposits do not count as assets that can be used to meet capital requirements. Demand deposits count as bank LIABILITIES and, contrary to money multiplier theory taught in most undergraduate economics classes, are not “loaned out.”

    If you were to talk to an individual who works as a loan officer at a commercial bank (as I have asked my cousin who works at the small-business desk of a medium sized bank in Boston) you will find that a bank’s decision to originate a loan is made quite independent of the bank’s reserve position. If a commercial bank is short required reserves it can borrow from another bank in the interbank market, but if the system overall is short of reserves these “horizontal” transactions will not add the required reserves. Banks that are short of funds can either sell bonds back to the Federal Reserve or borrow outright through a device called the “discount window.” There is typically a penalty for using this source of funds as noted in the qualification above by the FRNY. In reality, the Federal Reserve will ALWAYS provide the necessary reserves; if it did not it would lose control over its target rate. Therefore, at the individual bank level the price of reserves (the interest rate) will play some role in a bank’s decision to loan funds, but the reserve position per se will not matter. So as long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, the bank will lend.

    So in conclusion, the idea that reserve balances are required initially to finance bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is not constrained by the quantity of reserves it holds or any fractional reserve requirements. Banks expand their balance sheet by lending. Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank.

    Sorry for the length of this comment, but I feel this is an important point that is rarely discussed. I myself was quite resistant to the ideas I have expressed here when I first read about them, but after talking to my cousin about it I came to the conclusion that what I had been taught in my economics classes as an undergraduate about banking was incorrect. For a more detailed discussion of these points you may want to see this blog post by one Professor Bill Mitchell called “money multipliers and other myths:”


    Also of interest may be the blogs “Building bank reserves will not expand credit,” and “Building bank reserves is not inflationary,” which can be found here and here:



  12. This is off topic, but I recently started reading the “bond crash course,” section of Nemo and Bond Girl’s website, and I just want to say it is really a spectacular resource. I highly recommend it to anyone looking to learn about bonds. You can find it here:


  13. As appalling as the situation with too big to fail banks is, at least the problem has been diagnosed – the discussion is about remedies. Who is talking about the moral hazard that the Fed has become. Apart from Mr. Hoenig who has correct identified the source of moral hazard (in the “we will keep rates low for ever”), the rest of the FOMC is still deflecting blame and hiding behind dubious statistical evidence. Fire Bernanke and his band of Greenspan style radical rate cutters. We have paid enough for their stupidity and erroneous theories.

  14. Thanks, N Klein. The money multiplier has been declining for many years as shown by the below link to the St Louis Fed.


    I studied this same graph with data from the decades from fifties backwards.

    The multiplier is dogma we live with. The decline shown in the graph is stunning. The secular decline shown is obviously somewhat traceable to funds diverted from banking institutions to shadow banking. What would the plot on this graph look like if all shadow deposits were forced into formal banks?

  15. State banks are a great idea and should be pushed by state officials and legislators. They could be capitalized by the state, initially, and loan to state enterprises and get our local economies going. Forget Wall Street!

  16. I’ve said it before………..

    Until we get rid of the Fed everything else is mumbo jumbo, meaningless esoteric crap. Abolish the Fed. Period. Done. Gone. Forgotten forever.

    Replace it with a senate confirmed, independent body of total economy focused economists & business persons to set monetary policy & as the lender of last resort. And 49 more state banks like the Bank of ND.

    Until we do we’re just pissing in the wind.

  17. Jon Claerbout wrote:

    “Transparancy is more reliable than regulation.”

    New York Fed Warehousing Junk Loans On Its Books: Examiner’s Report

    03-22-10 01:12 PM – Huff Post – excerpts

    “As Lehman Brothers careened toward bankruptcy in 2008, the New York Federal Reserve Bank came to its rescue, sopping up junk loans that the investment bank couldn’t sell in the market, according to a report from court-appointed examiner Anton R. Valukas.

    The New York Fed, under the direction of now-Treasury Secretary Tim Geithner, knowingly allowed itself to be used as a “warehouse” for junk loans, the report says, even though Fed guidelines say it can only accept investment grade bonds… Meanwhile, the Fed and Geithner both strongly oppose a congressional measure to authorize an independent audit of the central bank and its lending facilities.

    Without an audit, the Fed is able to conceal the specifics of what it holds on its balance sheet. If the Lehman deal is any indication, the Fed is hiding billions of dollars in toxic loans on its books…”The net result of this is we know the Fed knowingly bought assets for more than they were worth — substantially more than they were worth — and actually created a market for garbage that Lehman was more than happy to push on the Fed because they regarded the public as the suckers of last resort,” said Grayson.”


  18. True. But he still wants more stuff, like control of the CFPA, and any kind of scam “resolution authority”. So he’s not an island yet.

  19. Wall Street is all about rogue corrupt self obsessed civil servants who believe they make the universe go around, because government backing allows them to create more than 4/5 of the money.

    Money creation ought to be seen for what it is: a REGALIAN function. By facing that fact, and re-incorporating money creation as an official regalian function, one will be cutting off qualificatives such as “rogue”, “corrupt”, “self obsessed”. Plus one will stop the instauration of a new so called aristocracy (I say “so called” because they are not “aris”, namely the best fitting).

  20. Is it possible that Obama is saving this issue for the campaign, and that he really does get it?
    Maybe the plan is to do immigration reform now, and use banking reform for the late summer and fall. It’s much easier to score political points by beating up Wall St.

  21. Thanks for the thoughtful contribution, which I just noticed. Unfortunately I am presently, at this very moment, travelling with my 5 months old daughter, on business, so I will need some time before I can think about this as thoroughly as it deserves.

    On a quick note, it seems to me, though, that one has to distinguish between “reserve requirement” and “multiplier”. As long as the central bank provides the reserve, the fact remains that the privates create and control most of the money, with the reserve provided by the government. So, if anything, it’s worse.

    Short of commanding an army, money creation is the most important function of an empire. Or so it was, for 5,000 years of civilization. The system we have now is different, and is a devolution to NEOLITHIC times, with the great chiefs, the great sorcerers and shamans, the bankers, creating the universe as we know it. They do that thanks to their democratically unsupervised use of the multiplier.


  22. The FRBNY was audited with a full clean opinion for 2008 by Deloitte & Touche. Of course, assets at the end of 2008 changed quickly in 2009 when assets based on central bank liquidity swaps were liquidated and mortgage backed securities were purchased.

    The 2008 audit letter was dated April 2, 2009 so the 2009 certified annual report should become public very soon.

    Skipping forward to the FRBNY numbers included in the weekly consolidation released by the FED . As of 3/17/2010, the FRBNY total holdings of Mortgage Backed Securities was $416,845 mn. Note 4 to these securities for all FRB’s issued by the Fed is as follows:
    ” Guaranteed by Fannie Mae, Freddie Mac,and Ginnie Mae. Current face value of the securities,which is the remaining principal balance of the underlying mortgages.”

    It should be noted that FRBNY is a quasi public body and does not follow GAAP applicable to private entities. This is explained in the notes to the audit every year.

    FRBNY is not required to mark to market. Besides, the loans that fail are purchased by Fannie, Freddie and Ginnie. The loans were not purchased for merchandising but for holding to term. That was their assumption.

    If you look at the year end numbers of FRBNY included in the Fed consolidation, you will see that the entire balance of mortgages purchased are covered by outstanding deposits owed Depository Institutions. That is, and in the spirit of looseness championed in the press today, the same as you selling your house for a cashiers check for the total and never cashing the check. I can only wonder if these mortgages will liquidate back to the sellers to the FRBNY by taking back the paper in exchange for the cashiers check in my desk drawer.

    Now why would the sellers to FRBNY sit on their proceeds credit to their account at FRBNY? The answer is they have only one choice for almost the entire balance. That is, they take currency which is probably greater in physical volume than their vaults can accomodate. Why did they surrender market rate interest for a mere 16 basis points. Cash in the vault earns zero basis points.

    But, the FRBNY has been audited with clean opinions and will again in a few days.

  23. simon what about huge multinational corporations? is it fair to tell the banks u r too big. yet GE is allowed to grow without limit & have significant exposure in all sectors of the economy. my recommendation is for anti-trust regulation on all companies

  24. JerryJ:
    The multiplier is going into a derivative universe, that is the explanation, indeed, and that is why the world economy is getting starved of capital. This was my most crucial point entirely. Shadow banking and off balance sheet sh.. ought to be, well, incorporated (figuratively and literally). That is where the regalian capital royally leaks.

    Then, of course, the banks do not feel like lending to simple mortals, when they can manipulate as one all these juicy derivatives.

    Keeping banks small will not alleviate that problem, because they could still act as one big conspiracy. Only stiff regulations about where money creation ought to go can prevent the conspiracy, and return banks to the real world.


  25. Transparency ought to be a regulation, the law, a basic requirement, whatever the amount, even one percent of one cent…

  26. “Although the Fed told The New York Times earlier this month that a third party verified the market value of the bonds Lehman used as collateral for loans from the Fed, they did not specify who the third party was. Of course, Lehman’s auditors at Ernst & Young are already implicated in helping Lehman cook their books and fake the value of their derivatives, so the Fed may well have allowed a third party to determine the valuation but, as with the Goldman-AIG valuation debacle, not done a particularly good job at making sure that third party was at all independent.”


  27. @Patrice Ayme and JerryJ

    In its most simple form the money multiplier is just the inverse of the required reserve ratio. So if the central bank told private banks that they had to keep 10 per cent of total deposits as reserves then the required reserve ratio would be 0.10 and the money multiplier would equal (1 / 0.10) = 10. More complex expressions of the money multiplier can be derived by adding in liquidity preferences, but this adds little and would needlessly complicates our discussion here. The standard formula out of any econ 101 textbook for calculating the money supply using money multiplier theory is:

    Money Supply = money multiplier x monetary base

    If all the money in the shadow banking system were to brought onto the balance sheets of commercial banks we see would see an increase in the monetary base and hence the money supply, but the money multiplier theory would still be fundamentally flawed.
    The problem with this theory presented in most intro economic textbooks is that it does not acknowledge that the money supply is essentially endogenously determined. That is neither private financial institutions nor the government have control over how much money is in circulation. This has been clear since at least the mid to late 1970’s (and early 80’s in some countries outside the U.S.) when central banks in several countries tried monetary targeting in an attempt to stem the tide of inflation by controlling the supply of money, but failed miserably (those Whip Inflation NOW buttons Ford liked to wear were probably more effective policy tools). While I share Patrice’s concern over derivatives, trying to curtail speculation in the derivatives market by fiddling around with interest rates or required reserve ratios is bound to fail. Better to just outlaw trading of the most offensive products.

    Finally, I completely agree with Patrice Ayme that regulating the money supply is a Regalian function which should belong solely to the Federal Government. However, it is important to distinguish between credit money banks can create and high powered money that only the consolidated government sector (Treasury plus the Federal Reserve) can create. In general, using the term “money,” is not terribly helpful because it obscures the differences between these two types of money. Better to be more specific and talk about whose liability and whose asset. As a general rule, only the consolidated government sector can safely create new financial assets (bonds or currency). All credit money created by private actors must eventually net to zero because one person’s asset is necessarily another person’s liability. In essence, when we rely on private institutions to fund our investments we are renting the money supplied to us for a set time. The price is the interest rate (usually rather high) and the duration is the amount of time allotted to pay back the loan (usually not very long, which is why the private sector has been unable to make the kind of long-term capital intensive investments needed to provide the human capital and infrastructure development necessary to be competitive in the 21st century). The consolidated government sector, on the other hand, has the wherewithal to create new financial assets out of nothing without any corresponding liabilities (the bonds and money issued by the Federal Reserve are not redeemable in anything but additional dollars that the Federal Reserve can create virtually cost-free). This is an incredibly powerful tool that must be carefully controlled lest inflation create distortions in the real economy.

  28. Collateralization is another matter. As a party making a loan for say $1 bn, I may require a pledge of $2 bn of collateral. The loan booked is $1 bn.

    Anyway, Lehman collapsed on September 15, 2008. The FRBNY audited financial statements show no adverse effect from the collapse. Under the circumstances, the FRBNY paperwork would have allowed immediate seizure of the collateral and it’s subsequent liquidation. The FRBNY netted $11,860 mn for 2008 and distributed $10,571mn to the Treasury as interest on Federal Reserve Notes.

    Whatever the effects of Lehman were on FRBNY, they were resolved by the end of the calendar year in so far as financial measurement is concerned. FRBNY did record a loss of $5,237 mn for ” Investments held by consolidated variable interest entities ( losses) , net “. This is a new category and obviously would include the Bear Stearns and AIG transactions in their various Maiden Lane entities.
    All other categories were at a profit.

    Whatever FRBNY did with Lehman came out OK or making money for FRBNY.

    The total 2008 FRBNY Annual Report for 2008 is 103 pages. I did not find anything specific to Lehman doing a quick scan just for Lehman.

  29. I should have added above that there was one other new category and it showed a profit of $1,357 mn titled ” U.S. government, federal agency,and government-sponsored-enterprise securities gains, net.”

    Here may be where the Lehman collateral enters the P&L for 2008. If so, overall FRBNY came out making money . Net , of course.

  30. It should come up searching the title. ” St. Louis Fed:Series:MULT,M1 Money Multiplier” I brought it up just searching US Money Multiplier.

    I printed it off this morning. The multiplier was about 3.2 in 1986 just before the US became a net international debtor. By 2009 it was steadily down to 1.6. In the last year it has plunged to about 0.70.

    The chart is ” The M1 multiplier is the ratio of M1 to the St. louis Adjusted Money Base” according to the St. Louis Fed.

  31. Simon Johnson praises Bernanke’s talk contra Too Big To Fail and criticizes Bernanke’s partiality to big private institutions: “There is no compelling case for today’s massive banks….Mr. Bernanke is a brilliant academic and, at this stage, a most experienced policymaker. What is holding him back?”

    Perhaps what is “holding him back” is his manifestation of the secular tendency of mature capitalism to generate large, oligopolistic firms, financial and otherwise. This is the “compelling case” of capitalist evolution–the concentration and centralization of capital long ago described by Karl Marx. Of course, Johnson is right in the claim that there is no “compelling claim” in mainstream academic economics for “today’s massive banks” et al.

    But that is an indictment of academic economics. Similarly, chronic unemployment and economic crises have “no compelling claim” in academic economics; but they keep happening, and will keep happening, academic nostrums notwithstanding.

    It is Bernanke the “experienced policymaker” who abandons academic economic doctrine in service to the oligopolistic capitalist system that Bernanke serves. If Simon Johnson were in Bernanke’s shoes, he’d be responding to the same imperatives, and somebody else stuck in academe would be wondering what makes him tick.

    By the way: I am no partisan of Marxism, but Marx got a few important things quite right.

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