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Sunday, December 11, 2011

Hamilton: "More on those secret Federal Reserve loans to banks"

by Calculated Risk on 12/11/2011 02:39:00 PM

From Professor Hamilton: More on those secret Federal Reserve loans to banks

The claim that the Federal Reserve extended trillions of dollars in secret loans to banks continues to be spread. Here at Econbrowser we will continue to try to correct some of the misunderstanding that is out there.
If you take the position that each new loan should be added as a running contribution to some total, then you are led to maintain that when the Fed loans $1 B to Bank A in the form of a 30-day loan, and loans $1 B to Bank B in the form of an overnight loan that is repaid and renewed each day, then the Fed has 30 times the exposure to Bank B as it does to Bank A. You are further led to infer that the Fed could have lost $1 B in lending to Bank A but somehow could have lost $30 B lending to Bank B. And you are led to infer that it is 30 times safer to make a 1-month loan than it is to make a series of overnight loans in the same amount. Good luck managing your or anybody else's finances, if that's your way of thinking.

But Professor Wray goes on to speak admirably about an analysis by his student James Felkerson that does exactly that, and concludes that the Fed lent not $7.77 trillion but instead $29 trillion. For example, Felkerson takes the gross new lending under the Term Auction Facility each week from 2007 to 2010 and adds these numbers together to arrive at a cumulative total that comes to $3.8 trillion. To make the number sound big, of course you want to count only the money going out and pay no attention to the rate at which it is coming back in. If instead you were to take the net new lending under the TAF each week over this period-- that is, subtract each week's loan repayment from that week's new loan issue-- and add those net loan amounts together across all weeks, you would arrive at a cumulative total that equals exactly zero. The number is zero because every loan was repaid, and there are no loans currently outstanding under this program.

But zero isn't quite as fun a number with which to try to rouse the rabble.
There is much more in Hamilton's piece.

CR Note: There is much more to this story - the need for transparency, the lawsuit to have the information released - but I'm glad that Professor Hamilton is trying to correct some of the faulty analysis of the actual numbers. We have to remember that banks (and other institutions) borrow short and lend long. During a panic (a liquidity crisis), banks are stuck with solid assets that are illiquid, but they have a need for short term cash. The Fed steps in as the lender of last resort, and the banks use the long term assets as collateral to obtain cash. This is a key role for the Fed.

During the crisis, the peak liquidity lending was about $1.5 trillion. A large number, but we need to compare that to the total amount of household and corporate debt outstanding (about $24 trillion in 2009). So, at the peak of the crisis, the Fed was providing liquidity for about 6% of the outstanding corporate and household debt.

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