How big banks get paid NOT to lend

If anyone is still wondering why private lending has become such a vital and necessary alternative to traditional bank loans, today’s editorial in the New York Times written by Bruce Bartlett, former Senior Policy Adviser to Presidents Reagan and George H.W. Bush, illuminates the method by which the Federal Reserve is actually paying U.S. banks to sit on as much cash as they can and collect interest on their massive reserves.

Nevermind the fact that Americans are trying to build houses, build business, build the economy and a future for themselves and their communities – Today, banks are turning away loan applicants who have 800 credit scores, just because they’d rather hoard that money and make an easy 0.25% interest on it risk free from the Fed.

But the banks’ failure to get behind Americans and their dreams won’t stop those Americans from building a toward their future, and today’s private lenders will be the ones who are there to support those American dreams when they become reality.

Here’s the nitty gritty of it:

The Fed Should Stop Paying Banks Not to Lend

By BRUCE BARTLETT

The Federal Open Market Committee, the policy-making arm of the Federal Reserve, meets Tuesday and Wednesday to discuss what, if anything, it will do to stimulate economic growth. There is widespread speculation that it will adopt further “quantitative easing” and inject more money into the economy.

It has done this twice before: between November 2008 and May 2010, and between November 2010 and June 2011. The expected new effort has been labeled QE3.

Many economists, however, are doubtful that more of what hasn’t worked already will do any good. Some suggest that it is time for the Fed to think “outside the box” and do something different.

In a Wall Street Journal commentary on July 22, Alan S. Blinder, the Princeton economist and former vice chairman of the Federal Reserve Board, suggested that lowering the interest rate the Fed pays banks on their reserves would force them to lend more and thus stimulate growth.

To explain why this is potentially important, it is first necessary to explain something about the relationship between the Fed and the banking system.

Typically, when the Fed wishes to stimulate growth it increases the money supply. It buys Treasury securities from banks and credits their accounts at the Fed. All banks maintain accounts at the Fed, just as people have accounts at commercial banks. When the Fed credits their accounts, they have more money to lend.

Banks must maintain a certain level of required reserves in the form of vault cash or balances at the Fed as a percentage of their deposits, in order to provide adequate liquidity. Reserves over and above those required are called excess reserves.

Historically, banks held as little in the way of excess reserves as possible, because this was money that could be lent immediately, upon which no income was earned. One way income on excess reserves could be earned was by lending them to other banks overnight, through what is called the federal funds market.

The interest rate charged on such overnight loans is called the fed funds rate and it is essentially controlled by the Federal Reserve, which routinely adds or subtracts reserves so as to meet its target rate. Since Dec. 16, 2008, the target fed funds rate has been between zero and 0.25 percent.

Under normal conditions, such a low fed funds rate would be more than adequate to create a considerable amount of new lending. Since the rate is the basic cost of money to banks, they would make a profit even if they made loans at a 1 percent interest rate.

But rather than make loans, banks instead are simply sitting on the money, so to speak. According to the Federal Reserve, they have $1.5 trillion in excess reserves. This is extraordinary. It is as if individuals took $1.5 trillion of their savings out of stocks, bonds and every other income-producing financial asset and put it all into non-interest-bearing checking accounts back in 2009, and just left it there… (Read the rest here)

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