While it is understandable that inflation hawks keep a close watch on the Federal Reserve’s money-creation activities, an equally worrisome Fed activity is taking place right under their noses. Whether or not the Fed is expanding the money supply, it has undoubtedly moved into a new activity under cover of addressing the financial crisis and recession: central planner of the allocation of credit.
As San Jose State University economics professor Jeffrey Rogers Hummel points out in The Independent Review (Spring 2011), Fed chairman Ben Bernanke “has so expanded the Fed’s discretionary actions beyond merely controlling the money stock that it has become a gigantic, financial central planner…. [The] Fed that emerged from the crisis is no longer the same as the Fed before the crisis.” It did not even have to expand the money supply to assume its new role.
It is standard operating procedure (though of course illegitimate by free-market standards) for a Fed chairman to inflate the money supply supposedly to provide increased liquidity during an economic crisis. It is then left to the market (distorted, to be sure) to “allocate” the money. What’s new is that under the Bernanke Fed’s self-expanded powers, the central bank is allocating credit to chosen financial institutions, including insolvent rather than merely illiquid ones. That is apparently unprecedented in the United States.
Just as central planning of the economy in general, besides violating individual freedom, can’t serve the general interest because the planner necessarily lacks the required information, so it is with the central planning of the allocation of credit. Bernanke cannot know better than the collective intelligence of the market which firms should get capital and which shouldn’t. Creating credit out of thin air in order to allocate it according to a central plan is an assault on the market. But it is also an assault if Bernanke “merely” moves existing capital from one part of the market to another. The new powers are independent of the Fed’s power to inflate.
According to Hummel, until September 2008 the Fed’s “borrowings would simply pull money out of the economy on one end of its balance sheet, and then it would put that money back in on the other end through loans to favored firms and purchases of favored instruments.” The Fed also acquired capital by cashing in matured bonds or selling securities, then allocating the proceeds. In another method Hummel describes, “the Treasury was borrowing money from the general public and lending it to the Fed, which then relent it to foreign central banks.” Also, since 2008 the Fed has paid banks interest on reserves left in their Fed accounts:
Bernanke in effect created money and then borrowed it back from the banks by paying them interest. The banks in turn partly financed their implicit loans to the Fed by reducing loans to the public by almost $500 billion as of the last quarter of 2009. Thus, the result is partly a net wash, with a shuffling of assets from the private sector to the Fed.
The first direct allocation of credit came when the New York Federal Reserve Bank set up a company called Maiden Lane, which directly bailed out Bear Stearns in March 2008. Other similar facilities were established to perform other bailouts. “The Fed, however, provided the bulk (if not all) of the money to these subsidiaries, whose other sources of funds never amounted to more than a few billion dollars,” Hummel writes.
He quotes economic historian Michael Bordo, who warned that such powers “exposed the Fed to the temptation to politicize its selection of recipients of its credit.”
The road to corporate statism
Who got the money? Hummel says it primarily went to depository institutions, the U.S. Treasury, federal agencies such as the mortgage guarantors Fannie Mae and Freddie Mac, and finally, holders of mortgage-backed securities, one of the culprit financial instruments in the housing and financial bust. It was the first time the Fed had bought those kinds of securities.
As late as last year, the Fed was devising new ways to borrow and allocate credit by setting up various “term deposit” facilities. “[Term] deposits make the Fed’s borrowing more explicit,” Hummel writes. “With this barrage of sometimes seemingly incremental steps when viewed individually,” he continues,
an amped-up Fed was bailing out such firms as Bear Stearns and AIG, assisting the Treasury with its TARP subventions, lending extensively to a new array of institutions including investment banks and money-market funds, and purchasing large amounts of such new financial instruments as commercial paper and mortgage-backed securities. More than half of that activity was financed not by issuing true base money, but by directly or indirectly borrowing from the private sector in one way or another. In this way, phase two of Bernanke’s policies transformed the Federal Reserve from a central bank confined primarily to managing the money supply into an institution that is also a giant, government intermediary that borrows large sums in order to allocate credit. In that respect, it has become similar to Fannie or Freddie, with the important distinction that the Fed has greater discretion in subsidizing a wider variety of assets.
Bernanke has been dubbed “Helicopter Ben” because of his so-called “quantitative easing,” which people assume distributes fiat money evenly across the economy, as if from a helicopter. But for Hummel, “A better moniker would therefore be ‘Bailout Ben.’” He adds, “Helicopter Ben talks a good line about being ready to unleash quantitative easing, but this talk only imparts an aura of justification for the Fed’s incredibly expanded role in allocating the country’s scarce supply of savings.”
One can hardly overstate the extent to which Bernanke’s new powers move the U.S. economy further down the corporate-statist road. In his 1936 General Theory,f John Maynard Keynes called for “a somewhat comprehensive socialisation of investment” as the “only means” of driving the interest rate on capital to zero and to secure full employment. He welcomed the “euthanasia of the rentier, of the functionless investor.” I doubt that’s Bernanke’s precise intention, but in a society that calls itself free, no one should have such power at his disposal. A free economy leaves savings and investment to the uncoerced choices of individual persons, just as it leaves money and banking to the market.
Bernanke, an admirer of Franklin Roosevelt and his experimental response to the Great Depression, promises to give up his extraordinary powers once the economy is well. But those words are small comfort to anyone familiar with the dynamics of government. As Hummel writes, “Bernanke may be sincere about his intention, but when in the history of the Fed — or of most other government agencies, for that matter — have newly acquired authority and reach been easily, entirely, and voluntarily relinquished?”
Sheldon Richman is senior fellow at The Future of Freedom Foundation, author of Tethered Citizens: Time to Repeal the Welfare State, and editor of The Freeman magazine.
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