Bernanke: Fed Bailout Creates Two Societies

Bernanke: Fed Bailout Creates Two Societies

A State of the Economy Report in Four Parts

PART THREE: Federal Reserve’s Two Societies

The irony of the official monetary policy and its tragic turn is found in the words of the Fed Chairman. When asked about the absence of small business credit, Bernanke explained to Scott Pelley that small business is cut out of credit due to bailed-out banks unwillingness to lend. Why? Because many small businesses “can no longer qualify for credit” since their collateral (usually personal assets) diminished and they “cannot meet terms and conditions of lenders.”

Apparently, this same lending policy does not extend to big corporations and banks. In the absence of private lending for banks and businesses that could no longer meet lending terms, the Feds stepped in to supply credit and capital to the Chosen Ones without condition. They certainly did not attach personal assets to reckless and irresponsible money managers. On the contrary, the Feds gave bankers money to reward themselves for their own bad behavior.

From the Federal Reserve’s own website: “Amid widespread concerns about the condition of many financial institutions, investors became very reluctant to lend…To address these funding pressures, the Federal Reserve first took steps to increase the amount of liquidity available to financial institutions.”

The Federal Reserve created eight different direct lending programs in addition to the infamous “discount window” and several repurchase (bad debt) programs for big banks, large corporations,essential companies like Harley Davidson and McDonald’s and billionaires like Michael Dell “to improve financial market conditions more generally.”

The Feds claimed they only lent to “financially sound institutions” against solid collateral. Firms like Morgan Stanley, Citigroup, and Merrill Lynch who reportedly borrowed $2 trillion each tells a very different story. These firms and many other financial giants were clearly insolvent—hence why their identities were hidden from the public for two years. (The Fed has yet to reveal the names of borrowers of the embarrassing “Discount Window” – anyone using this source of capital is viewed as desperate.)

In terms of collateral, the Fed and thus taxpayers have become the dumping ground for Wall Street bad bets and bad debt. The record number of defaults on mortgages, credit cards, and consumer loans means much of bank “collateral” wasn’t worth the paper it was printed on. Bloomberg reports, “By moving into the world of non-recourse loans, they started to accept risk exposures that the private sector was no longer capable of maintaining,” said Lou Crandell, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “That effectively turned the Fed into an asset warehouse.”

Three years after the crisis and subsequent Fed bailout began, we remain with trillions of dollars of bad assets on our books, hidden in a ”warehouse” at the Federal Reserve under names like Agency Mortgage-Backed Securities Purchase Program or Term Asset-Backed Securities Loan Facility (TALF) in amounts and from sources we may never know. 

Trillions upon trillions of dollars of banking loans and repurchases later, Bernanke states, “We’re not very far from the level where the economy is not self-sustaining.” In other words, we are still in big trouble.

 The Federal Reserve Chairman shared his concerns on 60 Minutes. The biggest threat to the economy according to Bernanke? Long-term chronic unemployment.

Yet Federal Reserve policies have failed to prevent massive layoffs. No conditions for continued employment were established with cash infusions. Hundreds of thousands were dropped from the bailout banks and business rolls -leaving the government to pick up the tab in other ways including unemployment insurance and a growing middle class crisis.

Companies like Caterpillar, General Electric, Harley-Davidson received billions in government capital and laid-off tens of thousands of workers. Bank of America fueled with government cash of nearly $100bn added 35,000 workers to the unemployment rolls. Citibank lay-offs are reported to total over 50,000.

Despite their federal funding and bad money management, these banks continue their double standard practices of foreclosing on home borrowers with abandon, freezing credit lines and demanding high costs from consumers. While claiming patriotic zeal, Bank of America, Citibank and JPMorgan Chase shipped entire departments overseas to places like Singapore and Indonesia adding to the jobless tallies.

The question is: what have these big banks and corporations done for the American people lately?

The bailout banks and businesses have added to our deficit, ballooned the jobless numbers and refused to expand credit to distressed small and medium-sized businesses in the same way the government expanded credit to them.

So much for the Federal Reserve…

PART FOUR: Now for Something Completely Different: Solutions

All this being said- Bernanke a student of the Great Depression -believes the Federal Reserve exacerbated the 1930s economic woes by the Hoover administration’s refusal to liquidate banks. By all accounts, he is right.  The multi-trillion dollar bailout saved our largest banks and the portion of our society that directly benefited from it from another Great Depression-so far. We needed to rescue the banking system. But did we need to save them at the expense of America’s middle and working classes? 

A basic adage of capitalism and perhaps ever other form of finance is “it takes money to make money.” Credit is the engine on which our economic system runs and the reasoning behind the Federal Reserve monumental lending efforts. No business (small, medium or large) can expand or operate without money. Every business needs cash to meet overhead and payroll, hire new workers, pay taxes, and provide services.

Goldman Sachs’ CEO Lloyd Blankfein said in January 2010, “Without question, direct government support was critical in stabilizing the financial system, and we benefitted from it.” Without question, direct government support is needed to stabilize the rest of the system.

State and local governments are reporting severe budget shortages and growing unemployment. Mayor Bloomberg in New York City recently announced layoffs of six thousand more workers. Tax revenues are down due to rising job losses, declining income, and defaulting businesses. A midtown banking officer explains his institution is handling a small business crisis as loan payments  are missed in record numbers.

Bernanke says he has faith in the entrepreneurial spirit of America. Yet entrepreneurs need three things to be successful: capital, credit and opportunity. The Federal Reserve’s one-sided bailout for the haves and have mores has forced the rest of America into a disastrous predicament—holding on for dear life.

If we view the financial system as Blankfein does—from the top, it has stabilized. Goldman used borrowed money to profit from high-frequency trading, buy distressed debt, continue foreclosures, invest in foreign lands,  buy, sell and trade junk, corporate and treasury bonds—opportunities not available to ordinary folks. The job of investment banks is take care of clients and stock price—not the general economy. That is the responsibility of Congress, the President, the Treasury, and the Federal Reserve. They are clearly not meeting that obligation.

Bernanke recognizes that the middle and working classes matter in the economic system—essentially they hold it up. Their jobs and businesses pay the lion’s share of local, state and federal taxes. They consume the products, credit, car loans and mortgages and supply the cash deposits that have served our prosperity for the past 50 years.

Yet knowing the crucial role the largest portion of the population plays in maintaining liquidity, the Federal Reserve has yet to use its new $600bn cash infusion to directly support those whose contribution is crucial in the economic cycle-the 70% of the financial system that supply the jobs: small and medium business and the entrepreneurial middle classes. Is 70% of the population too-big-to-fail?

Without conditions on how the trillions of taxpayer dollars were spent, the federal government (with a green light from Congress) has in effect abandoned the ordinary American population. Million dollar lobbying budgets, billions in cash bonuses, outsourcing hundreds of thousands of U.S. jobs and massive layoffs continue-all bought and paid for by the very people that these policies harm.

 The time has come for radical solutions if we want America back on its feet. Using the same philosophy applied to big banks, billionaires, and corporations, the Federal Reserve and Congress should liquidate the general population. The following actions are urgently needed:

1) Support business and entrepreneurial America with direct access to credit and capital, not just mega-banks and Fortune 1000 companies.

2) Relieve consumer debt in the same way the Fed bought bad securitized debt from gambling banks and put it in a vault “off balance sheet” for the next 5, 10, 20 years.

3) Guarantee housing debt (like Citibank and Bank of America guarantees of 100bn and 300bn respectively) and stop foreclosures by badly behaved lenders who destroyed the housing markets only to profit yet again from middle class misery. It’s time for direct government intervention in housing refinance.

Roberto Perli, managing director at International Strategy & Investment Group in Washington and a former Fed Board staff member, said the Fed, may have “crossed a line, but what would have been the alternative? … The alternative would have been a lot worse.”

If we continue to ignore the mounting burden placed on middle American society, the diminishing incomes, evaporating jobs, shrinking opportunities, scarce credit and capital- the alternative will become much worse. We could start seeing breadlines and homeless squatter villages like we did in the 1930s. We have a serious problem on our hands, created by the greed and gluttony of the lending and securitizing industry -the same folks who received trillions of dollars in rescue funds despite the “moral hazard.”

The Fed responded to an “economic tsunami” (the words of former Fed Chief Alan Greenspan) that it, along with Congress, created over the past decade. We had little choice but to bailout the perpetrators of this great social tragedy. Bernanke righted the wrongs of history and used the tools available to prop up the financial industry. Only when history is written on the Great Recession, the great wrong of this Federal Reserve, Congress and President will be that they failed to support the rest of the population.  FDR took great measures to support the common man-we have yet to see that happen now.

The task now is not to assign blame and claim “moral hazard” by refusing to relieve consumer debt and defaulting family homes. Our government must act as swiftly as it did with TARP, the “discount window” and the 13 other lending and debt purchase programs by supporting the growing crisis in the middle American economy- the one that has not benefitted from the trickle-down philosophy. It might be time to try a “trickle -up.”

Since the financial crisis began, our society has been split in two – the haves and have nots. Thehaves are employed, have access to credit and capital, earn much the same income as before and go on with business as usual.

The have nots are working at a fraction of their former incomes, are restricted in access to credit and capital, have lost their businesses, possibly lost their homes, or are standing on the unemployment line wondering how they ended up with nothing after years of responsible finance. These are not folks with reckless subprime mortgages, strategic defaults, or  those who lived beyond their means. This is the large and silent portion of our population who did everything “right” only to find out their government and banks did everything “wrong” and they are being forced to pay the price.

Bernanke says the divide in our society is  due to education: College grads versus high school grads. This is just not so. The level of college-educated unemployed and struggling entrepreneurs is huge and growing.  The increasing social divide is about opportunity for employment and access to credit and capital—there are college grads on both sides. If education were the simple solution, the Feds would not be so worried.

If we endorse government supported banking for private enterprise, this arrangement must serve the financial system at every level. In the continuing economic anemia of 2010, we have clearly failed.

America had evolved into a two system economy—survival-of-the-fittest capitalism for all but the most privileged bankers and moguls among us. If you are fortunate enough to be sitting in the catbird seat of a mega-bank or a top American company like McDonald’s or Harley-Davidson, you are exempted from those rules and afforded special privileges not available to mere plebes.

Congress and the Feds need to treat the consumer public like the banking elite and right the wrongs of the past to turn the troubled economy around. Pursuit of happiness includes opportunities for employment, livelihood, relief from debt, and a system of economy and government where everyone under it is served equally.

The Federal Reserve is planning to buy $600bn long-term Treasury bonds in a controversial program called quantitative easing–again hoping the funds will trickle down to the unemployed masses. The likelihood of this occurring is doubtful. The billions will most likely fall into the hands of yet again of the lending and securities industries and foreign investors.

Instead, the Fed can use its ample resources to fund job creators: American entrepreneurs and small and medium-sized businesses directly. They can  extend relief for consumer debt, restructure housing financing and generally support a public burdened by oppressive debt, diminishing opportunity, and bank hoarding of taxpayer cash.

It might be crossing a capitalist line in some eyes, but then what’s the alternative? Getting the economy moving again by debt relief and new employment right now is the only clear option. 

The solution of direct public support is pretty simple, if not radical. But then a multi-trillion dollar bailout of bad banking is pretty radical too.


Monika Mitchell

Executive Director

Good Business International, Inc.

Economy of Trust Blog