During the panic of 1907, J. P. Morgan stepped in and created a consortium of investors, and by so doing ended the panic and saved the banking system. Yet instead of showing gratitude to a great financier who put his own capital at risk in a time of panic, the chattering classes of the day reacted with bitterness. “Isn’t this too much power for one man to have?” they asked. “Shouldn’t the people themselves have an institution that can step in to be the lender of last resort?” “Wouldn’t a public entity more fully serve the public interest?”There are pros and cons to having a central bank. We have one, so let them do their job.
And so the Fed was born. Yes, conspiracy mongers, some Wall Street players participated in its creation, but that was more in the cause of minimizing the damage. The Fed was much more the brainchild of academic scribblers and progressive dreamers than of the debits-and-credits crowd. The bankers had to be sold on the idea. Yes, they would have to submit to more regulation. But as compensation they would get a true lender of last resort in a time of need.
That’s why I don’t get socialist Sen. Bernie Sanders. (That’s no right-wing epithet; he really is a socialist.) And that’s why I don’t get complaints about a “bailout for big banks” coming from the left. The liberals wanted a Fed and they got one. And as the chart above illustrates, it’s doing exactly what they created it to do: step in temporarily in times of turmoil.
Reasonable men can differ as to the utility of a central bank. Hamilton was for it; Jefferson against it. I tend to agree with Hamilton, but who am I to judge between such giants? The Jeffersonians among us, such as Ron Paul, have a point to make. A central bank is a very powerful institution, and power is dangerous. The Hamiltonians among us have a point, too. Panics also are dangerous, and we need institutions to minimize them.
See also video of Don Luskin on liquidity, bank runs and "the moral hazard state" and another video of the recent reduction of systemic risk from fed action. I think that market conditions have improved, but until credit spreads actually show further improvement, it is wise to be a little cautious.
3 comments:
The Fed was created to regulate banks tied to the Fed via specific policies which were the result of a trade-off between risk and return for the banks.
Bear Stearns was outside the Fed regulated banking system (an investment bank) so that it could reap higher returns by riskier policies. The 'right' thing to do would be let it fail--the ultimate reward for foolishly risky behavior.
The domino effect (failure causing failure) would have hurt any bank--regulated or not--that had not done due diligence on its contracts.
There really should be a consequence for buying a pig-in-a-poke.
We all would have suffered somewhat, but that is the price we pay for our own lack of diligence.
We only learn to not play with fire by being burnt.
Well said Tom. Unfortunately this is an election year, so unless we're really lucky, there will be some meddling.
Tom:
I'm all for allowing reckless types to fail - it's a vital part of creative destruction and progress. I think that the Fed was worried about systemic risk from a cascade. It will be interesting to see what the future holds: a bigger credit meltdown, a big inflation or something benign. One can only observe, not predict. Being an insightful observer is often enough to put one ahead of the game.
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