Tag Archives: Liquidity

Italian article this am

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Misrepresents what I say a bit, but they do have my picture next to JFK!
;)

The IMF: sovereign currency, no longer the monopoly of the banks

Eliminate the public debt of the United States at once, and do the same with Great Britain, Italy, Germany, Japan, Greece. At the same time revive the ‘ economy, stabilize prices and oust the bankers. In a clean and painless, and faster than what you can imagine. With a magic wand? No. With a simple law, but able to replace the current system, in which to create money out of nothing are private banks. We only need a measure requiring the banks to hold a financial reserve real, 100%. To propose two economists at the International Monetary Fund, Jaromir Bene and Michael Kumhof. You, the bank, you want to make money on the loan of money? First you have to prove it really that much money. Too easy to have it by the central bank (which the factory from scratch) and then “extort” families, businesses and entire states, imposing exorbitant interest.

The study of two economists, “The Chicago Plan Revisited,” with “a revolutionary and” scandalous “‘Maria Grazia Bruzzone,” La Stampa “, emphasizes the global resonance of the dossier, that bursts like a bomb on the world capitalist system now jammed. The global debt came the exorbitant sum of 200 trillion, that is 200 trillion dollars, while the world GDP is less than 70 trillion. Translated: the world debt is 300% of gross domestic product of the entire planet. “And to hold this huge mountain of debt – which continues to grow – there are more advanced economies and developing countries,” says the Bruzzone, stressing that “the heart of the problem and the cross” is the highest “power” Japan, Europe and the United States. Hence the sortie “heretical” by Bene and Kumhof: simply write off the debt, it disappears.Sparked the debate was the last IMF report, which points the finger on austerity policies aimed at reducing thepublic debt . Policies that “could lead to recession in the economies ‘, since’ cuts and tax increases depress the ‘economy ‘.

Not only. The IMF would be really worried the crisis that is ravaging the ‘ Europe threatens to be worse than the 2008 financial. The surprise is that even the IMF now thinks that “austerity can be used to justify the privatization of public services,” with consequences “potentially disastrous”. But if the problem is the debt – public, but now “privatized” by finance – you can not delete? Solution already ventilated by the Bank of England, which holds 25% of the British sovereign debt: the Bank of England may reset it by clicking on the computer. Advantages: “You will pay much less interest, it would free up cash and you could make less harsh austerity.” The debate rages on many media, starting from the same “Financial Times”. thread which breaks now the revolutionary proposal of the two IMF economists targati: cancel the debt.

“The Chicago Plan Revisited,” writes Maria Grazia Bruzzone, raises and explores the “Chicago Plan” original, drawn up in the middle of the Great Depression of the ’30s by two other economists, Irving Fisher, Henry Simons of the University of Chicago, the cradle of liberalism . Cancel 100% of the debt? “The trick is to replace our system, where money is created by private banks – for 95-97% of the supply of money – money created by the state. It would mean return to the historical norm, before the English King Charles II put in private hands control of the money available, “back in 1666. It would mean a frontal assault on the “fractional reserve” banking, accused of seigniorage on the issue of currency speculation: if lenders are instead forced to hold 100% of its reserves to guarantee deposits and loans, “pardon the exorbitant privilege of create money out of nothing. ” As a result: “The nation regained control over the availability of money,” and also “reduces the pernicious cycles of expansion and contraction of credit.”

The authors of the first “Plan of Chicago” had thought that the cycles of expansion and contraction of credit lead to an unhealthy concentration of wealth: “They had seen in the early thirties creditors seize farmers effectively bankrupt, grab their lands or comprarsele for a piece of bread. ” Today, the authors of the new edition of this plan argue that the “trauma” of the credit cycle that expands and contracts – caused by private money creation – is a historical fact that is already outlined with Jubilees Debt ancient Mesopotamia, as well as in ancient Greece and even Rome. Sovereign control (the state or the Pope) on currency, recalls Bruzzone, Britain remained so throughout the Middle Ages, until 1666, when it began the era of the cycles of expansion and contraction. With the “bank privatization” of money, add the “Telegraph”, “opened the way for the agricultural revolution, and after the industrial revolution and the biggest leap Economic ever seen “- but it is not the case of” quibbling, “quips the newspaper.

According to the young economists of the IMF, is just a myth – disclosed “innocently” by Adam Smith – that the money has been developed as a medium of exchange based on gold, or related to it. Just as it is a myth, the study points out the IMF, what you learn from books: that is the Fed, the U.S. central bank, to control the creation of the dollar. “In fact, money is created by private banks to 95-97% through loans.” Private banks, in fact, do not lend as owners of cash deposits, the process is exactly the opposite. “Every time a bank makes a loan, the computer writes the loan (plus interest) and the corresponding liability in its balance sheet. But the money that pays the bank has a small part. If it does borrow from another bank, or by the central bank. And the central bank, in turn, creates out of nothing that lends the money to the bank. ”

In the current system, in fact, the bank is not required to have its own reserves – except for a tiny fraction of what it provides. Under a system of “fractional reserve”, each money created out of nothing is a debt equivalent: “Which produces an exponential increase in the debt, to the point that the system collapses on itself.” The economists of the IMF hours overturn the situation. The key is the clear distinction between the amount of money and the amount of credit between money creation and lending. If you impose banks to lend only numbers covered by actual reserves, loans would be fully funded from reserves or profits accrued. At that point, the banks can no longer create new money out of thin air. Generate profits through loans – without actually having a cash reserve – is “an extraordinary and exclusive privilege, denied to other business.”

“The banks – says Maria Grazia Bruzzone – would become what he mistakenly believed to be, pure intermediaries who have to get out their funds to be able to make loans.” In this way, the U.S. Federal Reserve “is approprierebbe for the first time the control over the availability of money, making it easier to manage inflation.” In fact, it is observed that the central bank would be nationalized, becoming a branch of the Treasury, and now the Fed is still owned by private banks. “Nationalizing” the Fed, the huge national debt would turn into a surplus, and the private banks’ should borrow reserves to offset possible liabilities. ” Already wanted to do John Fitzgerald Kennedy, who began to print – at no cost – “dollars of the Treasury,” against those “private” by the Fed, but the challenge of JFK died tragically, as we know, under the blows of the killer of Dallas , quickly stored from “amnesia” of powerful debunking.

Sovereign coin, issued directly by the government, the state would no longer be “liable”, but it would become a “creditor”, able to buy private debt, which would also be easily deleted. After decades, back on the field the ghost of Kennedy. In short: even the economists of the IMF hours espouse the theory of Warren Mosler, who are fighting for their monetary sovereignty as a trump card to go out – once and for all – from financial slavery subjecting entire populations, crushed by the crisis , the hegemonic power of a very small elite of “rentiers”, while the ‘ economic reality – with services cut and the credit granted in dribs and drabs – simply go to hell. And ‘the cardinal assumption of Modern Money Theory supported in Italy by Paul Barnard: if to emit “money created out of nothing” is the state, instead of banks, collapsing the blackmail of austerity that impoverishes all, immeasurably enriching only parasites of finance . With currency sovereign government can create jobs at low cost. That is, welfare, income and hope for millions of people, with a guaranteed recovery of consumption. Pure oxygen ‘s economy . Not surprisingly, adds Bruzzone, if already the original “Chicago Plan”, as approved by committees of the U.S. Congress, never became law, despite the fact that they were caldeggiarlo well 235 academic economists, including Milton Friedman and English liberal James Tobin, the father of the “Tobin tax”. In practice, “the plan died because of the strong resistance of the banking sector.” These are the same banks, the journalist adds the “Print”, which today recalcitrano ahead to reserve requirements a bit ‘higher (but still of the order of 4-6%) required by the Basel III rules, however, insufficient to do deterrent in the event of a newcrisis . Banks: “The same who spend billions on lobbying and campaign contributions to presidential candidates. And in front of the new “Chicago Plan” threaten havoc and that “it would mean changing the nature of western capitalism. ‘” That may be true, admits Bruzzone: “Maybe but it would be a better capitalism. And less risky. ”

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Re: liquidity or insolvency–does it matter?

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(email with Randall Wray)

On Dec 15, 2007 9:05 PM, Wray, Randall wrote:
> By ________
>
> This time the magic isn’t working.
>
> Why not? Because the problem with the markets isn’t just a lack of liquidity – there’s also a fundamental problem of solvency.
>
> Let me explain the difference with a hypothetical example.
>
> Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
>
> Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices – and it may indeed go bust even though it didn’t really make that bum loan.
>
> And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.

If there wasn’t credible deposit insurance.

>
> But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity – the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Yes.

> Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.

Fed closes the bank, declares it insolvent, ‘sells’ the assets, and transfers the liabilities to another bank, sometimes along with a check if shareholder’s equity wasn’t enough to cover the losses, and life goes on. Just like the S and L crisis.

>
> My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.
>
> But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

More was lost then than now, at least so far. 100 billion was lost immediately due to the Russian default and more subsequently. So far announced losses have been less than that, and ‘inflation adjusted’ losses would have to be at least 200 billion to begin to match the first day of the 1998 crisis (August 17).

>
> In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system – both banks and, probably even more important, nonbank financial institutions – made a lot of loans that are likely to go very, very bad.

Same in 1998. It ended only when it was announced Deutsche Bank was buying Banker’s Trust and seemed the next day it all started ‘flowing’ again.

>
> It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.
>
> First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Incomes are sufficient to support the current prices. That’s why they haven’t gone down that much yet and are still up year over year. Earnings from export industries are helping a lot so far.

>
> Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

Yes, there was a large drop in aggregate demand when borrowers could no longer buy homes, and that was over a year ago. That was a real effect, and if exports had not stepped in to carry the ball, GDP would not have been sustained at current levels.

>
> As home prices come back down to earth, many of these borrowers will find themselves with negative equity – owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

‘Often’? There will be some losses, but so far they have not been sufficient to somehow reduce aggregate demand more than exports are adding to demand. Yes, that may change, but it hasn’t yet. Q4 GDP forecasts were just revised up 2% for example.

>
> And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

Not likely if income holds up. That’s why the fed said it was watching labor markets closely.

And government tax receipts seem OK through November, which is a pretty good coincident indicator incomes are holding up.

>
> That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

Enough money funds in particular have decided to not get involved in anyting but treasury securities, driving those rates down. That will sort itself out as investors in those funds put their money directly in banks ans other investments paing more than the funds are now earning, but that will take a while.

>
> How will it all end?

This goes on forever – I’ve been watching it for 35 years – no end in sight!

> Markets won’t start functioning normally until investors are
> reasonably sure that they know where the bodies – I mean, the bad
> debts – are buried. And that probably won’t happen until house prices
> have finished falling and financial institutions have come clean about
> all their losses.

And by then it’s too late to invest and all assets prices returned to ‘normal’ – that’s how markets seem to work.

> All of this will probably take years.
>
> Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

Right, only a fiscal response can restore aggregate demand, and no one is in favor of that at the moment. A baby step will be repealing the AMT and not ‘paying for it’ which may happen.

Meanwhile, given the inflationary bias due to food, crude, and import and export prices in genera, a fiscal boost will be higly controversial as well.

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Fed regs with comments

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Note they’ve also added the international arrangements as per my discussion earlier today.

The same recommendations suggested in August.

7 Lending by the Federal Reserve

The Federal Reserve’s authority to extend loans is a potentially powerful tool with

which it can stimulate aggregate demand. Loans to depository institutions can help spur credit extensions to households and firms. If depository institutions are unwilling or unable to lend to firms and households, direct loans by the Federal Reserve to firms and households could provide the financing needed for economic recovery- although such lending is subject to the restrictions discussed below.

The above has the causation backwards. In the banking system, loans ‘create’ deposits, which many incur reserve requirements.

In the first instance, new reserve requirements are functionally an ‘overdraft’ in the bank’s reserve account at the fed. Since an overdraft *is* a loan, as a matter of accounting loans create both deposits and any resulting new required reserves. What the fed does is set the price of the reserves (the rate of interest), which influences bank lending decisions, but doesn’t directly control bank lending.

Therefore, all fed lending to member banks is generally to replace ‘overdrafts’ in reserve accounts. At the end of each statement period, overdrafts are booked as loans from the fed’s discount window, which are 50 bp over the fed fund rate and also carry a ‘stigma’ of implying the bank is having financial difficulties. That’s why banks are willing to bid up funds above the discount rate when trading each other,

7.1 Lending to Depository Institutions

As shown in table 7.1, lending to depositories is authorized under several sections of the Federal Reserve Act: Advances are authorized under sections 10B, 13(8) and 13(13), while discounts are authorized under sections 13(2), 13(3), 13(4), 13(6) and13A.78 In recent decades, the Federal Reserve has extended credit to depositories only through advances (under sections 10B and 13(8)) and has not made any discounts. The broadest and most flexible authority under which the Federal Reserve can extend loans to depositories is Section 10B, under which the restriction on collateral is only that the Reserve Bank making the advance deems the collateral to be “satisfactory”.

Yes, and this makes perfect sense. All bank collateral is limited to what the federal regulators deem ‘legal’ along with regulated concentration and gap limits. Also, banks can issue federally guaranteed liabilities; so, functionally the government is already funding what they deem legal assets. So, for the fed to provide another channel for this process, to assist ‘market functioning’, changes nothing of substance regarding risk for the government.

The collateral can be promissory notes, such as corporate bonds and commercial paper- instruments that cannot be purchased by the Federal Reserve.

But, as above, instruments that are categorized as bank legal by federal regulation, and can already be funded via government insured deposits.

Currently, Reserve Banks accept as collateral various types of promissory notes of acceptable quality including state and local government securities, mortgages covering one- to four-family residences, credit-card receivables, other customer notes, commercial mortgages, and business loans. Apparently, even equity shares would be legally acceptable as collateral if a Reserve Bank found them to be acceptable as collateral.

78The differences between discounts and advances are discussed briefly below and in more detail

in Section 2.1 of Small and Clouse (2000).

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Table 7.1

Credit Instruments Used in Discounts or Advances

Borrower Credit Instrument

Depositories

10B Advances* Depository’s time and demand notes secured \to the

satisfaction of [the] Reserve Bank.” * *

13(8) Advances Depository’s promissory note secured by U.S Treasury,

U.S.-guaranteed, U.S. agency, or U.S. agency-guaranteed

securities, or by credit instruments eligible for discount or purchase.

13(2) Discounts * * * Notes, drafts and bills of exchange meeting \real bills” criteria.

13(4) Discounts * * * Bills of exchange payable on sight or demand which grow out of the shipment of agricultural goods.

13(6) Discounts * * * Acceptances which grow out of the shipment of goods

(section 13(7)) or for the purpose of furnishing dollar exchange as required by the usages of trade (section 13(12)).

13A Discounts * * * Notes, drafts, and bills of exchange secured by agricultural paper.

IPCs * * * *

13(13) Advances IPC’s promissory notes secured by U.S. Treasury, U.S. Agency or U.S. agency-guaranteed obligations.

13(3) Discounts Notes, drafts, and bills of exchange endorsed or otherwise secured to the satisfaction of the Reserve Bank, in unusual and exigent circumstances”, and provided the IPC cannot secure adequate credit elsewhere or is in a class for which this determination has been made.

Notes: All advances and the financial instruments used as collateral in all discounts except section 13(discounts are subject to maturity limitations. Section 13(14) authorizes discounts and advances to branches and agencies of foreign branches, subject to limitations.

*Section 10A provides for advances to groups of member banks.

* * Advances to undercapitalized and critically undercapitalized institutions are subject to limitations listed in section 10B.

* * * Must be endorsed by a depository institution.

* * * * Depository institutions are corporations and thus qualify for lending authorized for IPCs.

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Even though the Federal Reserve can extend credit to depositories through advances secured by a wide array of instruments, there may be limitations regarding the extent to which the Federal Reserve can take onto its balance sheet the credit risk of a private-sector security pledged as collateral{whether the security is pledged as part of an advance or a discount. With an advance, the loan is extended on the basis of a promissory note issued by the depository. During the course of the advance, should the ability of the depository to repay the advance come under question (for example, because the collateral is in default) the Federal Reserve would look to the depository first for repayment: The credit risk of the collateral therefore remains with the depository.79 In a discount, the depository does not issue its own note to the Federal Reserve, but the depository must endorse the security that is discounted (as indicated by the triple asterisks in table 7.1). Again, the credit risk of the underlying collateral stays with the depository institution, and the only risk the Federal Reserve takes onto its balance sheet is the risk that the depository will default.80

79In a similar vein, the Bank of Japan recently has undertaken repurchase agreements in commercial paper but has acted to protect its balance sheet from the credit risk of the issuer of the commercial paper:

The Bank recommends commercial paper (CP) operations (purchase of CP with resale agreements) in order to ensure smooth market operations.

CP will be purchased from financial institutions, securities companies, and tanshi companies (money market dealers) which hold accounts with the Bank. The CP is to be endorsed by the seller, and to have a maturity of 3 months or less from the day of the Bank’s purchase. Purchase is to be made under competitive bidding, and the period of the purchase is to be 3 months or less. (See Quarterly Bulletin (1996), page 100.)

In September of 1998, the Bank of Japan held, through repurchase agreements, about 35 percent of the outstanding stock of commercial paper in Japan. See Table VII in Economic Statistics Monthly

(See various dates).

80Discounts under sections 13(2), 13(4) or 13A for a bank require a \waiver of demand, notice and protest by such bank as to its own endorsement exclusively”, which is discussed by Hackley (1973)

(pp. 22). The effect of this waiver is to make the endorsing bank primarily liable because the Reserve Bank would not have to demand payment by the issuer of the discounted paper before proceeding against the bank. To further limit its credit-risk exposure, the Federal Reserve presumably would also take a \haircut” on the discount by extending funds that are significantly less than the value of the discounted instrument. Additionally, the Federal Deposit Insurance Corporation Improvement

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To the extent the credit risk of the collateral remains with the depository, lending to depositories may do very little to lower the credit-risk premiums charged by depositories in making new loans to private-sector borrowers. Credit risk premiums could be a major factor holding down credit expansion and economic recovery should nominal rates on Treasury bills be at or near zero and should the economy be weak.

In private-sector markets, credit risk can be managed through the use of credit- risk options. And, in some circumstances, the Federal Reserve’s incidental powers clause is consistent with the Federal Reserve using options.81 However, the view that the Federal Reserve could not accept the credit risk of the collateral used in discount window loans may leave little scope for the Federal Reserve to write credit-risk options in order to take that credit risk of the balance sheets of depositories and onto its balance sheet.

But even if Federal Reserve loans to depositories leave credit-risk premiums unchanged, such loans may provide some liquidity for the financial instruments used as collateral helping to lowering private-sector interest rates by reducing implicit liquidity premiums.

7.2 Lending to Individuals, Partnerships, and Corporations

Although the Federal Reserve currently does not make loans to individuals, partnerships, and corporations (IPCs), the Federal Reserve has the authorization to bypass depositories and make such loans under sections 13(3) and 13(13) of the Federal Reserve Act- as shown in table 7.1. However, lending under these authorities is subject to very stringent criteria in law and regulation, and such lending has not taken place since the Great Depression. For example, advances, under section 13(13), are limited

Act of 1991 (FDICIA), through its \prompt corrective action” provisions has imposed restrictions on depository institutions in weak capital condition. Among those restrictions are limitations on access to the Federal Reserve’s discount window.

81See footnote 46 for a discussion of the Federal Reserve’s recent use of options, and see Section 4 of Small and Clouse (2000) for a discussion of the Federal Reserve’s authority to engage in options.

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to those “secured by direct obligations of the United States or by any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, an agency of the United States.”

Because IPCs with such collateral could easily sell it in the open market, section 13(13) advances may not have much effect(unless done at subsidized rates) in stimulating aggregate demand.

In contrast, private-sector instruments may lack the liquidity of Treasury debt and, therefore, Federal Reserve loans that use them as collateral may provide liquidity and help stimulate the economy. Also, in a \credit crunch”, such direct loans would circumvent depository institutions and the \non-price” terms of credit imposed by them. Hence, we shall focus on section 13(3) discounts of:

“notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are endorsed or otherwise secured to the satisfaction of the Federal Reserve bank: … ”

Because notes, drafts, and bills of exchange include most forms of written credit instruments, section 13(3) provides virtually no restrictions on the form a credit instrument must take in order to be eligible for discount.82 And by merely requiring that the discount be \secured to the satisfaction of the Federal Reserve bank …”, there is no restriction on the use of funds (such as for \real bills” purposes) for which the discounted security was originally issued.

However, in making section 13(3) loans directly to IPCs, the Federal Reserve must impose standards that are much more stringent in comparison to those used in lending to a depository. Such lending to IPCs is authorized only in “unusual and exigent circumstances.” In particular, the statute requires that a loan can be extended only to IPCs for which credit is not available from other banking institutions.83 Activation

82The distinctions between notes, drafts, and bills of exchange are discussed in detail in Small and Clouse (2000).

83The Federal Reserve’s Regulation A (Section 201.3(d): Emergency credit for others) species that advances to IPCs would be contemplated only in situations in which failure to advance credit would adversely affect the economy.

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of this authority requires the affirmative vote of five of the seven governors of the Federal Reserve Board.

Section 13(3) further requires that the collateral be “endorsed or otherwise secured to the satisfaction of the Federal Reserve bank …” As interpreted by Hackley (1973):

… it seems clear that it was the intent of Congress that loans should be made only to credit-worthy borrowers; in other words, the Reserve Bank should be satisfied that a loan made under this authority would be repaid in due course, either by the borrower or by resort to security or the endorsement of a third party.84

If binding, this restriction could seriously curtail the effectiveness of such loans in stimulating aggregate demand in an environment of elevated credit risk and risk aversion.

But even if the Federal Reserve were able to accept private-sector credit risk onto its balance sheet, any social benefits to the Federal Reserve lending directly to the private sector would need to be balanced against the potentially serious drawbacks associated with placing the Federal Reserve squarely in the process allocating credit within the private sector. The information available to the Federal Reserve about nonbank credit would in many cases be inadequate to reliably assess credit risks{ and there is little reason to believe the Federal Reserve could assess credit risks more accurately than do private intermediaries. Problems with adverse-selection could lead to the Federal Reserve lending to precisely those credit risks that it most severely underestimates. After the credit is extended, the Federal Reserve may not be well situated to monitor the ongoing activities of the recipients of the funds to ensure the activities are consistent with the terms of the contract. Some of these problems might be addressed through the Federal Reserve using credit-ratings from private sector firms.

Moreover, such programs could develop important political constituencies that might make the programs difficult to dismantle once the immediate aim of policy|

84Hackley (1973), page 129.

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namely providing a short-run economic stimulus- had been achieved.

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More detail on the liquidity facility

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looks a lot like the recommendations Karim emailed to them:

An article in the Financial Times:

Fed officials have dusted down this proposal and adapted it to address the current credit market crisis.

Vincent Reinhart, a fellow at the American Enterprise Institute and former chief monetary economist at the Fed, says this kind of auction facility would allow the Fed to provide funds directly to a much larger group of banks than the limited number of primary dealers who participate in open market operations, against a wide range of collateral, without the stigma of the discount window.

“I think it would be very positive,” he says. Banks in need of liquidity could acquire funds relatively anonymously, while the large number of participants with direct access to Fed money would encourage arbitrage to exploit the gap between cheap Fed money and high interbank rates.

Moreover, the Fed could auction funds at whatever term it wanted to in order to target liquidity at particular term markets – for instance, the market for one-month loans. It would have the option of either auctioning a fixed amount of funds, or offering to supply whatever funds were needed at a target rate.

The intended interest rate spread over the Fed funds rate is not known. If the Fed decided to auction loans at or only slightly above the Federal funds rate, it would risk subsidising weaker banks, which normally pay a premium to borrow in the interbank market.

However, Mr Reinhart says this could be dealt with by varying the amount of collateral required in return for loans based on the creditworthiness of the bank seeking funds.

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