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The Invisible Bank Bailout

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August 23, 2010

By now, you are probably more than familiar with the “backdoor bailouts” of the Wall Street Banks – the most infamous of which, Maiden Lane III, included a $13 billion gift to Goldman Sachs as a counterparty to AIG’s bad paper.  Despite Goldman’s claims of having repaid the money it received from TARP, the $13 billion obtained via Maiden Lane III was never repaid.  Goldman needed it for bonuses.

On August 21, my favorite reporter for The New York Times, Gretchen Morgenson, discussed another “bank bailout”:  a “secret tax” that diverts money to banks at a cost of approximately $350 billion per year to investors and savers.  Here’s how it works:

Sharply cutting interest rates vastly increases banks’ profits by widening the spread between what they pay to depositors and what they receive from borrowers.  As such, the Fed’s zero-interest-rate policy is yet another government bailout for the very industry that drove the economy to the brink.

Todd E. Petzel, chief investment officer at Offit Capital Advisors, a private wealth management concern, characterizes the Fed’s interest rate policy as an invisible tax that costs savers and investors roughly $350 billion a year.  This tax is stifling consumption, Mr. Petzel argues, and is pushing investors to reach for yields in riskier securities that they wouldn’t otherwise go near.

*   *   *

“If we thought this zero-interest-rate policy was lowering people’s credit card bills it would be one thing but it doesn’t,” he said.  Neither does it seem to be resulting in increased lending by the banks.  “It’s a policy matter that people are not focusing on,” Mr. Petzel added.

One reason it’s not a priority is that savers and people living on fixed incomes have no voice in Washington.  The banks, meanwhile, waltz around town with megaphones.

Savers aren’t the only losers in this situation; underfunded pensions and crippled endowments are as well.

Many commentators have pointed out that zero-interest-rate-policy (often referred to as “ZIRP”) was responsible for the stock market rally that began in the Spring of 2009.  Bert Dohmen made this observation for Forbes back on October 30, 2009:

There is very little, if any, investment buying.  In my view, we are seeing a mini-bubble in the stock market, fueled by ZIRP, the “zero interest rate policy” of the Fed.

At this point, retail investors (the “mom and pop” customers of discount brokerage firms) are no longer impressed.  After the “flash crash” of May 6 and the revelations about stock market manipulation by high-frequency trading (HFT), retail investors are now avoiding mutual funds.  Graham Bowley’s recent report for The New York Times has been quoted and re-published by a number of news outlets.   Here is the ugly truth:

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group.  Now many are choosing investments they deem safer, like bonds.

The pretext of providing “liquidity” to the stock markets is no longer viable.  The only remaining reasons for continuing ZIRP are to mitigate escalating deficits and stopping the spiral of deflation.  Whether or not that strategy works, one thing is for certain:  ZIRP is enriching the banks —  at the public’s expense.



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