Two weeks ago, Bloomberg released a significant story on the actions of the Federal Reserve as the lender of last resort during the crisis and the extent of that lending. The article, an homage to the late great reporter Mark Pittman, revealed lending and guarantees of roughly $8 trillion, and estimated government-granted profit garnered by the big banks of $13 billion.
More disturbing were inconsistent statements by Bernanke publicly claiming he was lending only to sound institutions when the Fed’s internal assessments of those same banks showed otherwise. This article prompted a remarkable back-and-forth between Bloomberg and the Fed, in which neither side backed down while coming close to calling the other a liar. Bloomberg essentially argued that the Fed gave ill-gotten profits to money center banks through facilities set up to flood the system with liquidity. The Fed responded that it charged “penalty” rates to these banks, that it was fulfilling a well recognized function of central banks by serving as the lender of last resort.
I side with Bloomberg, and I’ll explain why.
American money is a political commodity, backed by nothing except the willingness of collective holders of that money to believe in the American system of wealth production and trade. Steve Waldman noted to me over email that the idea that there is a “penalty rate” in a liquidity crisis is absurd, since one can see a liquidity crisis as a period in which lending ceases. Other correspondents patiently explained to me that the Fed did a good job in its lender of last resort function, that it heroically unfroze credit. Indeed, 71% of investors prefer Bernanke’s Fed to the European Central Bank.