This week we saw why in times of economic uncertainty the American people in their infinite wisdom always – as they must – turn to the Party of Franklin Delano Roosevelt and Harry Truman for their protection.
Growing up on the North Shore of Long Island my late mother – heir to what on paper was the upper middle class – was a staunch and proud member of Roosevelt Coalition. Why? Because he saved the Capitalist system!!! He was the true Tory Reformer that Dan Walters dreams about. My father was always in his bones a New Deal-Fair Deal Democrat.
We had required reading in our household – which is why I got an 800 my American History Achievement test. One of the books that was required reading was by James MacGregor Burns entitled Roosevelt: The Lion and the Fox which was biography of FDR. From reading that book, it is no wonder that FDR was so successful. Because he came from the upper crust of society and understood its failings and he was not cowered by it he knew instinctively what worked to get it to do the right thing it. It is also true as an only child that he is a prime example of the observation that never fear for an only (or Jewish) child, his or her mother will not allow him to fail.
I should add that the Delano family (FDR’s Mommy side) fortune was made in the Chinese opium trade supplying opium-based medication to the US War Department during the American Civil War. A number of persons have stated that polio made FDR into FDR. I would say in response that he always had it in him but polio brought it out. Reflecting on Roosevelt’s presidency, “which brought the United States through the Great Depression and World War II to a prosperous future”, FDR’s biographer Jean Edward Smith in 2007 said, “He lifted himself from a wheelchair to lift the nation from its knees.”
I would argue that in his views of regulation he was reflecting his experience as part of the investor class because that was how the Roosevelt family money was maintained. FDR recognized that government had a responsibility to protect investors, police the markets, and maintain confidence. He also understood the role of government as backstop.
My late mother listened to the Fireside chats on the radio while a kid, she stated that you had a sense that after listening to him explain issues in a way that even a 10 year old could understand and why he was doing what he was doing, that after he spoke everyone seemed to feel better and more determined to vote a straight Democratic ticket. Justice Holmes stated that FDR had a second class intellect but a first class temperament. I would argue that FDR had a very high intellect in the sense that he instinctively knew what the problem was and could get people to work on a solution to the problem. In other words, he gave a sense that everything would be OK.
Whatever protections exist today in this market meltdown to reinforce stability are directly attributable to FDR: the FDIC (created as part of the Glass-Steagall Act of 1933), the SEC – whose head John McCain now wants fired, enhanced powers of the Federal Reserve created by the Banking Act of 1935, and other monuments to FDR.
I should add that FDR was leery about creating the FDIC but he was ultimately persuaded to go up on the bill at the behest of two staunch Southern New Deal members of Congress. Senator Carter Glass of Virginia who helped create the Federal Reserve in 1913 and Congressman Harry Steagall of Alabama who was Chair of House Banking and Currency Committee.
There was this notion, incidentally, that the New Deal was a one man show. Nothing could be farther from the truth. Depending on the issue, FDR had numerous and diverse legislative allies. Steagall and Glass were just part of the group. It also included US Senators Jimmy Byrnes, John Bankhead and Bob Wagner [who FDR served with in the NY State Senate and helped make the leader of that body] along with Representatives Sam Rayburn [FDR’s main go to guy on regulatory issues in the House], Carl Vinson, Fred Vinson, Robert “Muley Bob” Doughtion, and John McCormack were among FDR’s key legislative allies on Capitol Hill. In fact, LBJ was in FDR’s later years a strong foot soldier for FDR legislative initiatives – that is where he learened a lot of the methods of the “Johnson Treatment”.
If one need any example that it is any way back to “Happy Days are Here again” the number one example is the housing area. A number of persons are now realizing that the federal government should in effect buy up all owner occupied the troubled mortgages out there from the lenders and turn them into fixed rate mortgages – which is what a number of states are doing through their housing finance agencies but really are not large enough to do on their own.
The reason for this is that these ad hoc responses to each crisis are both costly and overly inflationary. Over the last several months over $700 BILLION has been injected into the financial system. While Senator Chuck Schumer has urged forming an agency to inject funds into financial companies in exchange for equity stakes and pledges to rewrite mortgages and make them more affordable I do not think that makes sense.
I think House Financial Services Committee Chairman Barney Frank’s proposal that Congress create a federal entity to buy bad loans and turn them into fixed rate mortgages makes the most sense. Hillary Clinton [and if she were the nominee we would be engaging in a discussion of who in her husband’s administration helped create the problem so it would be McSame as Teddy Roosevelt vs. Bill Clinton’s ghost] proposed resurrecting Home Owners’ Loan Corporation [HOLC] – a New Deal Agency which saved the Middle Class from foreclosures.
The HOLC was created as part of the Home Owner’s Refinancing Act of 1933. Its purpose was to refinance homes to prevent foreclosure. It was used to extend loans from shorter loans to fully amortized, longer term loans. Through its work it granted long term mortgages to over a million people facing the loss of their homes.
The HOLC stopped lending around 1935 once all the available capital had been spent. HOLC also assisted mortgage lenders by refinancing problematic loans and increasing the institutions liquidity. Hillary is correct in noting that there will not be any semblance of a normal or orderly market without “quarantining” the devalued loans outstanding.
One thing that does concern me is the status of the FDIC. Because of all the concerns over the soundness of a number of banks, persons have deposits way over the FDIC limits may well gradually remove those deposits and move them into smaller institutions. I think that there will have to be an effort to stabilize and increase the Deposit Insurance Fund.
The FDIC maintains the DIF by assessing depository institutions an insurance premium. The amount each institution is assessed is based both on the balance of insured deposits as well as on the degree of risk the institution poses to the insurance fund.
At the end of 2007, the DIF had a balance of $52 billion. Bank failures typically represent a cost to the DIF because FDIC, as receiver of the failed institution, must liquidate assets that have declined substantially in value while at the same time making good on the institution’s deposit obligations.
In July 2008, IndyMac Bank failed and was placed into receivership. The failure was initially projected by the FDIC to cost the DIF between $4 billion and $8 billion but shortly thereafter the FDIC revised its estimate upward to $8.9 billion. Due to the failures of IndyMac and other banks, the DIF fell in the second quarter of 2008 to $45.2 billion.
The decline in the insurance fund’s balance caused the reserve ratio (fund’s balance divided by the insured deposits) to fall to 1.01% as at June 30, 2008, down from 1.19 percent in the prior quarter. Once the ratio falls below 1.15 percent, FDIC is required to develop a restoration plan to replenish the fund, which is expected to involve requiring higher contributions from banks which deal in riskier activities. That has the effect of dampening down activities which is why we need to pick up the pace with public sector job creation. By the way, FDR was a big supporter of public works.
The one way that banks make money is to invest in activities. Given the fact that there is at this moment little confidence in other banks the only “safe place” is in government bonds. I heard yields on Treasuries are almost infinitesimal and there will be an appetite for safe local bonds which is why we need to do public works NOW – to help banks have places to invest money in.
I did want to make an observation about inflation. To their credit – because of all of this liquidity out there – the Fed and the Treasury – have tried to pump money into the system without trying to create more inflationary pressures with interest rates first going way down and then spiking up to shut down mishagoss. All of this is resulting in revitalization of tools that FDR’s financial go to guys would adopt or recognize as their own.
As noted in a Market Watch story, the Fed has pumped [with a lot of Treasury input] money into the banking system while trying to minimize inflationary risks by bypassing the traditional banking system.
Yesterday, in fact, the Treasury auctioned $40 billion in 35-day cash management bills [a new device] with the proceeds going directly to the Fed to lend to troubled financial institutions, particularly American International Group – thus avoiding increasing bank reserves. The Treasury is paying just 0.30% interest for the first $40 billion, but AIG will pay much more than that if it taps the Fed for a loan. At Wednesday’s rates, AIG would pay 11.53% interest back to the government which is a huge profit for taxpayers
Last July, the Fed had about $800 billion in government Treasuries in its vaults. Now, it’s around $480 billion, and about half of that already spoken for. It looks as if the Fed is running low on liquidity and I heard that the unencumbered treasuries are less than $100 billion which is nothing.
By auctioning securities to fund the AIG rescue package, the Treasury and the Fed are taking money from the private sector, laundering it into relatively riskless government securities and then handing it over to AIG to bulk up its balance sheet. You do not want to add to excess reserves to the banking system – you want to keep reserves inside the Government’s control. AIG financing doesn’t force the Fed to run down its stock of Treasuries. These auctioned supplies lots of high-value paper that is desperately needed in places like money market funds. The demand for the paper was so great that the yield was just 0.30% at the first auction. While the auctions add to the government’s debt given the yield (infinitesimal) they are designed to be paid back quickly once AIG can liquidate some or a lot of its assets.
The Fed is also asking for getting now another tool that it says – and I believe- would greatly simplify its task: paying interest on bank reserves – in other words getting more reserves within the fed – something that Marriner Eccles who was FDR’s Fed Chair pined for.
Congress has given the Fed the authority in 2006 to pay interest on the reserves that banks deposit at the Fed, but the authority doesn’t begin until October 2011. In May, Ben Bernanke asked Congress to move the effective date up to right now and that appears likely because of Barney Frank and Chris Dodd’s comments.
The argument is that if the Fed had such authority, it would attract excess bank reserves to the Fed increasing its powers and resulting in less buffoonery. Currently, banks deposit only the minimum reserve required law. Banks must meet set reserve requirements each day but since they receive no interest on those reserves, they have an incentive to lend out any excess cash in the open market to other banks while increasing liquidity it also can result in a lot of Buffoonery. Decreasing the growth in the money supply caused by these other efforts by increasing reserves the Fed actually holds decreases inflationary pressures.
If the Fed could pay interest on reserves the argument is that it could put a floor under benchmark rates and also increase the asset size of its balance sheet so that it would have excess cash to deal with any and all misghagoss and decrease the size of the money supply.
As one person observed, the interest rate paid on bank reserves would effectively serve as the floor on the funds rate – the rate that banks charge to each other. If the Fed paid 1.75% interest on reserves, the effective federal funds rate couldn’t go below 1.75%. Given the safety of what are government obligations, this makes sense.
Fed researchers believe monetary policy would be much more effective with this approach, because the Fed could more directly control the most liquid asset in the economy which is the excess cash and avoid interest rates going so low that interest rates would lose all meaning.
Given what is at stake, the $300 million in government is a pittance and worth the try. If you are a central bank run by the government more systematic tools are better than more ad hoc tools.
Since the mid 1980’s Irwin Nowick has worked for the California State Assembly and State Senate on a plethora of policy issues, m ost notably firearms legislation. He has been described as “The Assembly’s resident genius” by a former Speaker of the Assembly and is seen frequently in the Capitol hallways and offices assisting legislators in drafting and amending pending legislation.