Have been meaning to write about this, but I’m increasingly amazed at the overall lack of an uproar about the possibility of the government approving another corporate tax repatriation holiday.
I’ve been in and out of DC a few times in recent weeks and one thing I keep hearing is that there is a growing, and real, possibility that a second “one-time tax holiday” will be approved for corporations as part of whatever sordid deal emerges from the debt-ceiling negotiations.
I passed it off as a bad joke when I first saw news of this a few weeks ago, when it was reported that Wall Street whipping boy Chuck Schumer was seriously considering the idea. Then I read later on that other Senators were jumping on the bandwagon, including North Carolina’s Kay Hagan.
This is what Hagan’s spokesperson said:
Senator Hagan is looking closely at any creative, short-term measures that can get bipartisan support and put people back to work. One such potential initiative is a well-crafted and temporary change to the tax code that encourages American companies to bring money home and put it towards capital, investment, and–most importantly–American jobs.
For those who don’t know about it, tax repatriation is one of the all-time long cons and also one of the most supremely evil achievements of the Washington lobbying community, which has perhaps told more shameless lies about this one topic than about any other in modern history – which is saying a lot, considering the many absurd things that are said and done by lobbyists in our nation’s capital.
Here’s how it works: the tax laws say that companies can avoid paying taxes as long as they keep their profits overseas. Whenever that money comes back to the U.S., the companies have to pay taxes on it.
Think of it as a gigantic global IRA. Companies that put their profits in the offshore IRA can leave them there indefinitely with no tax consequence. Then, when they cash out, they pay the tax.
Only there’s a catch. In 2004, the corporate lobby got together and major employers like Cisco and Apple and GE begged congress to give them a “one-time” tax holiday, arguing that they would use the savings to create jobs. Congress, shamefully, relented, and a tax holiday was declared. Now companies paid about 5 percent in taxes, instead of 35-40 percent.
Money streamed back into America. But the companies did not use the savings to create jobs. Instead, they mostly just turned it into executive bonuses and ate the extra cash. Some of those companies promising waves of new hires have already committed to massive layoffs..
It was bad enough when lobbyists managed to pull this trick off once, in 2004. But in one of the worst-kept secrets in Washington, companies immediately started to systematically “offshore” their profits right after the 2004 holiday with the expectation that somewhere down the road, and probably sooner rather than later, they would get another holiday.
Companies used dozens of fiendish methods to keep profits overseas, including such scams as “transfer pricing,” a technique in which profits are shifted to overseas subsidiaries. A typical example might involve a pharmaceutical company that licenses the rights or the patent to one of its more successful drugs to a foreign affiliate, which in turn manufactures the product and sells it back to the U.S. branch, thereby shifting the profits overseas.
Companies have been doing this for years, to incredible effect. Bloomberg’s Jesse Drucker estimated that Google all by itself has saved $3.1 billion in taxes in the past three years by shifting its profits overseas. Add that to the already rampant system of loopholes and what you have is a completely broken corporate tax system.
And the whole thing is predicated on that dirty little secret – the notion, long known to all would-be major corporate taxpayers, that there would come a day when there would be another tax holiday.
That time, they hope, is now. According to Drucker, lobbyists met with President Obama last December to ask for another holiday. And now the drumbeats are rolling on the Hill for a new holiday to be included in the debt-ceiling deal.
Senator Carl Levin of Michigan, the same Senator who produced the damning report of corruption on Wall Street, has been trying to fight the problem, introducing a measure that would prevent companies from accessing offshored money through correspondent accounts and branches of offshore banks.
Levin’s Permanent Subcommittee on Investigations has also been investigating how companies might use the cash they save from a tax holiday, surveying companies like DuPont, presumably to find out just how many of these firms really intend to create new jobs with their tax savings.
I’m shocked there isn’t more of an uproar about this. Could you imagine what the Tea Party would be saying right now if there was a law on the books that allowed immigrants to indefinitely avoid taxes on income sent back to family members in the old country, in Mexico and Venezuela and India?
Imagine the uproar if Barack Obama, in the middle of this historic revenue crunch and "We're so broke the world is going to end tomorrow!" debt-ceiling hystgeria, decided to declare a second “one-time tax holiday” for, say, unwed single mothers, or recipients of public assistance? Middle America would be running through the streets, firing shotguns out its truck window, waving chainsaws in mall lobbies, etc.
As it is, leading members of the Senate are seriously considering giving the most profitable companies in the world a total tax holiday as a reward for their last seven years of systematic tax avoidance. Hundreds of billions of potential tax dollars would disappear from the Treasury. And there isn’t a peep from anyone, anywhere, on this issue.
We’re seriously talking about defaulting on our debt, and cutting Medicare and Social Security, so that Google can keep paying its current 2.4 percent effective tax rate and GE, a company that received a $140 billion bailout en route to worldwide 2010 profits of $14 billion, can not only keep paying no taxes at all , but receive a $3.2 billion tax credit from the federal government. And nobody appears to give a shit. What the hell is wrong with people? Have we all lost our minds?
Can you identify all 4 portraits? (send to: pappajohn15@gmail.com)
Reinstate Glass-Steagall – Now
[Another contribution from Seeking Alpha]
by: Joseph L. Shaefer December 29, 2009
Once upon a time, banks did banking and brokers made people broker and ne’er the twain did meet. Ditto for insurers and S&Ls and all the other sub-sectors Wall Street has now euphemistically titled the “financial services” industry, an oxymoron akin to “airline food” or “Congressional ethics.”
Sometimes I find a particularly well-written article on a subject and say, “I couldn’t have written it any better myself.” Such was the case with a recent article by Sy Harding of Street Smart Report (see his free daily blog at www.streetsmartpost.com). I’ve quoted much of it below, followed by my comments and ideas for possible purchases…
The Glass-Steagall Act was passed in the 1930’s to help prevent a recurrence of the 1929 market crash and the Great Depression. It provided strict separation of the activities of various types of financial firms, the overlapping of which had been significantly responsible for creating the late 1920’s market bubble and subsequent crash.
Under Glass-Steagall financial firms had to divest themselves of over-lapping operations and focus on their core business.
Basically, savings banks could take in deposits from customers and loan the money out in home mortgages, auto loans and other types of personal lending.
Commercial banks could handle deposits and checking accounts of businesses and make commercial loans.
Investment banks could provide investment banking services, including arranging for companies to go public, merger and acquisition activities, making bridge loans, etc.
Brokerage firms could handle investment services for investors.
Insurance companies provided insurance and annuities.
Real estate brokerage firms provided real estate services on a commission basis.
Mutual funds invested in stocks, bonds, or other assets and sold shares to the public to provide them with diversified portfolios.
The financial sector screamed and yelled, but the separations were made fairly quickly and enforced. And none of the dire consequences Wall Street firms warned would be the result if government set up such restrictions took place. All sectors of the financial system managed to flourish very well for the next 60 years under the separations and restrictions.
But in the late 1990’s, banks and insurance companies began looking over their walls in envy at the big profits that brokerage firms and mutual funds were making from the booming stock market. Brokerage firms looked over their wall at the profits that could be made from packaging home mortgages, auto loans, etc. into leveraged investment derivatives…
…in 1998 they began lobbying Congress, and bombarding the media with articles and interviews aimed at having the public accept the idea of tearing down the walls… Overnight the walls disappeared. Banks were suddenly in the brokerage business, introduced their own mutual funds, were neck deep in investment banking, had huge trading departments trading for their own profits, etc. Brokerage firms were providing home mortgages, packaging the mortgages of other lenders and selling them to investors, etc.
And we soon saw the results with the stock market bubble in 2000, and the subsequent real estate bubble just a few years later, and the near collapse of the entire financial system last year under the weight of all the toxic assets that had mushroomed on the balance sheets of all types of financial firms…
…Wall Street of course claims that the abolishment of Glass-Steagall in 1999 was a good thing, that it resulted in innovative investment changes that strengthened the economy and markets.
Huh? We’ve had two recessions and two severe bear markets since 1999, with buy and hold investors still way underwater over the last 10 years, consumers in worse trouble than they’ve been in since the great Depression, and the financial system near total collapse for the first time since the 1929 crash and its aftermath…
In the late 1990s, Congress and President Clinton embraced the campaign spearheaded by Sandy Weill, then head of Citicorp (C), to rescind Glass-Steagall. Weill and his ilk paid $200 million in lobbying fees for this endeavor in the 1997-98 election cycle alone (and contributed another $150 million directly to various Congressmen and other politicians during those months). That was chump change to Wall Street – and, in fact, it came out of the pockets of Citicorp and other shareholders, without Weill or his cabal of cohorts having to put up a penny of their own to pull off this taxpayer heist. No matter the source, it was enough to buy respect, votes, or whatever. And we are still paying for it today.
(According to PBS's "Frontline," just days after the Treasury Department agreed to support the repeal, Treasury Secretary Robert Rubin accepted the job as Weill's chief lieutenant at Citigroup. Weill and co-boss John Reed thanked President Clinton, whom Weill called in the middle of the night to keep the deal going, personally.)
There are only two times our elected representatives give a damn what we think – the first Tuesday in November in the years we elect our President and the first Tuesday in November two years hence. In fact, they still don’t care what we “think” even on these dates but they sure as hell worry about how we’ll vote. If enough of us tell them we will vote them out of office unless they restore Glass-Steagall, this is the year – these are the key months in which they will listen. Not because they care what we think, but because if we vote them out, they’ll have to find honest work somewhere (or become lobbyists, of course) and they’ll then be saddled with the same health care system and pension system they voted for the rest of us.
If we are successful in restoring Glass-Steagall, I would look at a number of regional banks like Wilmington Trust (WL), Bank of Marin (BMRC), Bank of Hawaii (BOH), United Bankshares (UBSI), Trustmark (TRMK), Heartland Financial (HTLF), Sterling Bancshares (SBIB) and Capital City Bank Group (CCBG) to do exceedingly well and recommend them for your further research. If we fail to reinstate Glass-Steagall, these banks might still do quite well, but more as takeover candidates by money-center banks Too Big Too Fail, Too Stupid to Succeed Without Regularly Reaching Into Our Pockets.
Write your Congresspersons, every one. Tell them you will vote them out in a flash if they don’t immediately reinstate Glass-Steagall. I live at Lake Tahoe in Nevada, 10 minutes from the People’s Republic border. If I believe we can vote out Harry Reid, the man who gave Congressional ethics its standing as an oxymoron – and I do – and his cohorts to the far left of us on the map – and I do -- your representatives should be easy!
Author's Disclosure: We and/or clients for whom it is appropriate are currently long WL, BOH, UBSI and CCBG, and are buyers of all the others at the right price as we free up funds from other sectors.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but will not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
by: Joseph L. Shaefer December 29, 2009
Once upon a time, banks did banking and brokers made people broker and ne’er the twain did meet. Ditto for insurers and S&Ls and all the other sub-sectors Wall Street has now euphemistically titled the “financial services” industry, an oxymoron akin to “airline food” or “Congressional ethics.”
Sometimes I find a particularly well-written article on a subject and say, “I couldn’t have written it any better myself.” Such was the case with a recent article by Sy Harding of Street Smart Report (see his free daily blog at www.streetsmartpost.com). I’ve quoted much of it below, followed by my comments and ideas for possible purchases…
The Glass-Steagall Act was passed in the 1930’s to help prevent a recurrence of the 1929 market crash and the Great Depression. It provided strict separation of the activities of various types of financial firms, the overlapping of which had been significantly responsible for creating the late 1920’s market bubble and subsequent crash.
Under Glass-Steagall financial firms had to divest themselves of over-lapping operations and focus on their core business.
Basically, savings banks could take in deposits from customers and loan the money out in home mortgages, auto loans and other types of personal lending.
Commercial banks could handle deposits and checking accounts of businesses and make commercial loans.
Investment banks could provide investment banking services, including arranging for companies to go public, merger and acquisition activities, making bridge loans, etc.
Brokerage firms could handle investment services for investors.
Insurance companies provided insurance and annuities.
Real estate brokerage firms provided real estate services on a commission basis.
Mutual funds invested in stocks, bonds, or other assets and sold shares to the public to provide them with diversified portfolios.
The financial sector screamed and yelled, but the separations were made fairly quickly and enforced. And none of the dire consequences Wall Street firms warned would be the result if government set up such restrictions took place. All sectors of the financial system managed to flourish very well for the next 60 years under the separations and restrictions.
But in the late 1990’s, banks and insurance companies began looking over their walls in envy at the big profits that brokerage firms and mutual funds were making from the booming stock market. Brokerage firms looked over their wall at the profits that could be made from packaging home mortgages, auto loans, etc. into leveraged investment derivatives…
…in 1998 they began lobbying Congress, and bombarding the media with articles and interviews aimed at having the public accept the idea of tearing down the walls… Overnight the walls disappeared. Banks were suddenly in the brokerage business, introduced their own mutual funds, were neck deep in investment banking, had huge trading departments trading for their own profits, etc. Brokerage firms were providing home mortgages, packaging the mortgages of other lenders and selling them to investors, etc.
And we soon saw the results with the stock market bubble in 2000, and the subsequent real estate bubble just a few years later, and the near collapse of the entire financial system last year under the weight of all the toxic assets that had mushroomed on the balance sheets of all types of financial firms…
…Wall Street of course claims that the abolishment of Glass-Steagall in 1999 was a good thing, that it resulted in innovative investment changes that strengthened the economy and markets.
Huh? We’ve had two recessions and two severe bear markets since 1999, with buy and hold investors still way underwater over the last 10 years, consumers in worse trouble than they’ve been in since the great Depression, and the financial system near total collapse for the first time since the 1929 crash and its aftermath…
In the late 1990s, Congress and President Clinton embraced the campaign spearheaded by Sandy Weill, then head of Citicorp (C), to rescind Glass-Steagall. Weill and his ilk paid $200 million in lobbying fees for this endeavor in the 1997-98 election cycle alone (and contributed another $150 million directly to various Congressmen and other politicians during those months). That was chump change to Wall Street – and, in fact, it came out of the pockets of Citicorp and other shareholders, without Weill or his cabal of cohorts having to put up a penny of their own to pull off this taxpayer heist. No matter the source, it was enough to buy respect, votes, or whatever. And we are still paying for it today.
(According to PBS's "Frontline," just days after the Treasury Department agreed to support the repeal, Treasury Secretary Robert Rubin accepted the job as Weill's chief lieutenant at Citigroup. Weill and co-boss John Reed thanked President Clinton, whom Weill called in the middle of the night to keep the deal going, personally.)
There are only two times our elected representatives give a damn what we think – the first Tuesday in November in the years we elect our President and the first Tuesday in November two years hence. In fact, they still don’t care what we “think” even on these dates but they sure as hell worry about how we’ll vote. If enough of us tell them we will vote them out of office unless they restore Glass-Steagall, this is the year – these are the key months in which they will listen. Not because they care what we think, but because if we vote them out, they’ll have to find honest work somewhere (or become lobbyists, of course) and they’ll then be saddled with the same health care system and pension system they voted for the rest of us.
If we are successful in restoring Glass-Steagall, I would look at a number of regional banks like Wilmington Trust (WL), Bank of Marin (BMRC), Bank of Hawaii (BOH), United Bankshares (UBSI), Trustmark (TRMK), Heartland Financial (HTLF), Sterling Bancshares (SBIB) and Capital City Bank Group (CCBG) to do exceedingly well and recommend them for your further research. If we fail to reinstate Glass-Steagall, these banks might still do quite well, but more as takeover candidates by money-center banks Too Big Too Fail, Too Stupid to Succeed Without Regularly Reaching Into Our Pockets.
Write your Congresspersons, every one. Tell them you will vote them out in a flash if they don’t immediately reinstate Glass-Steagall. I live at Lake Tahoe in Nevada, 10 minutes from the People’s Republic border. If I believe we can vote out Harry Reid, the man who gave Congressional ethics its standing as an oxymoron – and I do – and his cohorts to the far left of us on the map – and I do -- your representatives should be easy!
Author's Disclosure: We and/or clients for whom it is appropriate are currently long WL, BOH, UBSI and CCBG, and are buyers of all the others at the right price as we free up funds from other sectors.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but will not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
Why QE2 Failed: The Money Went Offshore
[blatantly stollen from Ellen Brown, Seeking Alpha, an investor website]
On June 30, QE2 ended with a whimper. The Fed’s second round of “quantitative easing” involved $600 billion created with a computer keystroke for the purchase of long-term government bonds. But the government never actually got the money, which went straight into the reserve accounts of banks, where it still sits today. Worse, it went into the reserve accounts of FOREIGN banks, on which the Federal Reserve is now paying 0.25% interest.
Before QE2 there was QE1, in which the Fed bought $1.25 trillion in mortgage-backed securities from the banks. This money too remains in bank reserve accounts collecting interest and dust. The Fed reports that the accumulated excess reserves of depository institutions now total nearly $1.6 trillion.
Interestingly, $1.6 trillion is also the size of the federal deficit – a deficit so large that some members of Congress are threatening to force a default on the national debt if it isn’t corrected soon.
So here we have the anomalous situation of a $1.6 trillion hole in the federal budget, and $1.6 trillion created by the Fed that is now sitting idle in bank reserve accounts. If the intent of “quantitative easing” was to stimulate the economy, it might have worked better if the money earmarked for the purchase of Treasuries had been delivered directly to the Treasury. That was actually how it was done before 1935, when the law was changed to require private bond dealers to be cut into the deal.
The one thing QE2 did for the taxpayers was to reduce the interest tab on the federal debt. The long-term bonds the Fed bought on the open market are now effectively interest-free to the government, since the Fed rebates its profits to the Treasury after deducting its costs.
But QE2 has not helped the anemic local credit market, on which smaller businesses rely; and it is these businesses that are largely responsible for creating new jobs. In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.
How QE2 Wound Up in Foreign Banks
Before the Banking Act of 1935, the government was able to borrow directly from its own central bank. Other countries followed that policy as well, including Canada, Australia, and New Zealand; and they prospered as a result. After 1935, however, if the U.S. central bank wanted to buy government securities, it had to purchase them from private banks on the “open market.”
Former Fed Chairman Marinner Eccles wrote in support of an act to remove that requirement that it was intended to keep politicians from spending too much. But all the law succeeded in doing was to give the bond-dealer banks a cut as middlemen.
Worse, it caused the Fed to lose control of where the money went. Rather than buying more bonds from the Treasury, the banks that got the cash could just sit on it or use it for their own purposes; and that is apparently what is happening today.
In carrying out its QE2 purchases, the Fed had to follow standard operating procedure for “open market operations”: it took secret bids from the 20 “primary dealers” authorized to sell securities to the Fed and accepted the best offers. The problem was that 12 of these dealers – or over half — are U.S.-based branches of foreign banks (including BNP Paribas, Barclays, Credit Suisse, Deutsche Bank, HSBC, UBS and others); and they evidently won the bids.
The fact that foreign banks got the money was established in a June 12 post on Zero Hedge by Tyler Durden (a pseudonym), who compared two charts: the total cash holdings of foreign-related banks in the U.S., using weekly Federal Reserve data; and the total reserve balances held at Federal Reserve banks, from the Fed’s statement ending the week of June 1. The charts showed that after November 3, 2010, when QE2 operations began, total bank reserves increased by $610 billion. Foreign bank cash reserves increased in lock step, by $630 billion — or more than the entire QE2.
In a June 27 blog, John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote:
In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market. This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit. . . .
Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . .[B]usiness loans continue to “tank” at the smaller banking institutions. . . .
The real lending by commercial banks is not taking place in the United States. The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow.
Tyler Durden concluded:
. . . [T]he only beneficiary of the reserves generated were US-based branches of foreign banks (which in turn turned around and funnelled the cash back to their domestic branches), a shocking finding which explains . . . why US banks have been unwilling and, far more importantly, unable to lend out these reserves . . . .
. . . [T]he data above proves beyond a reasonable doubt why there has been no excess lending by US banks to US borrowers: none of the cash ever even made it to US banks! . . . This also resolves the mystery of the broken money multiplier and why the velocity of money has imploded.
Well, not exactly. The fact that the QE2 money all wound up in foreign banks is a shocking finding, but it doesn’t seem to be the reason banks aren’t lending. There were already $1 trillion in excess reserves sitting idle in U.S. reserve accounts, not counting the $600 billion from QE2.
According to Scott Fullwiler, Associate Professor of Economics at Wartburg College, the money multiplier model is not just broken but is obsolete. Banks do not lend based on what they have in reserve. They can borrow reserves as needed after making loans. Whether banks will lend depends rather on (a) whether they have creditworthy borrowers, (b) whether they have sufficient capital to satisfy the capital requirement, and (c) the cost of funds – meaning the cost to the bank of borrowing to meet the reserve requirement, either from depositors or from other banks or from the Federal Reserve.
Setting Things Right
Whatever is responsible for causing the local credit crunch, trillions of dollars thrown at Wall Street by Congress and the Fed haven’t fixed the problem. It may be time for local governments to take matters into their own hands. While we wait for federal lawmakers to get it right, local credit markets can be revitalized by establishing state-owned banks, on the model of the Bank of North Dakota (BND). The BND services the liquidity needs of local banks and keeps credit flowing in the state. For more information, see here and here.
Concerning the gaping federal deficit, Congressman Ron Paul has an excellent idea: have the Fed simply write off the federal securities purchased with funds created in its quantitative easing programs. No creditors would be harmed, since the money was generated out of thin air with a computer keystroke in the first place. The government would just be canceling a debt to itself and saving the interest.
As for “quantitative easing,” if the intent is to stimulate the economy, the money needs to go directly into the purchase of goods and services, stimulating “demand.” If it goes onto the balance sheets of banks, it may stop there or go into speculation rather than local lending — as is happening now. Money that goes directly to the government, on the other hand, will be spent on goods and services in the real economy, creating much-needed jobs, generating demand, and rebuilding the tax base. To make sure the money gets there, the 1935 law forbidding the Fed to buy Treasuries directly from the Treasury needs to be repealed.
On June 30, QE2 ended with a whimper. The Fed’s second round of “quantitative easing” involved $600 billion created with a computer keystroke for the purchase of long-term government bonds. But the government never actually got the money, which went straight into the reserve accounts of banks, where it still sits today. Worse, it went into the reserve accounts of FOREIGN banks, on which the Federal Reserve is now paying 0.25% interest.
Before QE2 there was QE1, in which the Fed bought $1.25 trillion in mortgage-backed securities from the banks. This money too remains in bank reserve accounts collecting interest and dust. The Fed reports that the accumulated excess reserves of depository institutions now total nearly $1.6 trillion.
Interestingly, $1.6 trillion is also the size of the federal deficit – a deficit so large that some members of Congress are threatening to force a default on the national debt if it isn’t corrected soon.
So here we have the anomalous situation of a $1.6 trillion hole in the federal budget, and $1.6 trillion created by the Fed that is now sitting idle in bank reserve accounts. If the intent of “quantitative easing” was to stimulate the economy, it might have worked better if the money earmarked for the purchase of Treasuries had been delivered directly to the Treasury. That was actually how it was done before 1935, when the law was changed to require private bond dealers to be cut into the deal.
The one thing QE2 did for the taxpayers was to reduce the interest tab on the federal debt. The long-term bonds the Fed bought on the open market are now effectively interest-free to the government, since the Fed rebates its profits to the Treasury after deducting its costs.
But QE2 has not helped the anemic local credit market, on which smaller businesses rely; and it is these businesses that are largely responsible for creating new jobs. In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.
How QE2 Wound Up in Foreign Banks
Before the Banking Act of 1935, the government was able to borrow directly from its own central bank. Other countries followed that policy as well, including Canada, Australia, and New Zealand; and they prospered as a result. After 1935, however, if the U.S. central bank wanted to buy government securities, it had to purchase them from private banks on the “open market.”
Former Fed Chairman Marinner Eccles wrote in support of an act to remove that requirement that it was intended to keep politicians from spending too much. But all the law succeeded in doing was to give the bond-dealer banks a cut as middlemen.
Worse, it caused the Fed to lose control of where the money went. Rather than buying more bonds from the Treasury, the banks that got the cash could just sit on it or use it for their own purposes; and that is apparently what is happening today.
In carrying out its QE2 purchases, the Fed had to follow standard operating procedure for “open market operations”: it took secret bids from the 20 “primary dealers” authorized to sell securities to the Fed and accepted the best offers. The problem was that 12 of these dealers – or over half — are U.S.-based branches of foreign banks (including BNP Paribas, Barclays, Credit Suisse, Deutsche Bank, HSBC, UBS and others); and they evidently won the bids.
The fact that foreign banks got the money was established in a June 12 post on Zero Hedge by Tyler Durden (a pseudonym), who compared two charts: the total cash holdings of foreign-related banks in the U.S., using weekly Federal Reserve data; and the total reserve balances held at Federal Reserve banks, from the Fed’s statement ending the week of June 1. The charts showed that after November 3, 2010, when QE2 operations began, total bank reserves increased by $610 billion. Foreign bank cash reserves increased in lock step, by $630 billion — or more than the entire QE2.
In a June 27 blog, John Mason, Professor of Finance at Penn State University and a former senior economist at the Federal Reserve, wrote:
In essence, it appears as if much of the monetary stimulus generated by the Federal Reserve System went into the Eurodollar market. This is all part of the “Carry Trade” as foreign branches of an American bank could borrow dollars from the “home” bank creating a Eurodollar deposit. . . .
Cash assets at the smaller [U.S.] banks remained relatively flat . . . . Thus, the reserves the Fed was pumping into the banking system were not going into the smaller banks. . . .[B]usiness loans continue to “tank” at the smaller banking institutions. . . .
The real lending by commercial banks is not taking place in the United States. The lending is taking place off-shore, underwritten by the Federal Reserve System and this is doing little or nothing to help the American economy grow.
Tyler Durden concluded:
. . . [T]he only beneficiary of the reserves generated were US-based branches of foreign banks (which in turn turned around and funnelled the cash back to their domestic branches), a shocking finding which explains . . . why US banks have been unwilling and, far more importantly, unable to lend out these reserves . . . .
. . . [T]he data above proves beyond a reasonable doubt why there has been no excess lending by US banks to US borrowers: none of the cash ever even made it to US banks! . . . This also resolves the mystery of the broken money multiplier and why the velocity of money has imploded.
Well, not exactly. The fact that the QE2 money all wound up in foreign banks is a shocking finding, but it doesn’t seem to be the reason banks aren’t lending. There were already $1 trillion in excess reserves sitting idle in U.S. reserve accounts, not counting the $600 billion from QE2.
According to Scott Fullwiler, Associate Professor of Economics at Wartburg College, the money multiplier model is not just broken but is obsolete. Banks do not lend based on what they have in reserve. They can borrow reserves as needed after making loans. Whether banks will lend depends rather on (a) whether they have creditworthy borrowers, (b) whether they have sufficient capital to satisfy the capital requirement, and (c) the cost of funds – meaning the cost to the bank of borrowing to meet the reserve requirement, either from depositors or from other banks or from the Federal Reserve.
Setting Things Right
Whatever is responsible for causing the local credit crunch, trillions of dollars thrown at Wall Street by Congress and the Fed haven’t fixed the problem. It may be time for local governments to take matters into their own hands. While we wait for federal lawmakers to get it right, local credit markets can be revitalized by establishing state-owned banks, on the model of the Bank of North Dakota (BND). The BND services the liquidity needs of local banks and keeps credit flowing in the state. For more information, see here and here.
Concerning the gaping federal deficit, Congressman Ron Paul has an excellent idea: have the Fed simply write off the federal securities purchased with funds created in its quantitative easing programs. No creditors would be harmed, since the money was generated out of thin air with a computer keystroke in the first place. The government would just be canceling a debt to itself and saving the interest.
As for “quantitative easing,” if the intent is to stimulate the economy, the money needs to go directly into the purchase of goods and services, stimulating “demand.” If it goes onto the balance sheets of banks, it may stop there or go into speculation rather than local lending — as is happening now. Money that goes directly to the government, on the other hand, will be spent on goods and services in the real economy, creating much-needed jobs, generating demand, and rebuilding the tax base. To make sure the money gets there, the 1935 law forbidding the Fed to buy Treasuries directly from the Treasury needs to be repealed.
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