When Treasury Secretary Henry Paulson came to Congress in September seeking $700 billion in financial market "rescue" funds, a furor arose over the justification for and uses of such funds. By a cliffhanger vote, Congress approved half of the request, but the furor continues over how the money has been deployed and the lack of an accounting whether it is producing the intended stimulus to bank lending.
Yet during this same span of time, without any Congressional authorization and with scarcely any clamor, the Federal Reserve Board has pumped well upwards of a trillion dollars into the financial markets for an array of emergency lending and asset purchase programs similarly intended to relieve a credit crisis. Further accentuating the contrast, the Fed refuses to divulge the names of the recipients of most of its loans whereas the Treasury has made public the list of nearly 90 banks in which it has invested in order to shore up their capital.
All of that serves to highlight the mysterious ways in which the nation's central bank can exert great financial influence as a seemingly near-autonomous fourth branch of government. Somehow it can come up with vast sums of money without having to look to Congress for appropriations and without much oversight on the part of either the executive or legislative branches.
The Fed's autonomy was originally intended to let it exercise its traditional role of setting monetary policy free of political influence that might be prone to press for easy credit to stimulate the economy in ways helpful to the party in power in the next election, but with longer-term inflationary consequences. But until this year's economic crisis, its powers to ease or tighten credit (lower or raise interest rates) were mainly exercised by injecting or extracting reserves of lendable funds from the nation's banks by buying or selling Treasury securities. True, the Fed also acted as a lender of last resort to banks in times of stress but on nothing like the scale of recent months.
Now, the Fed has also opened its credit window to all manner of corporate borrowers of short-term funds known as commercial paper and on a longer-term basis to providers of the credit that supports everything from automobile and student loans to credit card borrowings. One of its few identified loans, on the order of $100 billion, went to American International Group to save that financial behemoth from insolvency.
Over and above all its lending activity (which Bloomberg News places in excess of $1 trillion), the Fed recently announced plans to purchase $500 billion in mortgage-backed securities in the name of helping to lower mortgage interest rates as a stimulus to home buying and thus the moribund housing market. This, of course, was the original purpose for which Paulson sought $700 billion from Congress in September but later put into buying preferred stock in banks instead.
So if Congress isn't providing any of the funding, how on earth is the Fed coming up with all the money that it's shelling out?
"The Fed can conjure up money out of thin air," says Harold Black, distinguished professor of financial institutions at the University of Tennessee. "Basically all it does is tell banks it has excess reserves, and the banks will give the Fed securities as collateral... and whatever the worth of that is the Fed simply says now you have money in your account, go spend it."
Black's explanation of whence cometh the excess reserves sounds almost like sorcery. But part of the answer can be found in recent Fed statements showing:
1. In recent months, it has borrowed $440 billion from the U.S. Treasury in what's called a Supplementary Financing Account—without any Congressional action on the outlay.
2. Since September, the Fed has accumulated about $600 billion in what are labeled excess reserves beyond the roughly $50 billion that banks are required to hold in reserve against their deposits. In this case, Congress did contribute to the buildup by allowing the Fed to pay interest on these reserve funds.
What are the implications of all this Fed funding for the national debt, the federal budget deficit, and ultimately the taxpayer? I'm only capable of a rough cut at the answers, but the Treasury loans would appear to have contributed to an increase in the national debt from $9.5 billion in July to $10.6 billion in November, and a further increase in the debt ceiling to $11.3 billion. On the other hand, as long as the Fed pays off its borrowing with interest, there's no increase in the budget deficit beyond the $1 billion now projected for the current fiscal year. Whether tax payers would end up on the hook for any losses incurred on the Fed's loans and asset purchases is problematic.
In ordinary times, all the economic stimulus provided by the Fed's extraordinary outlays would be highly inflationary. But with the nosedive of the housing market, and steep declines in many commodity prices, deflation rather than inflation may be the greater concern at present.
For my own part, given the dire economic straits in which the nation finds itself, I'd rather see the Fed err on the side of creating too much money than not enough in hopes of fostering a recovery. m