How The Fed Intervention Is Hurting Credit Unions

June 22, 2020 at 10:52 am Leave a comment

My blog’s a little late this morning because I put aside what I was going to write about after I saw the amount of attention that this opinion piece from Bill Dudley, the former president of the New York Federal Reserve and now a professor at Princeton, is getting. In it he explains why the Feds unprecedented intervention in the economy, which he predicts will soon reach $10 trillion, is a manageable and necessary support, at least in the short term.

He is right. But this is little consolation if you run a credit union or a small community bank. Once again, the Fed is intervening in the economy in a way which helps large businesses and investment banks while doing little to support mainstream lending institutions. It’s time for this to change.

There are two ways to help an economy in trouble. The first and more traditional method is to stimulate economic activity by flooding it with cash. This is what Congress did by printing money and sending it out to consumers. This is analogous to using an economic defibrillator to jolt the economy back to life.

A second much less common approach which the Fed started aggressively using in the Great Recession is to intervene directly into government bond markets to keep interest rates artificially low. This is more analogous to putting the economy on a ventilator since the Fed is so closely intertwined with the economy that it has to cautiously sell off these bonds in a way which doesn’t harm the economy.

In dealing with COVID-19, the Fed has taken this approach to a whole new level. It has set-up mechanisms not only to buy government bonds but corporate bonds as well. This is in addition to setting up facilities to   make loans to businesses too big to qualify for the PPP.

This approach has worked. Despite shutting down the economy, corporations still have cash and the market is booming, in part because there is nowhere else to get any type of return on investments.

But here’s the catch. As Dudley points out, when the Fed engages in such a large amount of purchases, the resulting money has to go somewhere:

“When the Fed buys a financial asset from a private holder, the proceeds received by the seller typically flow back into the banking system. Even if the seller reinvests the proceeds into some financial asset rather than depositing it at a bank, the cash eventually ends up either as an increase in currency outstanding or an increase in bank deposits. Because most people don’t want to hold large amounts of cash, almost all of the money eventually finds its way back into the banking system.”

Don’t banks want to convert all this cheap money into cheap loans? Perhaps, but Dudley points out that in 2008 the Federal Reserve Board was given the right to adjust the interest rate it gives on Fed accounts held by financial institutions. This was done to ensure that all that cheap money didn’t fuel inflation.

All this comes at a very steep price to those of us who believe that for capitalism to work, it can’t be a “Heads the big guys win, Tails the little guys lose” system. Once again credit unions are being driven into Prompt Corrective Action because members need a place to put their cash and interest rates are being kept at artificially low levels.

For the second time in less than a decade policy makers are explaining why this is all necessary. It’s time to start calling the Feds intervention what it is: a justifiable bail-out of larger companies and the institutions that fund them. It’s time Congress consider providing direct funding for credit unions and community banks. After all, the industry should be allowed to fight on a level playing field.

Entry filed under: COVID-19, Economy, econony, Regulatory. Tags: , , , , .

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Authored By:

Henry Meier, Esq., Senior Vice President, General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association. In addition, although Henry strives to give his readers useful and accurate information on a broad range of subjects, many of which involve legal disputes, his views are not a substitute for legal advise from retained counsel.

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