During and immediately after the sub-prime lending crisis of 2007-2008, the Fed invoked emergency powers to inaugurate a number of programs designed to ease credit and preserve liquidity in the banking system. These included things like “MBS,” in which the Fed bought bad loans backed by government-sponsored entities like Fannie Mae and Freddie Mac; and “TALF,” in which the Fed provided loans to eligible institutions so that they could acquire asset-backed securities. The Fed also provided direct assistance to specific firms in order to keep them afloat, as with the insurance giant AIG, or induce them to purchase failing firms, as happened in JP Morgan Chase’s acquisition of Bear Stearns.
Taken together, these first emergency steps came to be known as “QE1,” or the first round of quantitative easing. QE1 was widely seen as an appropriate response to the crisis, with the Fed acting as the lender of last resort in order to prevent a wholesale collapse of the banking system. In QE1, the Fed added $2.1 trillion to its balance sheet. How did it come up with the cash? Simple: when the Fed needs to, it just adds zeroes to its balance sheet. In other words, it “prints” more money. In 2010, the Fed embarked upon QE2, which involved the purchase of $600 billion in US Treasuries – bills, notes, and bonds – in order to inject even more liquidity into the credit markets and thereby stimulate the economy as a whole, which had foundered in recession.
In September of 2012, the Fed announced yet another round of quantitative easing that continues to this day and has come to be known as QE3. Under QE3, the Fed purchases $85 billion a month in treasuries from its preferred list of 22 “primary dealers. Here’s what happens: a dealer has a bond certificate that belongs to the dealer itself or its client. The dealer sells that certificate to the Fed in this month’s competitive auction. The dealer is then credited with cash on its balance sheet. In theory, the dealer or the dealer’s client now plows that cash back into the economy in the form of loans for business start-ups, investments in plant and equipment, research and development, hiring, etc. The program is intended to turn the Fed’s made-up money into productive capital that will stimulate the economy, encourage innovation and risk, and restore full employment.
But that is not what happens, as any review of the business pages will reveal. When the Fed transfers its newly minted cash, banks and their clients typically do one of four things: they either hold on to the money, which inflates the price of their own stock; they buy stock in other companies, which drives those stock prices higher; they buy more treasuries to sell at a mark-up to the Fed; or they use the profits realized to acquire profitable companies in fields other than finance. Rinse and repeat. The financial spin cycle blows an asset bubble while the real economy – the economy you and I inhabit – limps along.
Who are the “primary dealers” that play such an important role in this scheme? They are the brokerage departments of 22 big banks, including Goldman Sachs, JP Morgan Chase, Citigroup, HSBC, and others. They deal exclusively with the Federal Reserve Bank of New York, which is famous for its revolving doors – especially those that open into and out of Goldman. Stephen Friedman is a good example. In 2009, Friedman, a former Goldman Sachs CEO, was administering QE1 as chair of the New York Fed when it was discovered that he was actually still a member of the Goldman board! Friedman was both the bank regulator and the banker he was regulating. He resigned, of course, but not before he was able to buy 52,000 additional shares of Goldman stock and pocket a cool $3 million.
What Friedman did was legal, believe it or not; but the Fed’s partners are routinely involved in criminal behavior. In 2012, HSBC was fined $1.9 billion for money laundering cash from Mexican drug cartels. In 2013, JP Morgan Chase paid fines totaling $20 billion for everything from foreclosure fraud to manipulating electricity delivery to California – the same thing that got Enron shut and CEO Ken Lay sent to jail. But no one at JPM will be charged; it just doesn’t work that way on Wall Street.