LP.org: ‘Federal Reserve creates dangerous amounts of dodgy debt’

Posted at LP.org:

We favor free-market banking, with unrestricted competition among banks and depository institutions of all types.

The U.S. Federal Reserve released its third-quarter financial report on Dec. 13. The Fed’s own report — unaudited, of course — indicates that our country’s central bank is underwater in “fair value” market terms. Its bond portfolio is worth $66.5 billion less than what its original cost, and that shortfall is $27.4 billion higher than the Fed’s $39.1 billion in capital.

A good analogy would be a homeowner who is underwater by $66,500 on a house that cost $412,850, but who has only $27,400 in savings. A homeowner in that position would be in dire financial straits, but the Fed effectively owns a legal printing press allowing it to create the remainder of the money it owes.

Does it matter? A homeowner in that position could simply hold on to the house instead of selling, to avoid coming up with $66,500 to pay off the mortgage. Likewise, the Fed does not need to sell its portfolio of dodgy government-sponsored enterprise bonds, low-quality mortgage-backed securities, and U.S. Treasury securities. It can simply hold them until they reach maturity and realize full value — apart from those that default, of course.

The real problem is the Fed had an intended purpose for acquiring all that debt, to prevent the economy from spiraling into depression. The actual results have only continued contributing to that problem, by shoring up the banks that had made reckless loans and saving them from bankruptcy.

In 2008, the American financial system was in crisis mode because too many risky mortgage loans had been granted to people who were unable to make their house payments. Forced liquidation sales of houses drove down home prices. Debtors mailed their keys to the bank and walked away, leaving banks with an inventory of homes that were worth less than the outstanding loans. Large “systemically important” financial institutions were in grave danger of going bankrupt.

The Federal Reserve is the only institution with the legal ability to create money from nothing — if anybody else does it, it’s called counterfeiting. So, in order to save the banks that caused these problems, the Fed created trillions in new money to buy their junk debt and a bunch of U.S. Treasury bonds to fund unprecedented federal deficit spending.

Most of those newly created trillions stayed in the financial sector, inflating the stock and markets and making the wealthy even better off. The money that filtered down to Main Street did so in dangerous ways. American consumers are more indebted than ever. Auto loans, which fund rapidly depreciating assets, are at all-time highs. Record amounts of college loans, which cannot be discharged in bankruptcy, are being accumulated so that students can earn degrees that have increasingly questionable market worth. And mortgages are again being offered to people with questionable abilities to make the payments.

Corporate bond offerings are also setting records, and corporations have incurred significant debt to finance stock buybacks and buoy stock prices. Much of that debt has been issued at just barely investment grade. As the Fed continues its stated aim of raising interest rates, much of that debt will have to be refinanced at higher interest rates, which will push significant amounts of corporate debt into junk status. Many pension funds and other institutional bonds buyers are not allowed to buy junk bonds, so if a stock market correction occurs, pension and 401(k) funds will be in a world of hurt. This is a problem that the Fed itself caused by pushing interest rates well below free-market levels.

Those who enjoy the possibility of profits must not impose risks of losses upon others, such as through government guarantees or bailouts.

The Fed engages in two primary activities that are ultimately destructive to the economy. First, it sets interest rates, the price of borrowing money, which is arguably the most important price in a market economy. Centuries of empirical evidence demonstrate that price controls always lead to vast unintended consequences, so essentially giving czar-like control of the economy’s most important price to one person, Fed Chair Jerome Powell, is a recipe for disaster. Setting rates too low will encourage capricious consumption borrowing, and setting rates too high will stymie needed borrowing for capital investment. Market supply and demand will, by definition, do a better job of determining the price of money.

Second, the Fed enables unwise investment and spending decisions. Purchasing junk loans and bailing out “too big to fail” financial institutions encourages crony capitalism of the worst sort. Buying Treasury securities enables unprecedented government growth through deficit spending.

Both of these Fed activities create winners and losers. Banks take on more risk and increase their short-term profits, believing they will be bailed out if the risks go bad. Politicians woo their constituents by using deficit spending to offer and seemingly deliver something for nothing. The Fed’s newly created money must go somewhere, and much of it goes to the stock market, where the wealthy benefit from prices that rise even higher. The losers include students, home buyers, and others saddled with debt they cannot repay, along with those whose incomes don’t rise to meet inflation.

When government officials engineer the money supply, the winners are those with the political power to influence their decisions and the losers are all the ordinary people just trying to get by. Markets, on the other hand, tend to create winners and losers based on the value they add to the economy — and value can be added by almost anybody when restrictive policies don’t prevent them.

Too much debt at the consumer, business, and government levels led to the financial crisis in 2008, but the Fed tried to fix the problem with still more debt. That strategy bought time, but it will probably lead to eventual default risks that dwarf our country’s earlier problems with real estate debt.

All this sky-high debt is an enormous problem, and both Democrats and Republicans either do not understand this or they ignore it. Most of the politicians responsible will likely be enjoying a comfortable retirement when the real fallout occurs. Only Libertarians recognize that debt — especially debt that has been enabled by Fed-conjured money rather than from hard-earned savings — is an alluring siren but a cruel master.

The Libertarian Party platform clearly states the importance of financial integrity and responsibility in banking and other financial markets:

2.7 Money and Financial Markets

We favor free-market banking, with unrestricted competition among banks and depository institutions of all types. Markets are not actually free unless fraud is vigorously combated. Those who enjoy the possibility of profits must not impose risks of losses upon others, such as through government guarantees or bailouts. We support ending federal student loan guarantees and special treatment of student loan debt in bankruptcy proceedings. Individuals engaged in voluntary exchange should be free to use as money any mutually agreeable commodity or item. We support a halt to inflationary monetary policies and unconstitutional legal tender laws.

2.8 Marketplace Freedom

Libertarians support free markets. We defend the right of individuals to form corporations, cooperatives and other types of entities based on voluntary association. We oppose all forms of government subsidies and bailouts to business, labor, or any other special interest. Government should not compete with private enterprise.

12 thoughts on “LP.org: ‘Federal Reserve creates dangerous amounts of dodgy debt’

  1. William T. Forrest

    Sounds gloomy. How would we go about beginning to unwind this mess and get to somewhere like where we are and are on track to be in the future to somewhere more like the platform plank at the end there?

    Supposing the LP could do it, how would we depressurize this balloon without causing massive inflation or deflation, systematic debt default, lots of bank failures and personal and business bankruptcies all over the places, multi-millions with homes and vehicles seized, etc, etc? Or is that going to happen regardless so best to get it over with as soon as possible? If so, how would whichever party implemented that keep from taking all the blame for what would follow from the vast majority of voters?

  2. Libertarian Truth

    I think the LP should stop criticizing people and organizations on “dodgy” finances until they hold their own people accountable. The Libertarian Party of Florida lost at a minimum $15000 due to their treasurer getting scammed.

    https://docs.lpf.org/ec-emails/?place=topic%2Flpfec%2FpVpTHReTUPg%2Fdiscussion

    Additionally, the LPF is facing substantial fines and being removed from the ballot for failing to file quarterly reports to the state division of elections. That seems very shady

  3. paulie Post author

    Sorry I haven’t covered that yet, and I still plan to, but bad judgment on the part of one state party treasurer in one of the mostly independent state parties isn’t a reason for the national LP to not address national topics. That’s just a non-sequitur.

  4. Richard Winger

    The Florida Secretary of State web page posts documents about party campaign finance reports, and letters to and from parties to the Secretary of State about party campaign finance. I just looked (on Saturday afternoon, Dec. 22) and there is nothing hostile from the Fla. Sec. of State to the Libertarian Party that is posted.

  5. Chuck Moulton

    Again, I agree with most of what is written in the article, but I am unclear what the point is. I hope to God it’s not a press release because in that case it’s way too ling and doesn’t include quotes of candidates or the chair. If it’s inreach, then I’m a little surprised it didn’t mention free market money and banking beyond repeating the platform plank verbatim.

  6. paulie Post author

    Posted on one of the FB discussions:

    Steve Straits
    2 mins

    The Debt Trap

    The United States debt is fast approaching 22 Trillion and will be there very, very soon. No one who understands macroeconomics expects The United States to ever repaid this debt. As long as the debt is serviced by making interest payments on time everyone is quite happy and the system continues to operate. The interest rate paid on the debt has been forced down every year since 1991 when it was at 7.8% to 2.26% in 2017. The rate has been forced down to allow for increases in the debt without increases in the interest cost. In 1991 the debt was 3.665 trillion and the interest payments were 286 billion. In 2017 the debt has increased to 20.244 trillion an increase of about 6 times as much. While the interest payments increased from 286 billion in 1991 to 458.5 billion in 2017 not even a doubling of the interest cost.

    The problems with holding interest rates down so low for so many years are numerous. First it punishes anyone who has saved money or is trying to and wants the money in a safe risk-free investment like a savings account or certificate of deposit by giving them a rate of return after inflation of zero if not negative. Second it causes money to flow into more risky investments like stocks and real estate driving their prices artificially higher thus building bubbles which then pop. Finally, if rates are so low it can present a problem for the United States as it may not be able find willing lenders to borrow from. Anyone want to loan me a trillion dollars at 0% interest and I will pay you back just that trillion dollars in 10 years or better yet how about 20 years.

    So why can the United States not raise interest rates. With a 22 trillion debt serviced at just 5% the interest cost would be 1.1 trillion. Compared to the 2017 record interest cost of 458.5 billion, this would add an additional 641.5 billion to the current annual budget already running a trillion dollar plus deficit. Put in perspective just that additional annual interest cost is more than the FY 2018 Defense Budget and the total interest cost would be almost twice the FY 2018 Defense Budget.

    The only questions now are how long can this continue and how does it end. It will continue as long as Peter does not realize the United States is borrowing from him to pay Paul interest payments. Sadly, probably not too much longer. The end will not be pretty. An animal will sometimes chew a foot off to escape from a trap.

  7. paulie Post author

    Again, I agree with most of what is written in the article, but I am unclear what the point is. I hope to God it’s not a press release because in that case it’s way too ling and doesn’t include quotes of candidates or the chair. If it’s inreach, then I’m a little surprised it didn’t mention free market money and banking beyond repeating the platform plank verbatim.

    It’s in the “features” section of the website so probably closer to inreach. As for what specifically is included and what isn’t, have you tried writing the press secretary and seeing if he is open to some writing collaboration? I know Lauren Daugherty is looking for materials to update the issues section of the website but first they want to reorganize it etc. I would suggest writing her and seeing about getting involved with that process if you have an interest in it.

  8. William T. Forrest

    “Again, I agree with most of what is written in the article”

    I did not see anything to disagree with per se. If there were things in there to disagree with what were they?

    I also did not see a solution. Political parties should point out solutions when they point out problems. “Oh shit, a meteor is headed our way” is good to know but what are we going to do about it?

    The LP’s answer here as far as I can tell is something like “Well it would be nice if we had a cannon the size of France to shoot that sucker into bits before it gets here.” Great, but how does that help us in the real world?

  9. Jared

    “Too much debt at the consumer, business, and government levels led to the financial crisis in 2008, but the Fed tried to fix the problem with still more debt. That strategy bought time, but it will probably lead to eventual default risks that dwarf our country’s earlier problems with real estate debt.”

    I fail to see how federal debt led to the 2008 financial crisis. Federally subsidized real estate speculation and a usurious central banking system? Sure.

    A money issuer whose currency isn’t strapped to any commodity will not default on its debts. States can go bankrupt, but the federal government effectively cannot. Ideally we would run a deficit equal to the market’s demand for new money, measured against something like GNP, to reflect the rate of wealth creation and to facilitate increased domestic and international trade. Federal tax revenues under a fiat system are not a real public treasury. Taxes remove money from circulation to prevent inflation. Old money is essentially destroyed by means of taxation as new money is introduced into the economy, although the intended redistributive effects are the same.

    Austro-libertarian types like Peter Schiff have been predicting immanent financial collapse and hyperinflation for how many years now?

    Eliminate the middle man so that money, i.e., fiat money, can be spent directly rather than lent into circulation, without borrowing, without the banking system reaping interest our expense. Private debt is far more meaningful than public debt, and the Federal Reserve guarantees private debt through an artificial zero-sum game of musical chairs, a monetary black hole that drags all wealth back to the banks through interest payments and foreclosures. Principal is created, while interest is not, so there is never enough money to pay it all back. Debt gets reshuffled, but is never fully eliminated.

    “Only Libertarians recognize that debt — especially debt that has been enabled by Fed-conjured money rather than from hard-earned savings — is an alluring siren but a cruel master.”

    Debt from hard-earned savings? I’m not sure what that means.

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