Cut out the middleman

Something is not right in the state of Federal Reserve. For all that we were worried about banks' liquidity at the end of 2008, the immediate crisis has abated. They haven't made any toxic loans in the past year and the extremely low federal funds rate supplied enough money to keep the banks' reserves on a steady keel, thus protecting the depositors.

But, like all entitlements, the banks have learned to game the system and the big losers are us, the taxpayers. The huge bonuses on Wall Street are not in themselves an issue but are symptoms of how the federal government is currently providing the means by which the banks have reaped vast profits.

Here's the formula. The prime rate is currently 3.25% and the discount rate is currently .75%. The prime rate is charged only to a bank's absolutely one or two best customers. The rest pay considerably higher rates. Even at the prime rate the banks are making huge profits, lending at anywhere from 3.25% up to 22% for high risk credit card customers.

The prime rate for decades has been pegged by the Wall Street Journal at 3% above the federal funds target rate. The Federal Funds Target rate is essentially the cost of money banks must keep in reserve, unproductively. What they don't get from their depositors, for which they pay .1%, they must borrow at, currently, .25% from banks which have excess reserves. If they can't get money from other banks, at last resort they can go to the Federal Reserve's discount window which will currently lend them all they need for .75%. Essentially, the banks are currently getting money for 3/4% or less. When the Federal Funds Target rate is at 4% or 5% I can understand why they would charge 3% over this cost but at current rates, a prime rate 3% above the Federal Funds Rate is usurious.

The system is supposed to work like this. The banks get money from their depositors and lend out 90% of it. They make their money on the spread between what they pay their depositors and what they charge their borrowers. Everyone wins. The depositors get a safe return on their money, the banks make a profit on very secure loans. Only now, the depositors are cut out of the game. Does it make a difference to the banks if they borrow at .1% or .25% or even .75% if they can get 5% on a mortgage loan secured by good real estate. I don't think so. If the Fed raised its discount rate even by 1% I am not sure it would seriously impact current commercial and mortgage loan rates. With such a spread between the cost and sale price of money, there would bound to be competition between banks to make loans. I think the Fed should raise rates, to give depositors some decent return on their money and to cut back the banks' profits.

The attempt to regulate compensation at financial institutions which got bailed out in the 2008 shakeout is a fair one. The banks, in the words of Daniel Gross in Newsweek, "...moved into our house, raided our fridge, and set the joint on fire. Now they're complaining that our renovation efforts are cramping their style." They claim that without the huge compensation offered, their talent would go elsewhere. First of all, where would they go? Secondly, how much talent does it take to make money by borrowing at .25% and lending at 7%. And if this is the talent that took inordinate risks with depositors' money, the banks would be better off without them.


You can tell that the banks don't care to get depositors' money, giving only about .1% even for savings accounts. It's sort of like a large company having only a very limited number of distributors, thereby restricting competition. If this continues, the public will be impoverished and the banks will have all the money.

The banks aren't lending, or not at reasonable rates, they are distributing the Fed's money at 933% markup. No wonder no one has a job.

If the Federal Reserve won't raise the discount rate or Target rate, then maybe they should start lending directly to businesses and consumers. That might jump start the economy.