Former Federal Reserve Official: “I’m Sorry, America.”

Andrew Huszar is a former Federal Reserve official. He has harsh words for his former employer, and for the misdeeds they continue to perform. I am sure Huszar is a Keynesian, but that does not change that he seems to have realized the truth about the Federal Reserve, and who the Federal Reserve is actually designed to serve.

I can only say: I’m sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed’s first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I’ve come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.

Correct. The Federal Reserve, the institution in America that prints money, utilizes the process known as Quantitative Easing (QE) to supposedly revive the ailing US economy. In reality, QE is used to prop up Wall Street. QE functions not unlike the cartoon shown above. It is refreshing to see some honesty about this in the mainstream media for once.

Five years ago this month, on Black Friday, the Fed launched an unprecedented shopping spree. By that point in the financial crisis, Congress had already passed legislation, the Troubled Asset Relief Program (TARP), to halt the U.S. banking system’s free fall. Beyond Wall Street, though, the economic pain was still soaring. In the last three months of 2008 alone, almost two million Americans would lose their jobs.

TARP was one of the most outrageous pieces of legislation in history. TARP forcibly took money from taxpayers, many of whom were losing their homes and their jobs at the time, and gave it to crooked and/or stupid bank executives and CEOs so they could keep their own heads above water. It was a travesty. Any politicians who were in favor of TARP, such as Nancy Pelosi and John Boehner, deserve to be vilified by history.

The Fed said it wanted to help—through a new program of massive bond purchases. There were secondary goals, but Chairman Ben Bernanke made clear that the Fed’s central motivation was to “affect credit conditions for households and businesses”: to drive down the cost of credit so that more Americans hurting from the tanking economy could use it to weather the downturn. For this reason, he originally called the initiative “credit easing.”

It was a stupid idea from the beginning. An overextension of credit was one of the main causes of the 2008 crash in the first place. Bernanke’s words in a clearer translation read: “We didn’t know how to fix the mess that we caused by inflating credit, so we decided to fix it by inflating credit.”

Huszar goes on with his own backstory, before seguing into this:

In its almost 100-year history, the Fed had never bought one mortgage bond. Now my program was buying so many each day through active, unscripted trading that we constantly risked driving bond prices too high and crashing global confidence in key financial markets. We were working feverishly to preserve the impression that the Fed knew what it was doing.

Bingo. The Federal Reserve works feverishly to present the image that it is in control. In reality, the Federal Reserve has no idea what it’s doing. QE was supposed to kick-start the economy from the beginning; it didn’t. They’re out of ideas, but they still scramble to present the image that they know exactly what they’re doing. If you don’t believe me, read any press release from the Federal Reserve, and you’ll see what I mean: all gobbledy-gook and legalese. It is sophistry desgined to fly over the heads of average people and give the impression that brilliant economic scientists are at the helm, instead of economic idiots. Furthermore, each release basically says the same thing: “QE is working, we’re going to continue QE, and we’re optimistic.”

It wasn’t long before my old doubts resurfaced. Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

Banks are afraid to make loans to anyone not backed by QE or guaranteed by the Government. They want to be sure they will get their money back. Look a this chart; it shows the total amount of money created by the Federal Reserve.

There is a lot of money in the economy that was there not pre-2008. If all this money actually hit the general market, we probably be hit with hyperinflation. Most of this money sits in digital vaults at the Federal Reserve. The Federal Reserve can force banks to start loaning this money out at any time by imposing a fee on these excess reserves held by the banks in digital vaults. This would likely produce mass inflation very quickly. I have written an extensive article about this here.

From the trenches, several other Fed managers also began voicing the concern that QE wasn’t working as planned. Our warnings fell on deaf ears. In the past, Fed leaders—even if they ultimately erred—would have worried obsessively about the costs versus the benefits of any major initiative. Now the only obsession seemed to be with the newest survey of financial-market expectations or the latest in-person feedback from Wall Street’s leading bankers and hedge-fund managers. Sorry, U.S. taxpayer.

Correct. When President Obama famously quipped “the private sector is doing just fine”, he believed what he said. All his CEO and banker golf buddies were doing just fine, thanks to the Federal Reserve. As far as Obama could tell, the economy was doing great.

Trading for the first round of QE ended on March 31, 2010. The final results confirmed that, while there had been only trivial relief for Main Street, the U.S. central bank’s bond purchases had been an absolute coup for Wall Street. The banks hadn’t just benefited from the lower cost of making loans. They’d also enjoyed huge capital gains on the rising values of their securities holdings and fat commissions from brokering most of the Fed’s QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was starting off in much the same way.

Record highs continued to appear in 2011, 2012, and into 2013. The stock markets are soaring, while the general economy is stagnant at best. There is a clear disconnect between the stock markets and the health of the general economy. This should be apparent to everyone by now.

You’d think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2. Germany’s finance minister, Wolfgang Schäuble, immediately called the decision “clueless.”

That was when I realized the Fed had lost any remaining ability to think independently from Wall Street. Demoralized, I returned to the private sector.

Where are we today? The Fed keeps buying roughly $85 billion in bonds a month, chronically delaying so much as a minor QE taper. Over five years, its bond purchases have come to more than $4 trillion. Amazingly, in a supposedly free-market nation, QE has become the largest financial-markets intervention by any government in world history.

The Federal Reserve will not taper, or tone down, QE any time soon. The markets have come to depend on QE. They need these infusions of money. The Fed will continue with this practice until they are at the end of their rope. They are kicking the can.

And the impact? Even by the Fed’s sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed El Erian at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output). Both of those estimates indicate that QE isn’t really working.

Unless you’re Wall Street. Having racked up hundreds of billions of dollars in opaque Fed subsidies, U.S. banks have seen their collective stock price triple since March 2009. The biggest ones have only become more of a cartel: 0.2% of them now control more than 70% of the U.S. bank assets.

This is correct. The 10 largest banks in America control over 77% of the banking industry’s money. This is Pareto Distribution gone wild. These banks are the elephants in the room. They do not hold deposits from the little folks like you and I; they hold huge deposits from organizations like hedge funds. If these depositors smell blood in the economic water, they will make a run on the banks. These accounts are far too large to be insured by the FDIC; therefore, these banks will go bust, because they are fractional reserve and do not have enough money to pay off all these large depositors. When the Federal Reserve finally ends QE (which it will, at some point), this is the nightmare scenario that is going to come to life for these large banks. These banks will not have sufficient funds to pay off short-term lenders. This is going to cause short-term interests rates to rise. Rising short-term rates will plunge the economy into a long-overdue recession. The Federal Reserve will kick this can for as long as possible. They will continue to bail-out the large banks for this reason, and delay the inevitable.

As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a structurally unsound U.S. economy. Yes, those financial markets have rallied spectacularly, breathing much-needed life back into 401(k)s, but for how long? Experts like Larry Finkat the BlackRock investment firm are suggesting that conditions are again “bubble-like.” Meanwhile, the country remains overly dependent on Wall Street to drive economic growth.

Even when acknowledging QE’s shortcomings, Chairman Bernanke argues that some action by the Fed is better than none (a position that his likely successor, Fed Vice Chairwoman Janet Yellen , also embraces). The implication is that the Fed is dutifully compensating for the rest of Washington’s dysfunction. But the Fed is at the center of that dysfunction. Case in point: It has allowed QE to become Wall Street’s new “too big to fail” policy.

The US economy is unsound. The recession of 2008 should not have been fought by the Federal Reserve. Let me drill this fact through your skull: Recession is the cure, not the problem. If the Fed had let the 2008 recession run its course and “cure” the unsound economy, we would already be on the backside of the worst it had to offer and could look forward to a re-adjusted and healthier economy. Instead, they chose QE; they chose to bail out the unsound American banking system; they chose to reward poor business sense and misallocation of capital. They chose to kick the can. When the Federal Reserve finally chooses to no longer bail-out the largest banks, these banks will fail. This will produce a massive recession. Recession sucks, but this will ultimately be a good thing, because recession is the cure. Emerging from recession, we will finally have a healthy economy once again, and hopefully have a good shot at reforming the banking system at that time.

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