By now, we’ve all seen that the Federal Reserve’s “Quantitative Easing 2” program hasn't been a success.
They printed money that went into the banks. The banks held some of it in reserves and invested most of it in U.S. Treasurys. The banks made money off of “free money” deposited by the Federal Reserve.
It’s was a great deal for them if you think about it. You get free money. You get to invest it in Treasurys and earn money by using money that you never had before. You didn’t have to worry about investors paying off loans or needing money back from deposits, etc. It was a “free gift” from the Fed.
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Not only did banks make money this way, but also the Fed pays the banks interest on the money they are holding. So not only did they get free money handed to them but they get a steady stream of free interest too. Man, where can I sign up for a deal like that?
You see, the Fed felt that the banks would take the money and use it to make loans to businesses and individuals.
However, the bank’s job is to make a profit for themselves and not to revive an economy necessarily. They didn’t want to invest in a shaky market, so they went for what was “safe and steady” by investing in Treasurys.
So that’s how a lot of this mess happened.
Here is my simple solution that won’t cost extra money. In fact, it would save the Fed money and the economy would get jump-started much quicker.
What is the plan? Here it is.
1. Quit paying the banks interest on the money they are holding.
2. Actually charge them interest if they don’t issue out loans on the bulk of the “free money” given to them by the Fed.
This would change the equation all together. You see, banks are all about “making interest”. It’s what they understand. They don’t want to own homes.
They want to make interest on homes. They don’t want to own cars or businesses. They want to make interest off of the loans that finance them.
So by taking the steps above, the Fed would start to “talk their language” – the interest language.
If the Fed stopped paying interest on their reserves, they would have an incentive to make loans so that they could get to earning some interest again.
And if point 1 above wasn’t a big enough incentive…point 2 (charging interest) would be.
You see, banks understand the power of compounding interest. However, they always want to be on the correct side of that equation…you paying it to them and not them paying it out to anyone.
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If they are forced to pay interest, they want to make sure they are making far more than they are paying.
That’s why they may take your money and pay you 0.50 percent on it and then loan it out for a home loan at 6 percent.
So if more pressure is applied upon the banks, they will begin to make loans once again. If the Fed stops paying interest on reserves and actually threatened to charge them interest on a certain percentage of unused money, they’d get to making loans again real quickly.
If loans will be made to small businesses, etc….it won’t be long before you’d start to see the employment situation in the U.S. start to improve.
About the Author: Sean Hyman
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