Tuesday, October 7, 2008

The Fed Takes a Step Toward Public Banking

So now the Fed will directly purchase unsecured commercial paper, something a “real” financial institution does as a matter of course (except during a panic). Because even its resources are limited, it is acting on the liability side of the ledger as well, for the first time offering to pay interest on the deposits of commercial banks. (This also encourages banks to be less than fully lent, offsetting the credit creation implications of the Fed’s buying binge.)

If you put these two items together, you have the beginning of what I called Plan B in my earlier post on the subject. There is no need to bail out the private sector: it is possible to create a publicly owned and operated financial entity to carry on the normal tasks of issuing credit, pooling risk and supporting long-term investment. To go further down this road, the Fed would (a) expand the range of assets it would consider buying, and (b) offer competitive returns on deposits and shares of investment funds. Of course, it would be much better for this operation to be spun off to a new entity to avoid conflicts of interest and operational overload.

The overall situation is still in flux, and in particular it is not clear whether it will be possible to unfreeze private financial channels. It may be that, not only is public banking the best strategy—it may be the only one.

1 comment:

The Big Mook said...

There are existing agencies in the Federal government that could be mobilized with temporary hires to augment the existing agency bureaucrats in the Small Business Administration and the Department of Agriculture.

Direct lending is what the SBA disaster office does in time of natural disasters. Lets open the disaster office up for this financial panic. Waiting for the money to trickle down to Main Street from Wall Street is the way to guarantee a deep recession with greater waste than we have now. Salaried GS-11 Bureaucrats have demonstrated they are more capable of making better credit decisions than Wall Street speculators.