Interesting blog post on why QE2 failed

Why QE2 Failed: The Money All Went Offshore « WEB OF DEBT BLOG

On June 30, QE2 ended with a whimper. The Fed’s second round of “quantitative easing” involved $600 billion created with a computer keystroke for the purchase of long-term government bonds. But the government never actually got the money, which went straight into the reserve accounts of banks, where it still sits today. Worse, it went into the reserve accounts of FOREIGN banks, on which the Federal Reserve is now paying 0.25% interest.

 

Before QE2 there was QE1, in which the Fed bought $1.25 trillion in mortgage-backed securities from the banks. This money too remains in bank reserve accounts collecting interest and dust. The Fed reports that the accumulated excess reserves of depository institutions now total nearly $1.6 trillion.

Interestingly, $1.6 trillion is also the size of the federal deficit – a deficit so large that some members of Congress are threatening to force a default on the national debt if it isn’t corrected soon.

So here we have the anomalous situation of a $1.6 trillion hole in the federal budget, and $1.6 trillion created by the Fed that is now sitting idle in bank reserve accounts. If the intent of “quantitative easing” was to stimulate the economy, it might have worked better if the money earmarked for the purchase of Treasuries had been delivered directly to the Treasury. That was actually how it was done before 1935, when the law was changed to require private bond dealers to be cut into the deal.

The one thing QE2 did for the taxpayers was to reduce the interest tab on the federal debt. The long-term bonds the Fed bought on the open market are now effectively interest-free to the government, since the Fed rebates its profits to the Treasury after deducting its costs.

But QE2 has not helped the anemic local credit market, on which smaller businesses rely; and it is these businesses that are largely responsible for creating new jobs. In a June 30 article in the Wall Street Journal titled “Smaller Businesses Seeking Loans Still Come Up Empty,” Emily Maltby reported that business owners rank access to capital as the most important issue facing them today; and only 17% of smaller businesses said they were able to land needed bank financing.

How QE2 Wound Up in Foreign Banks

Before the Banking Act of 1935, the government was able to borrow directly from its own central bank. Other countries followed that policy as well, including Canada, Australia, and New Zealand; and they prospered as a result. After 1935, however, if the U.S. central bank wanted to buy government securities, it had to purchase them from private banks on the “open market.” Former Fed Chairman Marinner Eccles wrote in support of an act to remove that requirement that it was intended to keep politicians from spending too much. But all the law succeeded in doing was to give the bond-dealer banks a cut as middlemen.

Worse, it caused the Fed to lose control of where the money went. Rather than buying more bonds from the Treasury, the banks that got the cash could just sit on it or use it for their own purposes; and that is apparently what is happening today.

In carrying out its QE2 purchases, the Fed had to follow standard operating procedure for “open market operations”: it took secret bids from the 20 “primary dealers” authorized to sell securities to the Fed and accepted the best offers. The problem was that 12 of these dealers – or over half — are U.S.-based branches of foreign banks (including BNP Paribas, Barclays, Credit Suisse, Deutsche Bank, HSBC, UBS and others); and they evidently won the bids.

The fact that foreign banks got the money was established in a June 12 post on Zero Hedge by Tyler Durden (a pseudonym), who compared two charts: the total cash holdings of foreign-related banks in the U.S., using weekly Federal Reserve data; and the total reserve balances held at Federal Reserve banks, from the Fed’s statement ending the week of June 1. The charts showed that after November 3, 2010, when QE2 operations began, total bank reserves increased by $610 billion. Foreign bank cash reserves increased in lock step, by $630 billion — or more than the entire QE2.