Welcome to our Friday mailbag edition!
Every week, we get great questions from your fellow readers. And every Friday, I do my best to answer them.
Our questions today revolve around the most powerful central bank in the world – the Federal Reserve.
The Fed has the unlimited, unregulated, and unelected ability to create as much money as it is deemed necessary to meet the crises of the day.
It did that, to the tune of $4.5 trillion, in the wake of the 2008 financial crisis.
I’ve criticized the Fed for bailing out the big banks on Wall Street at the expense of Main Street. But one reader wants to know: was there an alternative?
I would like to hear from Nomi, what would she have done differently in 2008? The bailing out of the banks sounded outrageous, especially because they protected the big wigs’ salaries but did not protect the families from losing their homes. But if [then-Fed Chief Ben] Bernanke had not bailed them out, what would have happened?
– Maria C.
Hi Maria, thank you for your question and comments. I wrote about the alternatives to bailing out the banks in my 2009 book, It Takes a Pillage.
If you have a copy, it’s in Chapter 2, called “This Was Never About the Little Guy.” I also shared an excerpt in these pages, which you can read right here.
The alternative comes down to the numbers.
There were about half a trillion dollars’ worth of subprime loans that were in default. That’s out of $1.5 trillion that were extended to borrowers during the years that led up to the financial crisis of 2008.
Yes, some of those loans should not have been extended because the borrowers couldn’t afford to repay them from the beginning.
But a lot of the risks inherent to those loans weren’t properly disclosed to borrowers. Also, certain lenders were very loose with the information that they required from borrowers to provide these loans.
That was one major fault of the Federal Reserve. It did not regulate the bank lending process when it could have.
But nonetheless, the large Wall Street banks were able to engineer assets using these loans to the tune of $14 trillion. That’s a factor of 28 times.
Even if the subprime loans that banks bought to stuff into these assets had not defaulted, the entire exercise was a house of cards. Or like an upside-down pyramid destined to topple over.
Imagine you have a flat tire, and you can only pump in 1/28th of the air the tire needs to function properly. The tire isn’t going to be safe.
Plus, Wall Street was lending money to institutional buyers of those assets – using the assets as collateral!
When the subprime loans at the bottom of this upside-down pyramid scheme stopped paying interest out as expected, the entire scheme toppled.
I would not have bailed out the banks for doing that. Instead, I would have made those mortgages whole to stop the defaults and fined the banks for that difference.
The cost would have been half a trillion dollars and not the trillions we have spent since. Perhaps one or two more banks would have toppled during that time as a result.
But that was the risk they took. And it would have been a whole lot cheaper.
Have you written a book that explains how the Fed works? If you have, please send me the name so I can purchase it and learn.
– Gray W.
Hi Gray, thanks for your interest in my books.
Many of my books discuss various aspects of the Fed, historically and as it’s behaved since the financial crisis. So it depends on what you are looking for exactly.
My favorite for broad context on the Fed would be All the Presidents’ Bankers.
In that book, I wrote extensively about the origins of the Fed. I also wrote about how the Fed has operated since its inception in 1913 through 2014, when the book came out. Read an excerpt from it here.
For more recent behavior of the Fed since the financial crisis of 2008 with respect to Wall Street, check out my 2009 book, It Takes a Pillage. Here is that excerpt again, which I shared above.
Regarding the Fed as a powerful actor on the global stage, check out my 2018 book, Collusion. Read an excerpt here.
And to see how what the Fed has done impacts The Great Distortion between the markets and the real economy that we have today, check out my latest, Permanent Distortion. Read an excerpt from it here.
I hope that helps.
And that’s all for this week’s mailbag. Thanks to everyone who wrote in!
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can.
You can write me at [email protected]. Just remember, I can’t give personal investment advice.
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins