The role of central banks has been perverted
Central banks were designed as the lender of last resort for banks. If people wanted cash and a bank didn’t have the cash to sell quickly, they could turn to central banks for loans.
However, over time, central banks have become lenders of last resort (and sometimes first resort) to the entire financial system.
This is particularly noteworthy because the coronavirus financial crisis was not centered on the banks. Tighter capital rules after the financial crisis have left banks generally in good shape as a result of panic.
Rather, it was the shadow banking system that collapsed. Alternative mortgage lenders had to be saved; junk bonds have been bailed out; commercial paper, pensions and munitions were saved. Swap lines have been put in place to protect the credit market.
The reality is that the Fed has refused to draw a line on who will be saved when things get tough. In doing so, they created a system where everyone can take too many risks because they can count on a safety net.
The proliferation of non-bank loans is aimed at obtaining higher yields or paying lower costs than those of the banking system; but obviously with the best reward, there is no greater risk.
It is a broken system which suffers from a lack of coherent mission beyond the vague “protect the financial system”. A good financial system protects itself, it is far too fragile.
Ask yourself: Was it inevitable that the Fed activated these new programs? Whether this pandemic or a future recession? I have no doubt about it.
The good news is that the conversation is now starting on what needs to be done to fix it.
There is a large column at Bloomberg which is a great place to start:
Without a doubt, the Fed has done the right thing right now. Without sound
intervention, the economic damage would be much worse. But the need to
these extraordinary measures reveal a deeper problem: the government has
but lost control of money creation. In good times, this allows
financial institutions the freedom to create all kinds of money
instruments. In difficult times, central banks must support these instruments,
read the collapse of the financial system …
What is actually the aberration? A system in which the government
maintains some control over the creation of money, or that in which it
must repeatedly devise unprecedented measures to support forms of money
over which he has no control?