As you might have seen, the Federal Reserve has started buying government bonds with money it gets from the maturing mortgage-backed bonds that it bought during the recession. The goal is to try to cut interest rates on mortgages and corporate loans, which in turn would increase borrowing and help the economy grow faster.
However, this move says that the economy is clearly facing a double dip. The Federal Reserve’s purchases of government bonds is simply pushing rates down to absurdly low yields and competing with investors who may need safety or income, and indeed putting investors at risk should rates go back up.
This strategy does little to help the economy other than to help the highest quality entities borrow at lower rates for purposes they likely would have done in any event. What really matters is getting entrepreneurs, investors and less creditworthy businesses access to capital. There is nothing more important than capital formation in this economy.
The consolidation of banks and the heightened regulatory oversight since the credit crunch have served to inhibit access to financial stimuli, not help it.
The best model we could emulate is China’s where they encourage bank lending and even buy back at par some failed loans, so that capital can be distributed to where the growth is most likely to occur. We already know how to control the spigot of bank lending to stimulate or slow down the economy, so we know how to work this model.
The original theory for TARP was to buy troubled assets to keep the capital accounts of financial institutions in good shape, it was not to put capital into those institutions or to put money into the economy through every elected official’s pet projects which don’t have lasting stimulation or else have limited impact.
We need to go back to basics and encourage lending to individuals and businesses, especially the small businesses.