E The Federal Reserve Knew LIBOR Was Exploding In 2007 And Did Nothing

The Federal Reserve did nothing when LIBOR exploded in 2007 (chart at the end of this article). But since then, the Fed has taken the four steps listed below. The result of these steps will be a slow economy going forward.

Jeffrey Rogers Hummel recently posted an article spelling out the relationship of the Fed to banks and the government. I have no clue whether his main argument is valid although we know the Fed is paying banks 12 billion dollars in 2016 in interest on reserves (IOR). That seems like real money to me.

But the most interesting aspect of the article for me is Mr. Hummel stated that the big banks who are members of the Fed get few perks from that position. I think the big banks get massive perks from the Fed. I want to share again what I posted on Talkmarkets. I said:

So, we need to look at the ways in which the Fed has set things up to predispose it to keep rates low.

1. Grumpy's (Grumpy is John Cochrane) friend says the Fed can't afford to pay the treasury interest if rates are significantly raised. That is almost a hostage situation.

2. The banks have bet on low rates, taking the floating low side of the swaps bet when they issue loans.

3. The Fed pays interest on the excess reserves in order to restrain lending.

4. Long bonds are in massive demand as collateral, the new gold, and there are shortages, even with BRICS nations selling into a deep market.

Clearly, the Fed does not want to repeat the explosion of LIBOR, ever again. The chart at the end of this article shows that LIBOR was on a collision course with the Swaps Rate in September, 2007. The Fed could have lowered interest rates before that LIBOR line crossed the Swaps line.

Once LIBOR and Swaps crossed, it was curtains for interbank lending.  And swaps were placed at risk that were based on the banks taking floating LIBOR and the counterparties taking fixed high rate.

Sumner and his friends believe the Fed was too tight during that time. There could be some truth to that, knowing that the Fed paid IOR (interest on reserves), which slowed the money supply and growth, to be sure. But one wonders why the Fed did not attempt to reduce the LIBOR explosion that predated those reserves being put into place?

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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