return to letters list

Inquiry overdue on central banks’ role
letter published in The Australian Financial Review, 26 August 2011

Your report of the extraordinary extent of not previously known loans made in 2008 ($US 1.2 trillion) by the US Federal Reserve to banking and other financial institutions is truly alarming (“Wall St giants got huge Fed loans”, 23 August). It suggests that we can kiss good bye to any idea that these institutions, which amazingly included major foreign banks as well as US ones, will face a moral hazard in their lending policies.

Of course, we knew that moral hazard had been much diminished by the Fed’s role in 2008 in the “saving” of Bears Stern and its opening of the discount window to investment banks, together with the US Treasury’s bail out of Fannie Mae and Freddie Mac.

But this confirms the bad monetary policies of the Fed and many other central banks both before the global financial crisis and during it. Those policies allowed a build up of excessive private sector debt that is still being unwound, including by taxpayers that became responsible for it when banks were taken over by governments.

What is in some ways as concerning as the “never mind the moral hazard” approach is that a group of the biggest US commercial banks last year asked the Supreme Court to keep secret at least some of the Fed lending (this is reported in a version of the Bloomberg report that is longer than the one you published). While (fortunately) this was refused, it brings out the fact that these institutions had to obtain cash from the Fed at a time when they said they had plenty.

One can only surmise that the turbulence following the decision not to rescue Lehman’s in September 2008 not only scared other major institutions but led the Fed to adopt its easy lending policy rather than force other institutions to sell or risk their failure too.

It has been reported that some Republican Presidential candidates have started criticising the Fed’s current policy of flooding the financial system with cash. What seems to be needed is a major inquiry into the role played by central banks, both in the US and other countries, in allowing the creation of excessive debt by the private sector prior to 2008 and the subsequent handling of the resultant problem.

It goes without saying that Australia has a vital interest in the behaviour of overseas central banks.

Treasurer Swan should urge either the G20 or the IMF to undertake an inquiry along the lines I have suggested.

Des Moore
Director, Institute for Private Enterprise
South Yarra Vic

return to letters list