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One Reason the Economy Sucks in Graphs

Anthony Randazzo
October 27, 2010, 6:12pm

Yesterday I was talking with a medium-sized, regional bank vice president at the Mortgage Bankers Association annual convention in Atlanta about what it is going to take for banks to start investing their reserves in the economy again. His response was telling, "Get a better return other than with treasuries." Right now banks can borrow basically for free from the Fed, invest in government debt for a 3 to 4 percent return, and just sit on their hands until the uncertainly cloud over the economy clears away. And there is some $1.5 trillion under their hands that might be otherwise invested in the economy right now creating jobs and promoting recovery.

Here is a bit more visual presentation of the phenomenon:

Banks can borrow from the Fed or each other at rates of 1 percent or below.

bank borrowing rates

A simple way of understanding the above chart is that the "Fed Funds Rate" is the rate at which banks borrow money from each other, the "Discount Rate" is the rate banks can borrow from the Federal Reserve, and LIBOR (the London Inter-bank Offer Rate) is a rate at which banks can borrow from each other or the public. But by any measure, it is cheap to borrow right now.

Then banks can invest that money in Treasury notes earning as much as 4 percent.

Treasury Notes

Combined that equals this:

bank reserves

If banks were unable to earn easy money off of treasuries, they would have to put more of their capital to work to earn similar profits, drawing down reserves.

In normal times banks were holding under a trillion in reserve. Now banks are holding onto a lot of their money. Certainly not all of it. And there is private sector lending. But it is very limited. The whole right side of the above chart represents cash that could be invested in the economy (meaning job growth), but isn't right now. Banks are holding on to their cash for a number of reasons: uncertainty about taxes and regulation, an aversion to risk, and an increase in consumer savings.

And that is one big reason for our lethargic GDP growth and fledgling unemployment.

P.s. One could argue that banks should have kept more because of their risks, but if they had put the same money in less risky investments, they would have been fine with the same reserves.


Anthony Randazzo is Director of Economic Research


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