To avert a financial panic, central banks should lend early and freely to solvent banks against good collateral but at penal rates

First. That these loans should only be made at a very high rate of interest. This will operate as a heavy fine on unreasonable timidity, and will prevent the greatest number of applications by persons who do not require it. The rate should be raised early in the panic, so that the fine may be paid early; that no one may borrow out of idle precaution without paying well for it; that the Banking reserve may be protected as far as possible.

Secondly. That at this rate these advances should be made on all good banking securities, and as largely as the public ask for them. The reason is plain. The object is to stay alarm, and nothing therefore should be done to cause alarm. But the way to cause alarm is to refuse some one who has good security to offer… No advances indeed need be made by which the Bank will ultimately lose. The amount of bad business in commercial countries is an infinitesimally small fraction of the whole business…

The great majority, the majority to be protected, are the ‘sound’ people, the people who have good security to offer. If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed. But if securities, really good and usually convertible, are refused by the Bank, the alarm will not abate, the other loans made will fail in obtaining their end, and the panic will become worse and worse.

Walter Bagehot Lombard Street: A Description of the Money Market (1873).

The classical theory of the lender of last resort stressed

(1) protecting the aggregate money stock, not individual institutions,

(2) letting insolvent institutions fail,

(3) accommodating sound but temporarily illiquid institutions only,

(4) charging penalty rates,

(5) requiring good collateral, and

(6) preannouncing these conditions in advance of crises so as to remove uncertainty.

Did anyone follow these rules in the global financial crisis? The Fed violated the classical model in at least seven ways:

  1. Emphasis on Credit (Loans) as Opposed to Money
  2. Taking Junk Collateral
  3. Charging Subsidy Rates
  4. Rescuing Insolvent Firms Too Big and Interconnected to Fail
  5. Extension of Loan Repayment Deadlines
  6. No Pre-announced Commitment
  7. No Clear Exit Strategy

…{the Fed’s} policies are hardly benign, and that extension of central bank assistance to insolvent too-big-to-fail firms at below-market rates on junk-bond collateral may, besides the uncertainty, inefficiency, and moral hazard it generates, bring losses to the Fed and the taxpayer, all without compensating benefits. Worse still, it is a probable prelude to a severe inflation and to future crises dwarfing the current one.

Thomas Humphrey (2010)

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

The Market Monetarist

Markets Matter, Money Matters...

Climate Audit

by Steve McIntyre

healthcare-economist.com/

An unbiased look at today's health care issues

Plugging the Gap

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Mostly Economics

This blog covers research work in Economics with focus on India.

Velvet Glove, Iron Fist

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

The NEP-HIS Blog

Discussion and comment on the latest research in business, economic and financial history

Economics in the Rear-View Mirror

Archival Artifacts from the History of Economics

Green Jihad

Your source that tells the truth about the environmentalist movement's holy war against mankind

@STILLTish. Gender Abolition

Examining Gender Identity ideology and its impact on Women's Sex based protections. Exploring how this has taken such firm root in Western societies (Cognitive & Regulatory Capture).

200-Proof Liberals

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Family Inequality

by Philip N. Cohen

What Paul Gregory is Writing About

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Kids Prefer Cheese

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Offsetting Behaviour

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

JONATHAN TURLEY

Res ipsa loquitur - The thing itself speaks

single sex spaces

Single sex spaces are a question of consent

Adventures of a Tudor Nerd

Tudor History from the Wars of the Roses to the Death of Elizabeth I

Weapons and Warfare

History and Hardware of Warfare

TannerOnPolicy

Politics and Policy with a Libertarian Twist

Notes On Liberty

Spontaneous thoughts on a humble creed

Map Dragons

Written by map lovers for map lovers

CONVERSABLE ECONOMIST

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Barrie Saunders

Thoughts on public policy and the media

The Victorian Commons

Researching the House of Commons, 1832-1868

Coyote Blog

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

The History of Parliament

Blogging on parliament, politics and people, from the History of Parliament

Catallaxy Files

Australia's leading libertarian and centre-right blog

Books & Boots

reflections on books and art

Legal History Miscellany

Posts on the History of Law, Crime, and Justice

Sex, Drugs and Economics

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

The Long Run

the EHS blog

Vincent Geloso

Economics, History, Lots of Data and French Stuff

Climatism

Tracking Anthropogenic Climate Alarmism

Science Matters

Reading between the lines, and underneath the hype.

Point of Order

Politics and the economy

FREEcology

Libertarian environmentalism

%d bloggers like this: