10 Years Ago Today: The Lehman Shock

45:36: “We (the Fed) had only one tool which was lending against collateral, we were unable to put capital in, that would only come later with TARP.”—Ben Bernanke, 09/12/18, Fed Chair in 2008

48:15: “There’s a lot of magical thinking about what central banks can do, can they provide artificial support to asset prices, can they levitate them, but these tools the Fed were given were designed to be limited.”— Tim Geithner, 09/12/18, President of the NY Fed in 2008

51:31: “There was so much dry tinder, even if BOA bought Lehman then Merrill would have gone down, so ultimately, it was going to take capital, from fiscal authorities, we were going to have to go to Congress.”—Henry Paulson, 09/12/18, United States Secretary of the Treasury in 2008



I’m not sure if many MMTers would agree with this, but here goes anyway.

All reserves are not ‘High Powered Money’.

‘High Powered Money’ (a term coined by former Fed Chair Marriner Eccles) means newly-created dollars that are additions of dollars to the banking system (that adds Net Financial Assets). In other words, ‘HPM’ is federal gov’t deficit spending.

MMTers say ‘HPM’ means ALL reserves meaning ALL newly-created dollars for ALL federal gov’t spending, including surplus spending, because the MMT pillar is that the function of federal taxation and Treasury bond sales is no longer a gold-standard-era financing function—that ALL federal spending now comes ‘first’—then afterwards both federal tax collections & federal bond sales are done as a ‘dollar drain’ out from the money supply to maintain fiat dollar demand and also to maintain price stability.

However, it’s hard to defend that ALL reserves (created by the Fed for all federal spending) are ‘HPM’.

Marriner Eccles had a fight with the Treasury Secretary because he didn’t want to follow an order to use ‘HPM’ to buy Treasury bonds. Eccles refused to use ‘HPM’—he wanted to use existing dollars (he wanted the public to pay for the bonds). Eccles (not wanting inflation) stopped the Treasury (wanting cheap financing) from forcing the Fed to create ‘HPM’ to pay for bonds (a fight that Eccles won and led to the Fed’s independence from the Treasury in the ’51 Accord).

Fast forward to recent years, would you consider all of the $4.2T in reserves that the Fed created to pay for bonds during QE as being ‘High Powered’? That answer is no, you shouldn’t have considered any of those newly-created reserves ‘High Powered’ because that $4.2T was a swap of bonds for reserves. Unlike any federal spending, that $4.2T in newly-created reserves were added to the banking system but were not added to the money supply. Would you consider all the newly-created reserves that went to pay for $3.98T of total federal spending in 2017, that were added to the money supply, as being ‘High Powered’? That answer is also no, you shouldn’t have either because even though that $3.98T was newly-created dollars (that came into the money supply), most of it ($3.315T) was a swap for tax dollars (that came out of the money supply). Only the amount of federal deficit spending in 2017 ($666B) was ‘High Powered’ because an already-existing $666B was swapped for Treasury bonds AND THEN ANOTHER $666B was ‘vertically’ added (unlike ‘horizontally’, another $666B was added WITHOUT attached bank debt), meaning like any fiscal year’s amount of deficit spending, that newly-created $666B was a net addition of dollars to the banking system that goes into the money supply (aka Net Financial Assets). Only those newly-created, ‘NEWLY-EXISTING’ dollars are ‘HPM’. Which is why deficit spending dollars are ‘High Powered’—because it has an inflationary bias; and why surplus spending dollars (or heaven-forbid running sustained federal budget surpluses) are not ‘High Powered’—because it has a deflationary bias.

Some reserves created by the Fed are ‘High Powered Money’ and some are not. When asked why ten years ago, on September 15, 2008 the Fed didn’t save Lehman Brothers, holding over $600,000,000,000 in assets, from filing for Chapter 11 bankruptcy protection, the largest bankruptcy filing in U.S. history, the answer was that, unlike Bear Stearns with a liquidity problem (low on cash BUT still with assets greater than liabilities), Lehman had a solvency problem (low on cash AND with liabilities greater than assets). The Fed can help with the former and not the latter because the Fed is “unable to put capital in”, the tools the Fed are given “were designed to be limited” and that “ultimately it was going to take capital from fiscal authorities”.

In other words, Congress must first authorize the Fed to create reserves that adds capital (like for TARP); and likewise, Congress must first authorize the Fed to create reserves that adds Net Financial Assets (like for deficit spending). All NFAs are ‘High Powered Money’ (and all reserves are not).


P.S. This is where the ‘reserves is HPM’ meme comes from.


The first sentence is perfect and why MMTers should say ‘taxes don’t *technically* finance spending’ (instead of saying ‘taxes don’t fund spending’).

The second sentence is close but no cigar (see the above difference between ‘newly-created’ money for federal surplus spending that doesn’t add Net Financial Assets v. ‘newly-existing’ money for federal deficit spending that does).

The second sentence should say that ‘modern governments actually finance all of their DEFICIT spending through the direct creation of high-powered money.’ If not, then Dr. Kelton is, at best, jumping the gun to that Pure MMT phase (after MMT has been accepted by the mainstream) when we don’t use terms like national ‘debt’ (we instead say national debit or national savings), when we don’t say trade ‘deficit’ (we instead say trade differential), when we don’t say ‘deficit’ spending (we instead say how many dollars that the issuer added to the banking system); or at worst, Dr. Kelton and her listeners are still not fully grasping that gap between the modern monetary theory and that pesky, albeit unnecessary, modern monetary formality.


Thanks for reading,

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