Banks, Bonuses, and Bernanke

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On Thursday last week the Fed raised the discount rate on bank borrowings by .25%. They also removed some of the extraordinary measures that they’ve had in place since the winter of 2008. According to its web-site, the Fed thinks that the financial crisis is winding down.

It’s natural to ask why. Why did the Fed turn and raise the discount rate just after voting last month to keep interest rates low “for a considerable period?” One answer is inflation. Most governors think there is upside risk to inflation. But why now? This has to do with the banks.

We’ve just come through bonus season and it wasn’t pretty. The Fed’s low interest rates allow the banks to earn big bucks by just buying bonds. As long as they keep rates near zero, Bernanke and Co. could be accused of coddling the banks. And he was just about testify before Congress. In order to maintain his credibility as a regulator, Bernanke needs to distance himself from the Goldman and JP Morgan crowd. The rate hike was one way to do this.

By raising the penalty rate, the Fed signaled to Congress that that they’re the banks’ referee, not their cheering section. But when politics drives the Fed, I wonder who’s next.

Douglas R. Tengdin, CFA
Chief Investment Officer
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