The Fed Wouldn’t Cut it as a Normal Bank

The Fed is governed by institutional rules that separate it in operation and incentive from all other banks. Rather than being driven by profit and benevolence, it is ruled by a convoluted system of spoken and unspoken incentives that are often at odds with one another. The purpose of the Fed is nominally to keep unemployment low and pursue monetary stability, but its role as part of the government adds in layers of motivational complexity. The Fed was initially created to provide safety from the bank runs and crises around the early 20th century. However, as part of an expansionary state, it has gradually come to hold more power. The Fed makes three critical mistakes that show how its tangle of motivations make it act irresponsibly compared to normal banks where the stakes are far lower. The Fed’s first mistake is treating all banks as having equal credit-worthiness. This sort of lack of distinction would destroy any normal bank. Additionally, the Fed is very bad at determining whether decreasing the interest rate will lead to more economic growth, because that is entirely dependent on the ability of the banks they loan to to lend to productive enterprises. Finally, the Fed exacerbates negative situations by lending precisely when it would be least wise for a normal bank to lend. 

The center of all free market lending is the ability of the lender to calculate a reasonable risk premium. This varies depending on the borrower, because their ability to pay back is the only factor of significance to that customer’s unique rate. The Fed’s inability to distinguish between different banks is a massive problem because equally flourishing fundamentals are not automatically given to every bank. Sometimes, less trustworthy banks must be given price signals that will lower their chance of survival. Because false support will only sustain irresponsible banks, the Fed risks hurting both “productivity” and citizens. The Fed’s influence on all banks through manipulation of the federal funds rate, even for undeserving ones, has already exacerbated disaster in every recent banking crisis. While it might be a good thing to have equal opportunity in education or other developmental areas, the cut-throat industry of banking is an industry where mediocrity cannot be supported.…