In an effort to salvage a comatose credit market after the Lehman collapse, the Fed set the target rate for Fed funds – the funds that banks borrow from each other – at an extremely low 0.25 percent. Paying interest on reserves at that rate was intended to ensure that the Fed funds rate did not fall below the target. The reasoning was that banks would not lend their reserves to other banks for less, since they could get a guaranteed 0.25 percent from the Fed. The medicine worked, but it had the adverse side effect of killing the Fed funds market, on which local lenders rely for their liquidity needs.

It has been argued that banks do not need to get funds from each other, since they are now awash in reserves; but these reserves are not equally distributed. The 25 largest US banks account for over half of aggregate reserves, with 21 percent of reserves held by just three banks; and the largest banks have cut back on small business lending by over 50 percent. Large Wall Street banks have more lucrative things to do with the very cheap credit made available by the Fed that to lend it to businesses and consumers, which has become a risky and expensive business with the imposition of higher capital requirements and tighter regulations.

This is from Ellen Brown, “Why Banks Aren’t Lending: The Silent Liquidity Squeeze.”

What’s interesting, given that Ms. Brown is on the left, as will be clear if you read her proposal at the end of her otherwise-excellent piece, is that this is the first time in a long time that I had any hope for a possible alliance between those of us libertarians who want to do away with a central bank and some of the left who see some of the problems with a central bank.

HT to Jeff Hummel.