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Inverted yield curve puts Federal Reserve interest rate policy in jail…
When President Obama almost created a depression by raising taxes and increasing regulations during a bad recession, the Federal Reserve flooded the U.S. economy with liquidity by slashing its lending rate to below .5% and buying $2.5 trillion of assets.
But since President Trump was elected, the Fed has tried to strangle his tax cut and deregulation driven economic boom by raising its lending rate fivefold to 2.5% and selling off almost a third of the assets bought during the stagnant Obama years.
Normal lower short-term interest rates “inverted” to a higher yield than longer-term interest rates. Before the Fed raised its “Fed Funds” rate by .25% on December 20th, the yield curve had a normal slope upward over all time periods. But rates inverted in response to the move.
Such an event is often called a “Recession Alert,” because the bank business model is to bid low interest rates for short-term customer, and then lend the money out longer-term at profitable higher interest rates. Bank lose money when interest rates invert.
Bigger banks have other profitable activities than just lending to make profits when yield curves invert and they quickly become more profitable. But for smaller banks that are almost completely reliant on lending, the profit loss “stays negative and becomes larger.”
An American Enterprise Institute study found that smaller banks are key providers of small business loans, mortgages, and farm loans. They can operate with less overhead, because they maintain close relationships with local customers and make smaller loans.
Barack Obama's Dodd-Frank Act tightly regulated banks. Large banks could easily afford the added regulatory overhead, but the burden hammered the profitability of small banks. During Obama’s eight years, the number of U.S. banks plunged by 28% from 7,022 to 5,083 banks.
For only the third time since the Federal Deposit Insurance Corporation was founded in 1933 to protect small depositors, there were zero U.S. bank failures in 2018 due to the strong economic growth policies under President Trump.
According to Managing Director of Davos Investment Group Nicholas Pardini, “The Fed reversed gears because they feared they were choking off the economy by hurting Main Street wage growth.”
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