It's Time for the Fed to Get Serious - Barron's

While some former Fed officials think the central bank has already expanded its balance sheet too much, Barron's backs the opinion of former Fed operative Vincent Reinhart and the American Enterprise Institute think tank who say far bolder steps are still needed to stem the carnage on Wall Street and Main Street.

They recommend that the central bank purchase or guarantee massive amounts of all sorts of credit instruments to unclog the markets and push interest rates down from their punishing levels. While the Fed has more than doubled its balance sheet in less than four months, with assets now totaling $2.2 trillion, much more may be needed. The central bank's holdings may have to swell to $6 trillion or more to stem the destruction of capital.

It's "no time for the Fed to act like a bashful virgin," Reinhart says, noting massive purchases of collateralized debt obligations, non-agency mortgage debt and non-investment-grade corporate bonds would not boost the federal deficit. In fact, with the Treasury's borrowing costs a rock-bottom 1% or less, the government is likely to turn a profit on its buys.

Treasury Secretary Henry Paulson is to blame for not unleashing the government's full firepower, Barron's says, although it also faults Fed chief Bernanke for being too deferential to Paulson - and not adhering to his 'helicopter Ben' namesake of tossing money from the skies.

Former Fed vice chairman Alan Blinder is also dismissive of Paulson's 'boneheaded' approach. Had the government explicitly backed Fannie and Freddie's debt when they were effectively nationalized in September, last week's $600B intervention would not have been needed, he says.

It's unlikely the lame-duck outgoing administration will suddenly change its tack so drastically, but the incoming Obama team of 'avid interventionalist' Larry Summers, and Tim Geithner who supposedly fought with Paulson to save Lehman, seems more prone to pull out the heavy artillery. If they do, "One shouldn't discount the impact that the Fed might have on market psychology, should it begin a massive intervention in the credit markets," Barron's says.

Comments

[investor88:]

A tradeable bull into Jan 09 is possible but with stop loss.

2008 Nov 30 07:12 AM

[Vigilance:]

The Fed is more of a streetwalker than a bashful virgin. Many of our economic problems can be attributed to their inflation of our currency and fractional reserves policies. The answer to the current mess we are in is less interference in the free market by the federal government and its un-Constitutional creation, the Federal Reserve, not more.

2008 Nov 30 08:58 AM

[MikeLovesGold:]

Well said.


On Nov 30 08:58 AM Vigilance wrote:

> The Fed is more of a streetwalker than a bashful virgin. Many of
> our economic problems can be attributed to their inflation of our
> currency and fractional reserves policies. The answer to the current
> mess we are in is less interference in the free market by the federal
> government and its un-Constitutional creation, the Federal Reserve,
> not more.

2008 Nov 30 09:22 AM

[axelrod608:]

The Fed under the direction of Alan "Bubbles" Greenspin and his tsunami of easy, cheap, unlimited credit CAUSED this whole mess. Without his flood of money, more money, and even more money, there would not have been money available to make all those liar's loans and to buy all those bizarre derivatives on which the nation and the world are now choking.

The result is clear and obvious to any objective observer. The companies that grew fat on the flood of free money are a bunch of bloated dinosaurs. They are unsustainable. The financial companies and the retail companies we brought into the 21st century are (almost) ALL unsustainable. Corporations, individuals, families and government at all levels are drowning in debt. The idea that reinflating the credit bubble will get everyone borrowing and consuming again is ludicrous.

Albert Einstein - a pretty bright guy - observed that doing the same thing the same way and expecting a different result was a definition of insanity. The idea that the Fed can reinflate the credit bubble and fix everything is patently insane. Absurd.

Also, American financial institutions are holding some $130+ trillion in losses on their derivatives. The Fed doesn't have that kind of money. The Fed CANNOT fix this mess. It can only postpone the inevitable crash and increase the losses by the amount of additional money it pours into failing businesses.

Aretha Franklin perhaps put it best, singing "Who's zoomin' who ?" All this talk about "fixing" this mess is just the ramblings of born again zealots, whose faith in their economic theory is beyond question, uncriticizable. They are the economic 'terrorists' who are willing to destroy whatever they disagree with.

The only wise thing to do with the Fed is dismantle it. It is an unConstitutional construct that causes more trouble than it's worth and can't fix the messes it makes. Put it and the bloated companies it created out of their misery. Before they do more harm.

2008 Nov 30 09:58 AM

[Asbytec:]

Axel, like you, I am trying to make sense of this tremendous liquidity creation by the Fed. And I agree, it will not cover the trillions involved. (You say $130tn, I've read smaller figures on the order of $50tn. Still...)

The first thing that comes to mind is, of course, easing is a typical reaction to recession. But, apparently, even at zero percent, the banks aren't lending as they should. They're strapped with CDS payouts and really don;t have money.

The second thing that comes to mind is to flood the banking system with money to east the fear of (what is now more risky) lending. It's like trying to bust a dam by diverting too much water into the reservoir while trying to take some of those toxic debts off their books.

No matter what the case, the Fed is using the tools it has. It might need to be more aggressive, as the author states, but at least it acted first. October last year, Bernanke testified before congress and he told them they need to shore up the GSEs. He also pleaded with lenders to renegotiate loans. No one listened, until the stimulus package, anyway.

But, in fixing this mess, the Fed may be wrong headed in that the problem lies in our banking system in many levels. As you assert, we need to eliminate the Fed. By extension, I gather you also support getting off the fractional banking system all together. Really, so do I. There are other ways to create money other than through consumer debt. And those ways are inline with our constitution, with the government (congress) coining and setting the price of money.

But, I just don't see that happening. If you think the lobby is powerful, wait till you try messing with the folks who run the banking system. What I do see happening is the tight regulation or elimination of legalized gambling and insurance functions that are not and never should be part of any banking system.

2008 Nov 30 10:32 AM

[ronslim:]

Great comments and the Fed is not merely a powerful lobby but the engine for more federal government and the eventual international control of much of these US affairs. Selling the US constitution can hardly be called either bashful or virginal.


On Nov 30 10:32 AM Asbytec wrote:

>
> debt. And those ways are inline with our constitution, with the government
> (congress) coining and setting the price of money.
>
> But, I just don't see that happening. If you think the lobby is powerful,
> wait till you try messing with the folks who run the banking system.
> What I do see happening is the tight regulation or elimination of
> legalized gambling and insurance functions that are not and never
> should be part of any banking system.

2008 Nov 30 10:55 AM

[Gem Hudson:]

Inflating to bail out banks is only a lack of depositing any real money. Play money is flipping more than houses but selling flipped house need the fundamental up trend of an prospering economics. What they bought into. The sweeten up the deal all on a low, low down next to nothing sub prime payments. There is no need for credit check. We'll see what you could afford and when they couldn't afford it, ceased up credit is shut off. They swapped credit and guess who defaulted. King Henry bailing out the deficit death one bucket at a time fix nothing and betting away the house, the car and even right down to the dog should be pounding rocks.

2008 Nov 30 12:24 PM

[happysoul77777:]

There is an easirer way. Suspend or modify the FAS 157. This rule is designed by short sellers and their accounting cohorts under the guile of providing transparency to investors. This accounting rule ignores cash flows and rely on exit (liquidation) prices as the most accurate representation of fair value.

Banks have decimated as their portfolios are forced to use the latest liquidated prices. Even prices on the regulated exchanges at times can be manipulated or impacted by the changes in regulation.

The taxpayers keep having to come up with more money because of somebody are not doing their job.

2008 Nov 30 05:26 PM

[BerkeleyBob:]

We will not see an end to the economic disaster until both varieties of bank (are there any investment banks left?) accurately assess and realistically value loan portfolios. The problem with the Fed and Treasury is they backed off of taking a preferred equity position in faltering lenders. You don't like FAS 157, come up with a better way to accomplish the result. We can not print enough money to shore up housing prices and the long term pain is going to exceed the short term gain, if any. I'd recommend reading Michael Lewis' article in the current Portfolio, Niall Ferguson's article in the current Vanity Fair. Both are lucid, unlike some posters here.

2008 Nov 30 06:00 PM

[Steven Hansen:]

let me understand. the level of debt in the US is massive to the extent that banks will not loan because they question the viability of the borrower when they view the existing debt. all that will happen if the government assumes the risk of the credit instruments is the taxpayers now bear risk of loss (with no benefit).

sometimes doctors induce comas in patients with brain traumas to aid in recovery. this debt needs time to work out of the system without exposing the taxpayers to massive potential losses. it is time to put the economy into a coma instead of trying to get your virgin patient to jog around the block.

2008 Nov 30 10:01 PM

[Asbytec:]

Axel, and I forgot to mention another reason for unprecedented liquidity is the Fed trying to inflate it's way out of a deflationary spiral. That being said, it seems probable they should deflate our way out of the impending inflationary cycle.

All, I would not be to angry if the US government actually federalized the Fed.

Hand, the banking system is in a coma. It will be revived once it shows some signs it can survive.

2008 Nov 30 10:28 PM

[Asbytec:]

Happy, suspend short selling? Maybe modify rules that require banks to keep a reserve to back CDS? I say don't suspend, amend, or do anything with the existing rules except rewrite them in their entirety, keeping the tried and true stuff. We need to eliminate any activity that permits banks to engage in insurance activities.

2008 Nov 30 10:32 PM

[Leftfield:]

Happysoul77777 thinks banks using liquidated prices is a problem. I guess that refers to mark to market. Funny, when those went straight up the execs getting the bonuses from the inflated profits weren't complaining.

I see the power of the bank lobby mentioned above. Ya think? By the way, remember Elliot Spitzer? He got removed just before all this really hit the fan, but it was imminent no doubt to insiders. He would have been a great center for revolt against these banksters except for bad judgement. Or, was that a setup backed by threats?

2008 Nov 30 11:21 PM

[Tokyo Picker:]

The first thing to do is to allow a couple more A-list defaults to capture the value in synthetic CDOs largely owned by Equropean public sector investors. Once US FIs have harvested that, the Fed should recognize that there are a lot of bonds that are implicitly guaranteed by the US under the "too big to fail" doctrine and capture the value of the spreads on those bonds by buying them and selling equivalent maturity Treasuries. Otherwise investors are getting overpaid for US risk.

2008 Dec 07 02:51 AM