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

 |  Includes: AGG, DIA, SPY
by: SA Eli Hoffmann

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.