The Fed's Role in Helping the Economy

Excerpt from Raymond James Economist Dr. Scott Brown's latest economic commentary:

The year 2008 was a tough year for the economy and a punishing year for investors. Looking back, it seems like a bad dream. Who could have imagined all the major institutions that have failed, been bought out, or were taken over by the government? We appear to be in the worst recession in more than a quarter century. Indeed, the current downturn has already exceeded the average length of recessions experienced since World War II. There’s hope for improvement in 2009, but the economic outlook is very much uncertain.

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Clearly, it’s not just perceptions about the future that influence growth. The economy is largely driven by credit. No loan growth, no economic growth – that was the lesson of Japan’s lost decade. The collapse of the housing bubble and the ensuing problems in the credit market have been the major factors in the current downturn. Normally, the Fed can move to counter tighter credit. Yet, as we saw during the 1990-91 recession, it often takes some time before the credit markets begin to turn around. In comparison, the current difficulties are large compared to the real estate hangover in the early 1990s. It will likely take a lot longer to get back to normal. However, policy efforts have been significant and more efforts are expected in early 2009. Treasury has worked to recapitalize the banking system. However, banks may still be reluctant to make loans even if they have the capacity.

The current situation differs from previous episodes in the collapse of the shadow banking system. Bank lending has been well regulated and mortgage problems were not a devastating issue directly. However, there had been a growing market for debt outside of the banking industry. Auto loans, student loans, mortgage loans, small business loans, and so on, were securitized and sold to investors. The market for these securities has collapsed completely in the last few months. Securitization has been an important source of credit for the economy. Without it, there will be fewer loans available. The Fed has stepped in to fill the gap, temporarily buying large amounts of agency debt, mortgage-backed securities, and asset-backed securities. These purchases aren’t meant to be an ongoing Fed function. The Fed will have to back out of these markets at some point, and that could prove to be difficult. However, by not participating, the Fed would risk a deeper and longer-lasting downturn.

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In any downturn, the Fed should do the heavy lifting. However, massive fiscal stimulus will also arrive in 2009. As with the Fed’s quantitative easings, fiscal policy efforts aren’t going to be permanent and some care will be needed to keep an eye on long-term goals (such as deficit reduction). With a little luck, these efforts should help support economic growth by the second half of the year. A full economic recovery will take a bit longer.

Comments

[wolfb4u:]

I'm hearing economists talk and they like psycologists have no clue. The fed said they would buy debt but have squandered that money and not done so. The fed should stay out of this.

There is plenty of room for private money to buy these "bad loans" at a steep discount and renegotiate the debt with the borrower at the debt amount and a reasonable interest rate. I think profits of 50 - 100% + the negotiated interest rate are available while helping people stay in their homes. If I had only 1 million dollars to invest I would be doing it and I don't have any idea why some money funds are not jumping all over this sort of opportunity.

2008 Dec 16 12:18 PM

[Smarty_Pants:]

Let me guess: Economist Dr. Scott Brown is a Doctor of Keynesian Economics.

"The economy is largely driven by credit."

This is the Keynesian framework we find our economy trapped in these days. Austrian School economists would instead point out that past use of credit resulted in large mal-investments in economic activities that would otherwise not have occurred. Remove the ever expanding credit bubble and those mal-invested activities collapse to the point where non-credit driven demand will support them. It's called a recession and Keynesians don't like them. Any spending is good spending to a Keynesian, whether it's an efficient use of resources or not.


"The Fed has stepped in to fill the gap, temporarily buying large amounts of agency debt, mortgage-backed securities, and asset-backed securities. These purchases aren’t meant to be an ongoing Fed function. The Fed will have to back out of these markets at some point, and that could prove to be difficult."

Funny how Keynes original concept of "spend during bad times and repay during good times" is only half implemented. The repayment never occurs, just as it is highly unlikely that the FED will ever 'back out' of their current debt swaps and purchases because doing so will cause some part of the debt laden, credit driven economy to tank in response.

Keynesians have finally realized the dead end result of their credit driven system. Every attempt to rid themselves of the tar-baby will only result in having it stuck more firmly in place.

The only way to avert the recessionary/depressio... slowdown that the economy needs to stabilize will be to print dollars like there's no tomorrow.

Zimbabwe here we come.

2008 Dec 16 02:03 PM

[Jason Rines...:]

Bingo comment Smarty. I do not believe the Central Banking system is considering the geopolitical consequences in the nuclear age.

2008 Dec 16 02:26 PM

[Robert Nabloid:]

I'm with smarty, 110%.

2008 Dec 16 06:38 PM

[Ferdinand E...:]

I taught macroeconomics for many years, and taught it brilliantly, but I finally gave it up because I lost faith in it. But one thing I understand after reading this article: DR BROWN IS ABSOLUTELY CORRECT, and the people who say that he is wrong went to the wrong schools, or had the wrong teachers, or maybe even went to the right schools and had great teachers, but slept or were doing scag during the lectures. Let me add the following: belief in 'Austrian economists' is crank.

Professor Ferdinand E. Banks

2008 Dec 17 08:38 AM