The People's National Bank?

The Federal Reserve is running out of conventional monetary policy and bond market options. Thus, the time for unconventional policies may be at hand.

The Fed has cut the federal funds rate and its short-term lending rate to banks to near zero, but those moves have done little to unlock credit markets. Traditional mortgage money and business loans remain too scarce because regional banks - the arteries and capillaries of our credit system - remain short of loanable funds.

Near-zero short-term lending rates for banks do little to help, because the regional banks do not lack for short-term access to funds; the Fed is providing all the near-term liquidity they want. Rather, banks lack longer-term sources of funds to back up mortgages and commitments for medium-term lines of credit to businesses.

Since the savings and loan crisis of the late 1980s, regional banks have relied on both deposits and the sale of mortgages and other loans to big Wall Street banks to finance home and business loans. Loans sold to these big money center banks, for many years, were securitized - that is, bundled into bonds for sale to insurance companies, pension funds and other fixed-income investors.

In recent years, many of those fixed-income investors were burned by the sharp practices of New York bankers and investment houses - schemes that were central to the subprime crisis, housing bubble and collapse, and the crisis of confidence on Wall Street that has poisoned credit markets globally.

Now, fixed-income investors have lots of cash to invest but are reluctant to buy bonds backed by mortgages and other loans. The large Wall Street banks are not much interested in creating bonds from mortgages and other loans made by regional banks, because securitizing high-quality loans into bonds doesn't create the opportunities to write fancy derivatives that pay bankers huge bonuses.

Instead, the big Wall Street banks have used their massive injections of capital from the Federal Reserve and Treasury to go hunting for new, high-profit businesses and acquisitions. The presence of federal regulators in their offices keeps them from getting involved in dangerous new schemes - but it does not address the shortage of funds regional banks have to lend.

The Fed has other options, but they won't help much either. It can buy 10-year Treasuries to pull down long rates, such as conventional mortgage rates. That would lower the rates banks pay for deposits but would not increase their deposits; hence, it would not increase the amount of money they have to make loans. It also can continue to buy mortgage-backed Fannie Mae and Freddie Mac bonds, pulling down their rates - but again, lowering rates on those securities does not make them more attractive to investors.

Ultimately, Fed Chairman Ben S. Bernanke should gather the CEOs of the big Wall Street banks, which have received direct infusions of capital from the Treasury and huge loans from the Fed, together with the biggest fixed-income investors to define the parameters of acceptable mortgage-backed securities. Then, the Fed should require its wards on Wall Street to buy loans from regional banks and bundle those loans into bonds for sale to fixed-income investors. Regional banks would finally have the funds to provide home loans once again.

The Fed could also buy bonds backed by conventional mortgages, just as it has Fannie and Freddie securities. In the end, though, the Fed may have to start making direct loans to the regional banks by accepting as collateral solid, prime conventional mortgages. Also, it could purchase those mortgages and bundle them into securities for sale to fixed-income investors directly or through large securities dealers. The latter are among the banks now receiving Treasury injections of capital and generous Fed loans.

This is all well outside the limits of what the Fed has done since World War II, but these are dangerous times.

In the end, if the New York banks won't do their job, the Fed may have to do it for them.

Comments

[Moon Kil Woong:]

At this rate there will be only 1 bank left, the Federal Reserve Bank. Why do you need others... eh? They can pay interest on deposits, insure all debt, and are asking to issue their own debt. In fact, after they do that we don't even need the Treasury either. And why have the Congress since the Fed can make all the money or destroy all the money at will. As Paulson said, "The Fed and Treasury need as many tools in their toolbox as possible."

Maybe Paulson figures the Fed will essentially be the treasury soon. What a merger. Will there need to be an anti-trust hearing lol? Monopoly on money? Any objections?

Haha... well I don't want to be a giant conspiracy theorist but hey, don't you think the Fed should keep their hands out of everyone's pockets? They can't even manage what they are currently suppose to do, promote economic stability through the properly controlling money supply and interest rates. They get a D- on that job.

Gee let's give them more power. It's like giving someone who gets under 70% on a ABC test the option to pick D (none of the above on the next test). There is a 100% chance their performance will not be better but much much worse.

2008 Dec 29 03:28 AM

[carey_jim:]

The impulse to centralized, totalitarian authority has deep historical roots.

For thousands of years most human beings have looked up for moral guidance to authoritarian churches whose priests, imams, rabbis and gurus tell them exactly what to do, when to do it and what will happen to them if they don't.

The worldly representatives of these all-knowing sages were kings and their families and relatives were anointed with 'divine rights' by the priests.

This totalitarian alliance was backed by victorious armies and military victory and divine will were synonymous.

Democracy and self-determination through representative government and free-enterprise are very new appearances on the world stage and old habits die slowly and sometimes not at all.

2008 Dec 29 01:20 PM

[uss?:]

You misconstrue this problem as a liquidity/lending crisis when in fact it is a solvency crisis. The U.S. banking system is insolvent with massive fraud occurring on the balance sheets of the major banking institutions. The Federal Reserve is now the central threat to American democracy because it is acting acting outside of the law and perpetuating fraud on a truly massive scale.

Until policy recognizes that the bust is the recovery, the U.S. will be mired in this mess. Cleanse the balance sheets, fire incompetent managers, reform policies to level playing field for manufacturers, reward savers, and punish the imprudent. Create sound money backed by tangible assets while you are at it. Insure depositors and leave risk takers to their just desserts.

Getting the banks lending again is the least of our problems.

2008 Dec 29 05:54 PM

[thatguy57z:]

this will give you some in site how it is going to start working. and how they've all ready have it moving foreword go to.
www.youtube.com/watch?.... copy and paste to your web browser , or click on my website

2008 Dec 29 09:12 PM