Bill Poole: A Fed 'Put' Exists

Provocative speech by St. Louis Fed commissioner Bill Poole at the Cato Institute Friday. Among other things, he unapologetically confirms that a "Fed put" -- i.e., a predictable bailout to financial markets -- exists. Here is an excerpt:

Did the Fed “bail out” the markets with its policy adjustments starting in August of this year? Have we observed an example of what some observers have come to call the “Fed put,” typically named after the chairman in office, such as the “Greenspan put” or the “Bernanke put”? Why has no one, at least not recently to my knowledge, argued that a more expansionary Fed policy in 1930-32 would have “bailed out” the stock market at that time and, by implication, have been unwise?

I can state my conclusion compactly: There is a sense in which a Fed put does exist. However, those who believe that the Fed put reflects unwise monetary policy misunderstand the responsibilities of a central bank. The basic argument is very simple: A monetary policy that stabilizes the price level and the real economy cannot create moral hazard because there is no hazard, moral or otherwise. Nor does monetary policy action designed to prevent a financial upset from cascading into financial crisis create moral hazard. Finally, the notion that the Fed responds to stock market declines per se, independent of the relationship of such declines to achievement of the Fed’s dual mandate in the Federal Reserve Act, is not supported by evidence from decades of monetary history.

According to the wires, Poole apparently added some rate-cut color after the speech, saying that a strong job report could change the markets' view on rates. That will keep people hopping next week around employment data.

Turning to his speech again, I take particular issue with the following statement toward the end:

Macroeconomic stabilization does not raise moral hazard issues because a stable economy provides no guarantee that individual firms and households will be protected from failure.

I cordially disagree. The trouble is, as has been demonstrated many times, some financial services companies -- LTCM, major banks, etc. -- have been deemed too big to fail in the past, and will likely be again in the future. So while, in general, individual firms and households cannot expect to be protected from failure -- thumbtack manufacturers don't get bailed out -- that is not the same as saying that there are companies in certain sectors, financial services in particular, that do not predictably end up being collateral non-damage from the Fed put.

Comments

[Jay Jay]

Think what that disingenuous hack was saying is that if your firm's risk taking is large enough to have a macroeconomic effect, we will bail you out. If you are an individual, or a small firm, you're can help pay for it by depreciation of your savings and future wages. I don't understand how he thinks this is no cause for moral hazard. And regarding the hostorical precidence for bailing the market, this just shows that the past we had good leadership at the fed, and now we have political hacks that advocate only for short term incentives.

[Greg Harris]

I'm not sure I caught you quite right there... LTCM survived intact w/o any consequences to their actions!? Are you really arguing that? So it really was so horrible that a bailout was devised in order to handle an orderly drawdown of their assets so that the enormous amounts of counterparty risk could be handled in a contained way? I cordially suggest that history would show that major criticism of how LTCM was handled is extremely misguided. Let's look at the final results of the '98 crisis. Not a damn thing macroeconomically happened and LTCM is gone. The problem in the 30s was the Fed stood by with a smirk on their face as banks failed and people lost or took out all of their money from the system. Sounds like great fun, let's try it again!!

[Greg Harris]

btw - second point, wasn't the bailout for LTCM completely funded by the banks themseves? The Fed played the role of facilitator. Woe to the world to have a facilitator help devise settlements between a mass consortium of banks to ensure an orderly drawdown of an entity with massive worldwide exposures. In fact, I can't think of a better role for the Fed to play in such a situation.

[Jay Jay]

Interventions in smaller conflagrations (LTCM) only enable further risk taking up to the point at which even the resources available to a govenment granted agency are inadequate to contain the collapse.

Regarding your comments on Americas first Great Depression. The credit expansion and malinvestment of the preceeding period were the cause of the neccessary liquidation. There was no other possible outcome from that point in time although it could have been postponed and amplified by earlier easing by the nascent Fed.

I wish it weren't so, but I fear we are going to try that again. Seems we've discovered interest only loans all over again 80 years later.

To make an analogy to another large system, the ecosystem of Americas west, it was the multitude of small fires that burned off dead fuel in small batches that keep things in balance. When man first started stopping these it was an easy task, and seemed to show obvious benefit. But as the dead and diseased fuel built up, the size of the fires increased until they have fires that are so large that they cannot be controlled anymore by man. The fires simultaniously burn vast areas as they liquidate the accumlation of malinvestment. So instead of little patches here and there every year, they get huges fires every 10 years or so.

When corrections happen in disparate areas, its easier for those effected to recover by moving to an uneffected areas. When it happens all at once more suffer for longer.

[Jay Jay]

Ya you make my point "the goverment helped facilitate it.."

I've studied Americas first great depression plenty. You would do well to do the same. I'd recommend you start with Rothbard's "Americas Great Depression" and go from there.