Fed too Little, too Late?

Dramatic cuts in interest rates are expected to be announced by the Federal Reserve tomorrow, Tuesday, March 18. This could provide some relief.

But the Federal Reserve bungled its handling of the liquidity crisis last week. The initiative to lend up to $200-billion (U.S.) of Treasuries to brokers in exchange for mortgage bonds looked good initially but was flawed because it operated through twice-monthly auctions -- the first of which was not scheduled until March 27. As the Bear Stearns debacle indicates, there was a need for immediate and ongoing sources of liquidity (which the Fed is now providing to the investment bankers).

If Bear Stearns (BSC) had not collapsed, the forthcoming cuts to the Fed rate would have had a greater chance of having its usual (lagged) impact on the economy. Now, that linkage is under a cloud of doubt because of a widening loss of confidence in the financial intermediary function. Lenders’ coffers might be filling up with money but they won’t lend if they don’t have confidence in getting their money back.

The Martin Feldstein option is increasingly looking like it will be called upon. The former president of the National Bureau of Economic Research, now a Harvard University professor, says a Keynesian style fiscal stimulus is needed to keep a virtually certain recession from snowballing into something more severe.

If the financial intermediary function is seized-up, then the central bank will have to buy up chunks of new government bonds to give the government the funds to spend like crazy and guarantee the injection of purchasing power into the economy. An agency like the Resolution Trust Corp., which cleaned up the savings and loans mess of the late 1980s, may also be necessary to handle the write-off of asset-backed securities.

Comments

[j4thelonghaul:]

Gosh Larry you sound like a Democrat! Bernanke is doing a great job of handling this mess. He is dealing with the liquidity issue first since none of the other "investment banks" are stepping up and handling the problem of raising capital for a mess that they created. Let's remember, it has never been the Fed's job to bail out investment banks!

While this site is dominated by traders who focus on market theme for short time profit, none of you are focusing on the new theme. The new theme is clearly that the government has the power to tax, regulate and force action or face the consequences. The last thing that the Fed and Congress need to do is start making bids on CDOs and other exotic mortgage securities in the marketplace. That will force the hands of some of these greedy investment houses that want a taxpayer bailout to fund their lavish lifestyles!

2008 Mar 17 08:28 PM

[deefree:]

giving an investment banker access to the Fed window is like giving a crackhead access to a cocaine mine

2008 Mar 18 06:50 PM