The Fed is Terrified

The Wall Street Journal is reporting Fed Weighs Its Options in Easing Crunch.

The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail.

Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed's name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.

The Fed holds assets to manage the nation's money supply and influence the federal-funds rate, which banks charge each other on overnight loans. When the Fed buys Treasurys or makes loans directly to banks, it supplies financial institutions with cash; in effect, it prints money. The cash ends up as currency in circulation or in banks' reserve accounts at the Fed.

Since reserves earn no interest, banks lend cash that exceeds their required minimum. That puts downward pressure on the federal funds rate, currently targeted by the Fed at 2.25%. The Fed could purchase securities and make loans almost without limit, expanding its balance sheet. That would cause excess reserves to skyrocket and the federal funds rate to fall to zero. The Fed would contemplate such "quantitative easing" only in dire circumstances. The Bank of Japan took this step this decade after years of economic stagnation.

The Fed is Terrified

Read the entire WSJ article. It's a good one. That the Fed officials are having these kinds of discussions at all shows just how terrified of the perception setting in that we are following Japan, which of course we are.

The Fed is effectively in a position of not to being able to print money to buy Treasuries from banks, because of restrictions mentioned in the WSJ article and also because the banks are insolvent. Simply put, banks do not have the cash to accumulate Treasuries on their books to sell to the Fed this time around. And more writedowns on commercial real estate, auto loans, credit card debt, Alt-A mortgages, and pay option arms are coming. This will require still more capital raising efforts.

This is what's behind Citigroup's repeated efforts to raise capital. See Less Than Meets The Eye at Citigroup, Goldman.

The Fed now has to buy risky paper from the banks or lend the banks the Fed's own riskless assets at 1-2% yields to maturity on short paper against risky assets. There is no capital gain cushion built into the banks selling to the Fed for cash as in a normal reflationary cycle.

The Fed has already sponsored 3 new lending facilities, yet is having still more discussions on what to do next.

Recap Of Fed Sponsored Facilities

• The TAF (Term Auction Facility) failed to restore liquidity.
• The TSLF (Term Securities Lending Facility) failed to restore liquidity. See The Fed's Swap Meet for more on the TSLF.
• The PDCF (Primary Dealer Credit Facility) will be the next "facility" to fail. See Fed Fails To Halt Debt Meltdown for more on the PDCF.

The Fed's ongoing discussions shows deep concern that the above facilities will not be sufficient. And Volker is already saying Fed's Bear Loan Stretches Legal Power.

"The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices," Volcker said in a speech to the Economic Club of New York.

However, that is not stopping Fed discussions of further illegalities. Please consider Fed Uncertainty Principle corollaries Two and Four.

Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

The Fed is now considering borrowing from the Treasury (US taxpayers). Were the Fed to have to do this to remain whole, i.e., have the Treasury underwrite the Fed's balance sheet, the US central bank would be de facto insolvent, having insufficient assets to carry out its mandate.

The perceived invincibility of the Fed's ability to reflate is now clearly in question. The Fed's own discussions prove it.

Comments

[punk_ash:]

good article. Ben is a sorry figure in all of this mess, on one hand, he has to prevent the BSC like scenarios and then maintain inflation and $ value. Greenspan did it. At least he is gone

2008 Apr 10 11:12 PM

[WaveNet Pharma:]

Not impressed neither with the depth nor with the mindset behind this article. Criticism is easy to direct, especially when no responsibility is assumed by the initiator. On the other hand, to be constructive and provide ideas as to how will our nation put this financial crisis behind is a lot harder. Since, for the sake of this and future generations, we have no other option but prevent this crisis from paralyzing and harming our economy, what other brilliant suggestions does the author have to compare with what the Fed has done ??

2008 Apr 11 03:38 AM

[liorio1:]

I am starting to believe that what we need here is simplicity and then let the chips fall where there may. Potential solution? Freeze the ARMS rates and anyone else on any other type of mortgage takes it on the chin. No more interest rate drops and stop the liquidity spigot. Now no more variables for the banks to hide behind, let them unwind their positions ( most of it is hot air anyway and will not be made up in the short run). The point is, we need to get the air out of the bubble and no one is addressing that. Seems to me, JQ Public is more worried about food, gas and the price of bread than the financial sector. Looks like we are forcing a recession with a high dose of inflation onto Main St (stagflation anyone?)

2008 Apr 11 08:42 AM

[Fabien Hug:]

To WaveNet; how can you be constructive in face of such a mess. People have been living in LaLa land for 5 years and this FED is trying to keep the illusion alive. Since when borrowing on unrealized equity to purchase a RV or put granite in a kitchen, is a sound economic decision? Now people all over the world are starving, mighty America is whining like a baby and nobody wants to bite the bullet. It is ridiculous. Any sane social group would stop it all, reassess the situation and give new direction. There is no leadership, no vision anymore and it doesn't bode well for future generations as well as for our.

2008 Apr 11 10:33 AM

[redmuddler:]

Bernanke was well respected and confirmed by both parties for the job. Greenspan has been lauded for years until now. These men did not and do not act alone. There are 11 others on the committee. NO ONE sees a recession coming: i.e. look how all the smart guys trading stocks one day, are taken by surprise the next. The ecomomy is too big, and has too many moving parts to be controlled. All you can hope for is a good fire company.

2008 Apr 11 10:47 AM

[vaduz:]

this is really a mess, made up by greenspan. poor bernanke who possibly cant have an easy solution.
we will see the lows of march again.

2008 Apr 11 11:03 AM

[Still Renting:]

Sometimes the most constructive thing you can do is make sure the bomb shelter is fully stocked - and muster the will to shoot your neigbors if the need arises.

Yeah, I'm being melodramatic. But I hope it still makes the point. Saying the emperor has no clothes is the first step to recovery!

2008 Apr 11 12:05 PM

[MattGigEm:]

WaveNet Finance, I am not the author but here is my solution. Much like pulling off a band aid quickly it will hurt for a while but we will get over it. 1.) Raise interest rates 2.) Cut goverment spending drastically 3.) Stop bailing anyone out.

This would be a painful couple of years but the strong will survive and at least we wouldn't be making the problem worse.

2008 Apr 11 01:24 PM

[Jason Rines...:]

Add to MattGigem: Declare Energy crisis and Independence. Create millions of jobs and valid, competing energy product. Politicians are elected whom are Patriots that stop listening to the enviro/big oil lobby. Solve America's energy crisis and then become an exporter. Remember the term 'fiscal and moral' responsibility. What I mentioned above will occur when the common man starts rearing pitchforks demanding heads from the pain. That will finally get encapsulated Washington & NYC financial elites to take accountability. Until then, invest personally in guns and vacation retreats 50 miles away from large population centers which have plenty of supplies to avoid eating government cheese and wheat pasta.

2008 Apr 11 05:02 PM

[Just The Facts:]

<<< Not impressed neither with the depth nor with the mindset behind this article. Criticism is easy to direct, especially when no responsibility is assumed by the initiator. On the other hand, to be constructive and provide ideas as to how will our nation put this financial crisis behind is a lot harder. Since, for the sake of this and future generations, we have no other option but prevent this crisis from paralyzing and harming our economy, what other brilliant suggestions does the author have to compare with what the Fed has done ?? <<<


Criticizing the arm-chair quarterback? I understand that. And I second the comments of some of those before. You can't "save" a failed system. You must let it fall and replace it with something which will stand on its own feet.


Pull a "max" chart on the DOW or the S&P, and put it on linear scale. Then compare those charts to any of the tech companies through 2001 at the peak of the "tech bubble". Maybe you'll get the point. Our current situation is a mirage, a bubble. Unsustainable over the long run, no matter "what" Bernanke or Paulson or Congress or the current (or future) President --- or anyone else --- does. Quite simply, it CANNOT be saved.


We'll get back on our feet and start moving forward again, after we correct for the excesses of the past 20 or 30 years. When the DOW reaches 1800, we'll be at the bottom.


And if we want to "fix" it for our future generations, then our government will never be allowed to grow beyond 5 percent or so of our total economy.


So yes, next year's federal budget must be halved. I'll let you all fight over whether that means surrendering in Iraq or throwing old people and children into the street without ANY medical care whatsoever.


But that's the choice we face.

2008 Apr 11 09:55 PM

[swaps:]

So even the privately owned Central Bank is bankrupt?
May I quote a newsletter:

The most frightening forecast so far comes from the Global Europe Anticipation Bulletin (GEAB), available for 200 euros - about $300 - for 16 issues annually. Its prediction is quite specific.

Where my warnings never spelled out an exact date, this think tank has it pegged precisely. Here are its very words:

"The end of the third quarter of 2008 (thus late September, a mere seven months from now) will be marked by a new tipping point in the unfolding of the global systemic crisis.

"At that time indeed, the cumulated impact of the various sequences of the crisis will reach its maximum strength and affect decisively the very heart of the systems concerned, on the front line of which (is) the United States , epicentre of the current crisis.


The Fed should be abolished. First Greenspan wowed Wall Street by rates down to near zero.

At that point the criminals issued tons and tons of ticking timebomb ARMs.

Then the Greenspanke brothers from the same ethnic and cultural pool began to ratchet interest rates back to "stop inflation."

The Greenspanke brothers got the disaster they were seeking. But now you say the Fed may soon be bankrupt, which it would be if the increasingly homeless Americans have to pledge their blankets and buckets as collateral for the debt Americans will have to assume on behalf of the Fed.

The Fed, the open borders, the war on Third Countries, free trade with China has busted America. If America goes broke, it should take its central bank down with it. It deserves to die.

2008 Apr 11 11:24 PM

[Austrian Sc...:]

FUBAR

2008 Apr 12 02:05 AM

[elwind45:]

I think the G-7 governments should exchange 2 trillion dollars for super senior government debt. We could issue 20 year bonds at 2%! We could use proceeds to reflate banking system. We have sure got a marshall plan type of deal ahead of this country. Heck lucky we have pretty surrounding in this place, we used to call our own!

2008 Apr 12 06:47 AM

[DCM:]

There is only one solution to our economic dilemma - redistribution of the wealth. It is both absurd and crass that 10% of the population holds 90% of the wealth.

I suggest that for those of you that think that the answer is to punish all the people who have been living beyond their means, you can rest easy, as that is exactly what is happening and is certain to continue. By one estimate, at least $2 trillion of equity will be eradicated as the result of this housing bust. Will the market come back? Will housing prices increase? Maybe someday but given the systemic problems in the lending system that led to this bust, it is unlikely that credit will be eased and even if it were, will there be investors willing to buy sub-prime mortgages again? The only way home equity will increase will be as mortgage principal is paid down. With retirement looming, many of us baby boomers, who have endured many inflationary periods since entering the work force and who have seen a large percentage of our jobs and careers lost and/or outsourced to high tech and third world countries, now face the prospect of little or no retirement savings, social security nor equity from our homes. Given the foreseeable future, we are in for hyperinflationary times and with no medical safety net until we qualify for Medicare and how long or to what level will that remain intact?

A large percentage of the baby boom generation is going to get completely screwed over. But, I am sure some of you think, we are just being whiney! The irony here is that many of you are the offspring of baby boomers and we brought you into this world, raised you and educated you. It is true we borrowed a lot of money and often lived beyond our means but we also became two income families and took second jobs to raise a family and have some comforts. Now that our kids are adults and prospering in this new high-tech economy, you are ready and willing to throw us under the bus for our errs.

2008 Apr 12 09:18 AM

[bearfund:]

DCM, there's no wealth to distribute. The banks are broke; you think the bankers aren't? There are very few wealthy Americans; there are a lot of ostentatious American spenders. Don't let their fancy cars and vacation homes in the Hamptons fool you; they're in debt up to their eyeballs just like you are, and for the same reason: no self-control. The only people who are wealthy are those who have kept their spending under control and invested their excess income wisely. You'd be surprised who they are - they may well be your neighbours or colleagues. When the numbers get really large, you learn about some of these people, the Buffets and the Gateses, but because most truly wealthy people live modestly you won't really know who they are.

So tell me, why should people who work for a living, spend modestly, and invest wisely have their life's work taken from them to feed the insatiable maw of greedy consumerism? I hold the "poor sods" who bought SUVs and plasma TVs with borrowed home equity in the exact same regard as I do bankers who drive around in their Maseratis and spend their winters in Tahiti. As you admit, you "lived beyond [your] means." Instead of having "some comforts" you should have saved and invested. Then you'd be wealthy and we wouldn't face an entire wasted lifetime of work to bail you out at the point of a government-issue gun.

If you want to see what the death of a nation looks like, keep pursuing your bailout strategy. You think it looks like the Great Depression and the bailouts are needed to prevent it, but you're wrong. It looks like Somalia, and the theft, manipulation, and alienation your bailouts represent are its seeds. Quit now while you're still ahead.

2008 Apr 12 02:50 PM

[bugtussle bob:]

bearfund - very well said.
Since I'm somwhat of a novice investor,
could you tell me what you have your
money in right now? I want to profit from
this trainwreck!

2008 Apr 12 10:00 PM

[cat & mouse:]

When Greenspan was the powerful FED Chief, my son told me that when Greenspan sneazes, the whole financial world trembles. They followed his utterances with great devotion. Now see what poor BERNANKE, his successor is facing! The mess, which Greenspan left, is a cesspool, and Bernanke has to clear it, with novel bright ideas and new inventive methods. Kudos to Bernanke and his team for preventing banks and traders going brancrupt and investors losing their hard earned money.

2008 Apr 13 03:37 PM