Five Notes on What the Fed Can Do

1) There have been a number of recent articles questioning/explaining what the Fed can do in this present environment. Here are some examples:

• What Could the Fed Do?
• “What Could the Fed Do?”
• The size of the Fed’s balance sheet limits the scale of the public’s losses
• Fed Looking at How to Beef Up Lending Power: WSJ

My own view is that the Fed has used up a lot of firepower on the asset side, but still has a lot to work with. That said, the Fed should be careful not to complicate its balance sheet with a lot of off-balance-sheet agreements. Policy flexibility for a central bank is a real plus, so complicated agreements that make formerly liquid assets illiquid are to be avoided, particularly in a crisis.

Regarding Fed funds, it looks like they will cut 25 basis points on 4/30, but make noises that they are getting close to being done. Perhaps 1.75% will be the low for the cycle.

2) I already miss Alea. Before jck went on hiatus, he commented that the TAF was not effective at lowering rates, and that the TSLF was a success, though by success, he means that it’s not in hot demand. Tony Crescenzi speaks similarly. Perhaps the existence of the PDCF reduces the need.

3) Perhaps Lehman is an example of that, moving buyout loans off of their books, and getting financing for the AAA portion from the PDCF. Given the imitative culture of Wall Street, I would expect to see this repeated by other investment banks.

4) Volcker-mania. In one sense, it’s weird to see him speaking out now, given that he was silent for Greenspan, save for a little at the end. I agree with almost all of what he has been saying; it reads like my writings over the past five years. For a sampling of opinion:

• Volcker’s Demarche
• Volcker Says Fed’s Bear Loan Stretches Legal Power
• Volcker Stands Tall, Greenspan Keeps Shrinking: Caroline Baum
• It’s a Crisis, and Ideas Are Scarce

Greenspan ate sour grapes, and Bernanke’s teeth have been set on edge. Bernanke inherited Greenspan’s ignored problems. At this point he and the Fed are puzzled — seeing rising inflation, but fearing what higher rates could do to the banking system. With a similar view that the Fed has few good options, consult Tim Duy.

5) Finally, if we turn off the microphones, and shut down the cameras, will Alan Greenspan cease to exist? His defensiveness toward his record undermines his record. Better he should stop talking publicly, particularly if he were foolish enough to suggest that the housing market will bottom in 2008.