Five Unconventional Ways That The Fed Can Add Liquidity

by: ContraHour

Nobody expects the Spanish Inquisition!

Our chief weapon is surprise. Surprise and fear. Fear and surprise. Our two weapons are fear and surprise. And ruthless efficiency. Our three weapons are fear and surprise, and ruthless efficiency and an almost fanatical devotion to the Pope.

Our our weaponry....amongst our weaponry are such elements as fear....I'll come in again.

-- Terry Jones, Monty Python's Flying Circus

Last week, Ben Bernake told Senator Chris Dodd that he was willing to use "all available tools" to calm markets and restore market liquidity. What Senator Dodd didn't mention was that Bernake also told him that simply lowering the Fed Funds Rate "is so old school and, well, so...Greenspan."

Which got me wondering, what other tools the Fed Chairman has in his bag of tricks? Here are my top five guesses as to how the Fed plans on increasing liquidity, countdown from five to one.

5. Forget the loans, just buy the collateral. Last week Jeffrey Lacker, President of Federal Reserve Bank of Richmond, re-iterated that the Fed's discount window is wide open and it will take mortgage backed paper, auto loans, even boat loans as collateral. Boat loans? Why doesn't the Fed just go ahead and buy your boat? Buying foreclosed McMansions would be way too obvious but buying boats would be discreet and more helpful. Nothing would add liquidity faster to the economy than letting people get rid of the sink-hole-money-pit that is their boat. Just imagine all the cash people will have when they don't have to pay for storage, docking, repairs, insurance and party supplies to fund their twice a year boating getaway. It might be enough to pay for their mortgage. And, good news hedge fund managers, the Fed will even take that beautiful $23.5 million Trinity yacht off your hands. The Fed governors are still debating the moral hazard effects of bailing out hedge fund managers, one yacht at a time.

4. Break out the comfy chair. Ben Bernake, a great student of the Spanish Inquisition, has used its chief weapons to perfection.

Among the elements the Fed has used are surprise, fear and the soft cushions. First, St. Louis Bank President William Poole scared the bejesus out of the market by telling everyone that he was waiting for a "calamity" before acting. Which got the market wondering, what sort of calamity worse than the bankruptcy of nation's biggest mortgage bank, Countrywide, was the Fed waiting for?

Then, Bernake's surprise 50 basis point discount rate cut shocked the market out of its fear induced depression. It came at just the right time to save the market from further meltdown.

Next, Bernake broke out the soft cushions by "urging" Bank of America to make an investment in Countrywide Financial. Punk Zeigel's provocative bank analyst Richard Bove speculated that the Fed probably had a behind-the-scenes-hand in brokering that deal to help further stabilize the market. I'm sure that Countrywide CEO Leo Mozilo wasn't dying to give up 11% of Countrywide for $18 per share, especially if he really didn't think his company was headed toward bankruptcy. Mozilo might have needed some prodding from Bernake with the soft soft cushions to get him to accept the terms of the deal and keep the run on his bank from escalating into another full blown market panic.

With that success under his belt, Bernake is now going to break out the comfy chair by engineer an investment in Bear Stearns (NYSE:BSC), which is the market's other Achilles heel. Haimchinkel Malintz Anaynikal is still rolling over in his grave, given how fast Bear Stearns squandered its image as the most conservative and stable investment bank on The Street so shortly after Alan Greenberg retired.

Rumors have it that Bernake is "nudging" MGM Mirage (NYSE:MGM) or Harrah's Entertainment (HET) to invest in Bear Stearns, which would have the dual benefit of increasing Bear's cash flow and lowering its risk profile.

Other rumored Bear Stearns investors include the Blackstone Group (NYSE:BX) or KKR, both of which have much more experience dealing with the crushing debt loads that bankrupted the Bear Stearns hedge funds. Blackstone or KKR could return much needed "fiscal discipline" to the ailing investment bank by firing all the quant traders, cutting research analysts not on the Institutional Investor All Star list and, last but not least, saving more paper clips. Plus, after leveraging up the firm's debt to equity ratio 20:1 and paying themselves a "special dividend" for being such smart, swell guys, they could "flip" Bear Stearns to a naive international commercial bank.

3. Buy it Now on eBay. If the Fed really wanted to put money in home owner's hands, it could use its eBay account ("HelicopterBen") to raise the bids on all kinds of stuff. Underwear, unused wedding dresses, keys to my old car, mac and cheese (hmm-hmm good). That would put cash dollars right into the hands of consumers who have to sell all their belongings to meet the higher mortgage payment from their reset ARMs.

2. A new Bravo reality show. Five Fed Governors go head-to-head trying to save the financial system, one foreclosure at a time. These deeply flawed, yet lovable characters race against the clock (and each other), trying to flip a house before the foreclosure auction ends and another hedge fund blows up. Ben is the brainy academic who tries to lead his team of talented but socially misfit governors, Don is the cranky and stubborn bank veteran, Kevin is the naive one who can't ever stand up to the others, Randy is the cocky one who knows his mad central banking skillz trump all the others, and Fred just tries to make it to the next round by not doing anything too daring or too stupid. Find out whose left after this weeks episode of "Property Bailout".

1. Carpet bomb the US with cash. Screw the helicopters, bring out the big guns. Instead of dropping wads of cash on Iraq, Bernake should direct our commander-in-chief to fire bomb cash dollars onto the worst areas of the housing recession - Florida, Arizona, Nevada and California. Bernake, a great student of dropping things out of helicopters, has stated that, while unconventional, carpet bombing money is also an effective monetary policy tool. The government already tested this technique in 2002 by sending every parent in the US a $400 "tax credit". This averted a more serious recession and only had the minor side-effect of raising the CPI from 1.2% to 3.0%. Bernake speculates the only side effect of carpet bombing bags of money is inadvertently killing some of the intended recipients.