How Worried Is the Fed?

In a move that surprised many observers for its aggressiveness, the Federal Reserve Board on Tuesday, Dec. 16^th, lowered the federal funds rate, the interest rate at which banks lend to one another, from 1% to a range of 0 to .25%. Many observers had expected a .50% cut, not the .75 to 1.0% cut that the Fed has effected. The lowering of the interest rate points to a Fed extremely worried about the health of the economy going forward.

The Fed also announced other efforts to fight the specter of deflation, using, as it says, “all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” These tools include supporting

the functioning of financial markets and stimulat[ing] the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Federal Reserve Building

Together with the interest rate cut, these policies give insight on just how concerned federal officials are about the state of the economy. With job losses increasing, credit still tight, and prices deflating, the Fed wants to pump a flood of liquidity into the system to prevent a disastrous deflationary spiral.

The incoming Obama administration is also promoting an immense stimulus package that will pump even more money into an economy that it and the Fed are trying to reflate. Congress’s cooperation, with Democratic majorities, seems assured, although the defeat in the Senate of the auto bailout bill may portend a willingness on the part of Republicans to be obstructionist if they see political advantage.

The trouble is that if these efforts don’t work, what other ammunition do  the Fed, Congress, and President-elect Obama have left? If the auto companies fail, what will the resulting shock do to the crisis of confidence the economy is in? TARP money for the automakers has yet to be forthcoming (as of this writing), and people generally seem so sour on the automakers, not without reason, that President Bush and Henry Paulson seem reluctant to drink from this cup.

I suppose one could point to the equities market and see a glimmer of hope, but that’s, at this stage, fool’s gold. With the recent volatility of those markets, how can anyone rely upon them?

And even if the Fed and Congress through monetary and fiscal policies manage to reflate the economy, what then? With the world awash in liquidity, a new specter looms: inflation and its attendant risk, hyperinflation.

By the way, lest you think I’m all gloom and doom, Merry Christmas. Look out for the New Year.

Image courtesy of wwarby’s photostream at Flickr and used under license of Creative Commons.

No Confidence — in Leadership

If banks won’t lend to other banks, let alone to customers, then credit markets will dry up. And that’s exactly what has happened. Fear, lack of confidence and trust, not only in capital markets but also in leadership, are creating a perfect storm.

The way to liquefy the markets, as administration and Congressional leaders advocate, is to follow the basic outline of the plan that the House defeated yesterday. The problem is that this is an election year, and the public views the bailout as something solely for Wall Street. In fact, it’s enjoying the pain and discomfort and anxiety that the markets are now experiencing, a perfect example of schadenfreude. Investors and banks and those who support them and benefit from them deserve what they get, or in this case not getting. We seem, even, in a punishing mood, and forgiveness may be a long time coming. That’s why Congressional leadership is having such a difficult time getting their caucuses to go along with the $700 billion rescue. Congressional rank and file, particularly in the House, simply won’t go along with a package that appears to bail out Wall Street. Their constituents are opposed and enjoying the spectacle, and their representatives won’t lead. They lack the courage.

Of course, such a do-nothing view is extremely shortsighted and troubling. Frozen credit markets are devastating not only to Wall Street but to Main Street as well. Endangered are not just the rich and wealthy; they’re not islands, and neither is the middle class. To think that what happens in one doesn’t affect the other is myopic. If you feel good about the pain that Wall Street is undergoing, how will you feel when the wave hits you?

The trouble is that if there is a crisis of confidence in financial institutions, there is also a crisis of confidence in leadership. President Bush, Paulson and Bernanke, Congressional leaders, public opinion makers, simply are not trusted. We’ve reached a state of mutual distrust, and no clear way out of this thicket seems apparent.