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.

Economy on the Skids, Frenzy of Hatred — Country Imploding?

The Dow Jones Industrial average fell nearly 680 points yesterday, losing value for the seventh trading day in a row. The S & P 500 and Nasdaq also suffered steep losses. This morning’s Dow Jones Futures (still down as of 6:34 CDT) suggests that the sell-off will continue. CNBC has described an atmosphere of panic on Wall Street. Credit markets remain tight, though CNBC reports that the LIBOR loosened somewhat overnight. It’ll take much more grease, however, to thaw frozen credit markets. Risk aversion has taken hold. The President is scheduled to address the nation at 10:25 EDT, and Secretary Paulson seems more willing to inject capital directly into banks, which means the government will have an ownership stake in the banks it saves. Many economists and Wall Street insiders are calling for such action, and the sooner the better.

All of this comes against an election year backdrop that is turning increasingly ugly. This morning’s ($)WSJ online reports (“McCain Campaign Is at Odds Over Negative Attacks’ Scope”) that the McCain campaign is divided about just how far to go in attacking Senator Obama. McCain has approved attacking Obama over his association with William Ayers, a former member of the Weather Underground. Some in the campaign want McCain to ramp up attacks by also hitting the Reverend Wright story again. McCain himself, the story says, seems reluctant to do this, declaring Rev. Wright off limits.

But what is really disturbing is how McCain campaign rallies have whipped up a frenzy of hatred against Obama and Democrats. Monica Langley and Elizabeth Homes, the WSJ reporters, write that

Some McCain campaign officials are becoming concerned about the hostility that attacks against Sen. Obama are whipping up among Republican supporters. During an internal conference call Thursday, campaign officials discussed how the tenor of the crowds has turned on the media and on Sen. Obama.

Someone yelled “Off with his head” at a rally Wednesday for Sen. McCain and Gov. Palin in Pennsylvania. Later that day in Ohio, a man stood outside a rally holding a sign that said “Obama, Osama.” At a rally in Jacksonville, Fla., on Tuesday, someone in the crowd wore a T-shirt depicting Sen. Obama wearing a devil mask.

Gail Collins, in Wednesday’s column for The New York Times, notes that “Sarah Palin has been telling her increasingly scary rallies that [Obama] is somebody ‘who sees America as imperfect enough to pal around with terrorists.’” Such inflammatory rhetoric cannot bode well. Are Republican leaders, especially Senator McCain and Governor Palin, prepared for the possible consequences of such rhetoric? Do they not realize the risk they’re taking? Do they not see the danger? Are we in the midst of something happening in this country that months from now we’ll look back upon this time period and say to ourselves, “That’s when we imploded”?

Picture courtesy of earthpro’s photostream at Flickr under Creative Commons License.

Lehman Going Under; Merrill Lynch Needs a Lifeline; AIG Treading Water

The latest news reports out of Wall Street cry havoc for tomorrow’s stock market opening. Short sellers, if they haven’t already missed the boat, should have a field day. The New York Times reports that Barclays has walked away from a deal to rescue Lehman Brothers, a huge investment firm with a long Wall St. history, because it could not persuade the feds to provide financial support for the deal. In other words, the situation at Lehman Brothers is dire — they’ll be forced into liquidation — with the federal government unwilling to bail it out as it did Bear Stearns earlier this year. The feds have little choice in the matter; Mr. and Mrs. Taxpayer can’t rescue everybody. Or can they? Have we lost appreciation for the term moral hazard?

Meanwhile, another huge investment bank and brokerage firm, Merrill Lynch, fearing the worsening mood from the Lehman disaster, is looking for a suitor to take it over, and it may have found one — Bank of America. Merrill’s stock has lost 68% of its value since the beginning of the year and 77% of value over the previous 12 months, so reports Tim Annett of the WSJ’s Marketbeat (9/14/08). The Bank of America rescue would pay $29 a share for Merrill (in closed on Friday at $17.05), according to the WSJ online (9/14/08).

American Insurance Group (AIG), whose stock has also taken a beating, is looking to sell assets to raise cash. Whether it will be successful in raising the kind of money it needs — a reported $40 billion — remains to be seen.

All of this news this Sunday comes after the federal takeover of Fannie Mae and Freddie Mac a week ago and the rescue of another Wall St. financial firm — Bear Stearns — earlier this year.

The WSJ online also reported today that the dollar had lost ground against other foreign currencies today (after several weeks of improvement). Foreign investors have largely propped up a debt-ridden economy, and the federal takeover of Fannie Mae and Freddie Mac was, at least in part, to reassure them. But with Sunday’s trouble on Wall St., how much longer are they going to continue to prop us up?

Credit markets seem certain to tighten even further. Serious deflation may be on the near horizon.