The Fed and the Credit Crisis: More Readings & Resources
The other aspect of the credit crisis to understand is the Fed. While we don't pretend to speak for them, or even too them :), we do think that most of their actions are readily understood by a) understanding the deeper structure of the environment and trends and b) how they see the world. More on that later but we believe that they've become increasingly transparent and are being entirely rational and logical in their actions, within the limits of the available data, analysis and human insight of course.
The critical problem is not that the Fed is facing the classic tradeoff between inflation and a slowing economy. No - it's much....much worse. They're between the rock of inflation and dollar problems on the one hand the hard place of an increasingly fragile economy.
The real problem, though, is that there is a tsunami of credit market breakdowns due to structural problems in leveraged debt instruments mounting toward them.
And us. Anyway you'll find an appropriate collection of readings and resources below the line here...
Federal Reserve
As Fed Meets, Recent History May Be Portent With the Federal Reserve meeting on Tuesday, it's a good time to take a short trip down memory lane to the last rate-setting decision. In mid-October, most investors believed the Fed wouldn't be cutting its target overnight bank lending rate -- known as the fed-funds rate -- when it met late October. But as the month ran its course, they began to see a reduction as a sure thing. Stocks rallied. When the Fed came through and lowered the fed-funds rate by a quarter percentage point to 4.5%, they rallied some more. The next day stocks fell, sending the Dow Jones Industrial Average 2.6% lower. They kept on tumbling through much of November. Likewise, preliminary uncertainty about whether the Fed would cut its target at today's meeting has given way to near certainty that it will lower it by another quarter percentage point. What's more, there's a growing sense that the Fed will take additional steps to try to break up a logjam in short-term credit markets that's beginning to weigh on the economy. It's now widely expected that the Fed will also cut the discount rate -- which is the interest rate it charges for the overnight loans it makes directly to banks from its discount window. That's expected to go down by a half percentage point, taking it to 4.5% -- just a quarter point above the expected fed-funds rate. That could help get money flowing to the financial sector. Right now, financial institutions try to avoid the stigma of borrowing directly from the Fed. It looks desperate. But at 4.5% it might look like good business. It costs roughly 5.25% to get one-month money from other banks. Stocks have been rallying ahead of today's meeting, just as they rallied ahead of the October meeting, with the Dow up 2.7% so far this month. Now, as then, the risk for investors may not be that the Fed won't come through with the actions they expect, but that those actions won't be the magic wand they desire. The place to look for this will be in the interbank-lending market. If banks are still charging each other 5.25% for one-month loans after all of the Fed's work, the market could lose its footing once again. Then there's the economy itself, which is looking increasingly unhealthy.Fed's Favored Inflation Measure Says Rates Can't Decline as Traders Expect Any evidence that accelerating inflation is becoming entrenched may heighten the Fed's debate as policy makers consider cutting rates to keep the worst housing market in 16 years and mounting losses in securities related to subprime mortgages from tipping the economy into recession. The gauge used by Sack, dubbed the five-year five-year forward breakeven inflation rate, suggests bets on lower Fed funds rates may be too bold. The fact that the rate stayed steady for much of the past two months as pessimism about the economy grew bolsters that view, said Michael Pond, an interest- rate strategist in New York at Barclays Capital Inc., one of the 20 primary dealers of U.S. government securities that trade with the Fed. A cooling economy typically tempers inflation concerns. While Bernanke has cut interest rates by three-quarters of a percentage point since mid-September, his approach so far has been more calibrated than that of his predecessor, Alan Greenspan, in 2001. Greenspan, 81, cut rates by 1.5 percentage points in the first quarter of 2001 in an ultimately unsuccessful effort to head off a recession. Bernanke's more measured approach may, in part, be born of necessity. As Greenspan himself acknowledged in his book, ``The Age of Turbulence,'' he benefited as Fed chief from the disinflationary forces of globalization and faster productivity growth. Bernanke, who took over in February 2006, hasn't been so fortunate.
· Bernanke May Have to Risk Becoming `Fool in the Shower' to Avert Recession Federal Reserve Chairman Ben S. Bernanke may have to risk becoming the proverbial ``fool in the shower'' to keep the U.S. economy out of recession. Renewed turbulence in financial markets puts Bernanke, 53, under pressure to open the monetary spigots wider to pump up the economy. Traders in federal funds futures are betting it's a certainty the Fed will cut its benchmark interest rate from 4.5 percent tomorrow, and they see a better-than-even chance the rate will be 3.75 percent or below by April.
· Fed Splits With Markets Over Recession Prospects, Seeing Continued Growth Federal Reserve officials still expect the economy to grow and are reluctant to deliver the deeper interest-rate reductions demanded by some economists and investors. The Federal Open Market Committee lowered the benchmark rate by a quarter-point yesterday to 4.25 percent, and said cumulative cuts of 1 percentage point this year should promote ``moderate growth.'' Policy makers also dropped their assessment that growth and inflation risks were ``roughly'' equal and cited ``uncertainty'' about the outlook. The move put the central bank, which has struggled to contain the subprime credit collapse, further at odds with investors. The Dow Jones Industrial Average fell the most after a Fed decision since Ben S. Bernanke, 53, became chairman in February 2006 as traders speculated he will fail to avert a recession. Officials haven't ruled out further steps to ease the credit squeeze in financial markets before they meet Jan. 29-30. Officials are actively considering ways to stem a surge in borrowing costs among banks and increase liquidity in markets. Some economists were disappointed the Fed didn't announce a greater cut to the discount rate than the quarter-point that officials delivered yesterday.
(WSJ) Fed Sifts Options As Rate Cut Fails To Cheer Market With a deepening credit crunch threatening to drag the stalled U.S. economy into recession, the Federal Reserve cut interest rates for the third time since August, and left the door open to further cuts. The Fed lowered its target for the federal-funds rate, charged on overnight loans between banks, by a quarter percentage point to 4.25%. It also cut the discount rate, at which it lends directly to banks, by the same amount, to 4.75%. Fed officials, however, continue to consider ways of using various tools -- including the discount rate -- to combat banks' unwillingness to lend even to each other, which they view as a threat to economic growth. The central bank could take action within days. A variety of steps, widely discussed in the markets, are likely to be on the table, including another cut in the discount rate, longer-term loans to money-market dealers, easier collateral rules for loans from the Fed, and other steps last taken in 1999 to alleviate funding pressures ahead of the year 2000, when many feared a "Y2K" computer bug would disrupt markets and create economic havoc. The FOMC's 10 voting members approved the rate cut 9-1. Federal Reserve Bank of Boston President Eric Rosengren dissented in favor of a sharper, half-point cut. One FOMC member also dissented in October, but in favor of no rate cut. The shift in the dissents, from wanting less rate cutting to wanting more, shows the turn toward pessimism at the Fed. Unlike the previous two rate cuts, yesterday's wasn't portrayed as "insurance" against improbable but potentially damaging economic scenarios. That suggests Fed officials view the economy as weaker than they expected as recently as late October.
· More Fed moves expected U.S. central bank is working on steps, which could come in days, to help banks lend more easily to each other, two papers report.
Fed, ECB, Central Banks Join to Add Cash, Ease `Elevated' Funding Pressure The Federal Reserve plans to ease ``elevated'' short-term funding pressures by injecting cash to banks through auctions and providing $24 billion in currency swap lines to the European and Swiss central banks. The Fed is coordinating the measures with the European Central Bank, Bank of England, Bank of Canada and Swiss National Bank, the Fed said in a statement in Washington. The Fed will auction term funds to banks against a ``wide variety of collateral.'' All ``generally sound'' institutions can participate, the statement said. The central banks are taking the steps after demand for cash sent borrowing costs climbing. The Fed's previous attempts to ease the credit squeeze that began in August have failed to have lasting effects. One gauge watched by central bankers, the three- month dollar London Interbank Offered Rate, rose to 5.15 percent a week ago, the highest in almost two months. Federal Reserve Statement on Measures to Address Funding `Pressures': Text ,Yen Drops as Five Central Banks Announce Measures to Ease Credit Crunch