Friday, November 05, 2010

The Fed's Plan

"Stocks rallied Thursday to their highest level since September 2008 as investors applauded the Federal Reserve's latest effort to stimulate the struggling economy."

"Investors pushed stocks higher as they digested the Fed's plans, announced on Wednesday, to purchase an additional $600 billion of longer-term Treasury securities by June in a second round of quantitative easing, dubbed QE2. The central bank also will keep reinvesting principal payments from its securities holdings. "I'm a little surprised that there wasn't a 'sell the news' reaction, but people are clearly relieved at the size of the quantitative easing package," said Ben Halliburton, chief investment officer at Tradition Capital Management."

Unfortunately economists like Brad DeLong and Paul Krugman aren't relieved. Two Years Late and Many Dollars Short and QE2: Meh. "So now the Fed is buying longer-term debt — but still only 5-year debt, with a current interest rate of slightly over 1 percent. How much more effective is that likely to be? And $600 billion really isn’t a lot when you’re trying to move a $15 trillion economy. One more thing: the Fed statement basically reaffirms the existing inflation target, it doesn’t raise it. So not much traction on the expectations side either."

Mark Thoma also agrees, Bernanke: What the Fed Did and Why. "The purchase should have been much larger, and it should have involved longer term Treasury securities (the plan is for 5 to 6 year bonds). The language in the Press Release about maintaining stable expectations was also disappointing to those who have ben advocating a higher inflation target. This is not, by any means, a bold plan. That's unlikely to change. Even if the economy continues to struggle, it's hard to imagine the Fed doing anything more than moving at a "measured pace," a pace too slow to do much except chip away at the margins. With fiscal policy out the window and a timid, tip-toeing Fed, we're likely headed for an agonizingly slow recovery."

Economist Karl Smith goes into a little more detail on what the Fed should do, Recovery is still job No. 1. "For a variety of reasons, I’ve argued that the Fed move to a permanently higher inflation target, something in the range of 4 percent -- a smidge above the inflation rate we had during the Clinton administration. There are many reasons for this. It would serve as a buffer against future economic crises, and because of the relationship between inflation and mortgage rates, it would mean that homeowners would naturally grow into their monthly payments and the inflation-adjusted principle on home loans would decline over time. However, the biggest reason to support an increase in the rate of inflation is that it would jolt the economy into growing again. Right now business and banks are holding tons of cash on their balance sheets. Part of the reason they do this is because, unlike in previous eras, there is little financial penalty for hoarding cash."

Krugman wrote, The Strange Death of Fiscal Policy. "So, it’s an amazing thing: Obama and company have managed to convince people that big government failed, without actually delivering big government." DeLong agrees. "This is an absolutely remarkable government that we have. And an absolutely remarkable political class."

Meanwhile, the unemployment numbers came out.

1 comment:

Anonymous said...

The Fed's new plan is simply more swag for Wall Street.

Written by K. Galbraith today on HuffPo:

"The original sin of Obama's presidency was to assign economic policy to a closed circle of bank-friendly economists and Bush carryovers. Larry Summers. Timothy Geithner. Ben Bernanke. These men had no personal commitment to the goal of an early recovery, no stake in the Democratic Party, no interest in the larger success of Barack Obama. Their primary goal, instead, was and remains to protect their own past decisions and their own professional futures.

Up to a point, one can defend the decisions taken in September-October 2008 under the stress of a rapidly collapsing financial system. The Bush administration was, by that time, nearly defunct. Panic was in the air, as was political blackmail -- with the threat that the October through January months might be irreparably brutal. Stopgaps were needed, they were concocted, and they held the line.

But one cannot defend the actions of Team Obama on taking office. Law, policy and politics all pointed in one direction: turn the systemically dangerous banks over to Sheila Bair and the Federal Deposit Insurance Corporation. Insure the depositors, replace the management, fire the lobbyists, audit the books, prosecute the frauds, and restructure and downsize the institutions. The financial system would have been cleaned up. And the big bankers would have been beaten as a political force.

Team Obama did none of these things. Instead they announced "stress tests," plainly designed so as to obscure the banks' true condition. They pressured the Federal Accounting Standards Board to permit the banks to ignore the market value of their toxic assets. Management stayed in place. They prosecuted no one. The Fed cut the cost of funds to zero. The President justified all this by repeating, many times, that the goal of policy was "to get credit flowing again."

The banks threw a party. Reported profits soared, as did bonuses. With free funds, the banks could make money with no risk, by lending back to the Treasury. They could boom the stock market. They could make a mint on proprietary trading. Their losses on mortgages were concealed -- until the fact came out that they'd so neglected basic mortgage paperwork, as to be unable to foreclose in many cases, without the help of forged documents and perjured affidavits.

These facts were obvious to everybody, fueling rage at "bailouts." They also underlie the economy's failure to create jobs. What usually happens (and did, for example, in 1994 - 2000) is that credit growth takes over from Keynesian fiscal expansion. Armed with credit, businesses expand, and with higher incomes, public deficits decline. This cannot happen if the financial sector isn't working.

Geithner, Summers and Bernanke should have known this. One can be fairly sure that they did know it. But Geithner and Bernanke had cast their lots, with continuity and coverup. And Summers, with his own record of deregulation, could hardly have complained.

To counter calls for more action, Team Obama produced sunny forecasts. Their program was right-sized, because anyway unemployment would peak at 8 percent in 2009. So Larry Summers said. In making that forecast, the Obama White House took responsibility for the entire excess of joblessness above eight percent. They made it impossible to blame the ongoing disaster on George W. Bush. If this wasn't rank incompetence, it was sabotage.

This is why, in a crisis, you need new people. You must be able to attack past administrations, and override old decisions, without directly crossing those who made them.

President Obama didn't see this. Or perhaps, he didn't want to see it. His presidential campaign was, after all, from the beginning financed from Wall Street. He chose his team, knowing exactly who they were. And this tells us what we need to know, about who he really is."