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Monday, September 15, 2008

Fed Throws Liquidity At It

They really have no other option:
The Federal Reserve added $70 billion in reserves to the banking system, the most since the September 2001 terrorist attacks, to keep bank borrowing costs low after the bankruptcy of Leman Brothers Holdings Inc.

Fed funds traded as high as 6 percent, or 4 percentage points above the central bank's target rate for overnight loans between banks, according to ICAP Plc, the world's largest inter- dealer broker. The margin is the greatest since Bloomberg began tracking the data in 1998. The rate dropped to as low as 1.75 percent after the Fed added the temporary reserves.
If they cut rates now they'll have nothing left when they really need it. This is the mechanism by which they are attempting to fend off a world depression, but a most unpleasant global recession is now unavoidable.

I am working on a long post explaining how we got here. The battle now is to prevent money from drying up to the point at which it takes out the real economy. The real economy is in recession, but recessions aren't dangerous or unstable events. Credit contractions on a massive scale are.


The Fed effectively did cut rates as the FF rate traded at 1.00% at the close.

Sure, they can still reverse today's injections in the coming days. What are the chances of that?

If the Fed doesn't cut this meeting, expect to see a de facto cut anyway as FF trade persistently below target.

There are two reasons why the Fed will probably cut:

1) Since banks cannot raise capital, the Fed will try to steepen the yield curve to generate bank capital in the form of retained earnings.

2) Bernanke believes a stagnant money supply (base growth) contributed to the Great Depression (as did bank failures).

We have a permanent policy of easy money in this country. Its the one thing that, if it had been different, would have prevented this whole mess. In particular, if Greenspan had hiked rates at a faster-than-measured pace, most of this pain could have been avoided at very little cost.
If they cut rates now they'll have nothing left when they really need it.

They don't give a crap. It's all about making things look as un-bad as possible right now - to kick this can down the road to the next administration (I predict that Bernanke will quit right around Jan 20 if not sooner).

These people don't give a shit about the day after tomorrow - it's about prererving the appearance of status quo for as long as possible, even if it means killing the country to do it.

Between the FHLB and the Fed, they've already thrown a trillion at it, and most of it just went into more bullshit. That's money that would really have been nice to have to use in a sensible fashion, a year form now, but is gone forever.

Paulson in particular is so full of shit it's unbelievable. Everything that guy says is wrong, just a lie.
I've said all along that a lost decade (as the Japanese had) should not be viewed as a failure. Indeed, it may be the best that can be accomplished.

Some rant about the bailouts and say that everything should be allowed to fail. That was certainly Mellon's position in 1930. It didn't work out so well the last time, did it?

The Fed and the Treasury are trying to unwind this mess slowly, only bailing out the things they absolutely have to. Lehman was a shot across the bow to the Street -- not everyone will be saved, so you'd best be doing your part. The Fed and Treasury have gambled that letting Lehman, AIG, and WaMu fail (or be bought out by private interests) is not going to bring down the whole house of cards. It will be fascinating to see if they gambled RIGHT ...

Saving Bear Sterns, in retrospect, has to be looked at as saving JP Morgan, not as saving Bear Sterns. That's the risk that the Feds decided was too big to take. Fannie and Freddie were way too big not to get bailed out. It will be interesting to see who else is big enough and critical enough to be worthy of saving.
David - it is true that flooding the market with money will bring down effective rates. We'll see how long it lasts!

I think the Fed is looking ahead six months and won't cut. Because if they do, they are going to get themselves in a Japanese box. Anyway, if the Fed tries to fix the errors of the past right now, they'll cause a depression. I agree the policies of the past should have been stricter, but that doesn't change the magnitude and global scale of the current problems. This is no joke. It is a genuine crisis of exceptional depth and range. What started as a collapse of a small class of assets in the US is now a worldwide collapse of several classes of assets. We have manufacturing overcapacity. It will not take much more!

Bob, I try to make allowances for what I might not be aware of and for my own limitations, but having stated that, I still think Paulson is a chump. Either he is or I am.

John - I agree with you. Fannie and Freddie and FHLB are liquidity moves. Lehman's demise is an attempt to take the licking up front. Bear Stearns didn't get saved. The stockholders were pretty much wiped out. What was saved were those who held other commitments, just as F&F market value is gone, but the bondholders have temporarily been assured.
I agree that times are dire. I agree I'd rather see a Japanese-style lost decade than a full-blown depression.

But is that what Paulson and Bernanke are fighting for? Bernanke was the idiot who suggested *raising* GSE limits during congressional testimony. Paulson seems to be fixated on business as usual at the GSEs now.

So, as the plane runs out of gasoline, instead of handing out parachutes, these guys are trying to deny the existence of gravity. That scenario ends poorly.

I don't think Paulson is a chump - I think he is a lying scumbag whose only plan is to kick this down the road.
David - it is true that flooding the market with money will bring down effective rates. We'll see how long it lasts!

As in "PRINT! PRINT! PRINT! PRINT! PRINT!" like Zimbabwe?

Might generate jobs in the mint, officially-inking the new zeros behind all the numbers on the bills; Zimbabwe was adding a new zero every week that way.
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