Still digesting the news from the Fed yesterday on the new $200B Term Securities Lending Facility. This type of arrangement has been discussed for some time as a possibility, but its still dramatic to see it unveiled like this. This is a big deal for a couple reasons – first, it allows for 28-day loans, not just overnight, and second, it allows a much broader range of bonds as collateral, including mortgage-backed securities. Combined with the other two $100B initiatives, the Fed has opened up over half of its $700B+ balance sheet to stabilize the credit markets.
It’s becoming fashionable in circles to doubt the Fed. I’ll be posting a book review of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve” soon, and I’ve seen a lot of commentary doubting Mr. Bernanke. All I can say at this point is that it is way too soon to be counting out the Fed.
They can’t work miracles, of course, but the power of almost unlimited resources is significant, if wielded properly.
The most fascinating aspect about central banking is it’s amazing foundation on the irrational and the immeasurable. In the end, it’s more about confidence than anything else. By convincing the markets that you will solve the problem, you create the confidence that increases liquidity and solves the problems. You can’t be predictable, because, like in warfare, predictability leads to people thinking steps ahead and countering your actions. Like a great General, you have to be unpredictable enough to instill fear and uncertainty in those who would fight against you, and through that uncertainty, ironically you win.
So you want uncertainty, but only the type that destabilizes those that would bet against you. You want to reduce uncertainty around the likelihood of Fed success.
If the juxtuposition sounds funny, blame it on the fact that I read the Greenspan book and a biography of George Washington all within a two week period.
Anyway, at times like this, it’s good to remember that the guy we have at the helm, at this time, is someone whose fundamental academic expertise is the mistakes made in the 1930s Great Depression, and the mistakes made in Japan in 1990s. A quick reference from Paul Krugman:
What you probably should know is that Ben Bernanke, in his capacity as a professional economist, spent a lot of time worrying about Japan’s experience in the 1990s. (So did I.) What was so disturbing about Japan was the way monetary policy became ineffective; by the later 1990s the short-term interest rate was up against the ZLB — the “zero lower bound.” This is alternatively known as the “liquidity trap.” And once you’re there, conventional monetary policy can do no more, because interest rates can’t go below zero.
Krugman also points out that today’s TED spread indicates a mixed message – confidence seems better slightly, but not significantly. That could be an indicator that the weight of uncertainty. Still, in his own words, yesterday’s move was a big slap in the face for the credit markets.
I can’t wait until the weekend when I have time to dig into all of this further.