Sunday, March 30, 2008

Alan Meltzer gets it right

...and of course by getting it right I mean "agrees with me". I've been posting (see here and here) that while I applaud the recent "lender of last resort" actions by the Fed, that driving short term real rates negative is bad monetary policy.

Here is Alan Meltzer this past week:

Monetary policy is too lax at present. The Fed has done too much to prevent a possible recession and too little to prevent another round of inflation. Its mistake comes from responding to pressure from Congress and the financial markets. The Fed has sacrificed its independence by yielding to that pressure. As a result, real short-term interest rates are negative. Borrowers are being paid to borrow. Negative real rates were a cause of the current problem; they are not a cure. The Fed must raise interest rates in order to prevent inflation.

On the other hand, the Fed’s credit policy has been good. It has been alert to problems in the payment and settlement system. Banks and financial institutions are uncertain about the solvency of other institutions, so they prefer to hold cash rather than to lend it. The traditional way to solve problems of this kind is to provide as much cash as the market wants. And indeed, the Fed has invented new ways of pumping reserves and liquid assets (Treasury bills) into the market. This has helped to prevent a genuine market crisis—at least so far. The Fed did not “bail out” Bear Stearns. It arranged a sale that wiped out the equity and replaced the management without closing the firm.

The Fed’s only mistake was to guarantee $30 billion of Bear’s portfolio. This action transferred potential losses from the market to the taxpayers. I do not believe the present system can remain if the bankers make the profits and the taxpayers share the losses.

Mungowitz: can I get a Amen?


Anonymous said...

Query (and a sincere one)--what, precisely, is the difference between the Fed providing liquidity as LLR (and as a consequence expanding the assets that the Fed accepts in exchange for said liquidity) and guaranteeing $30 billion of BS's portfolio?
Forms_of_Fed_Lending.pdf and especially the new programs announced in March).

I don't understand how the broader LLR functions as they have evolved are any different than the specific BS action. Could you explain this?

Shawn said...

so, does BS now only mean Bear Stearns? Or is BS bs appropriate?