Bernanke: Please Tell Us There are More Tricks in Your Bag

March 31, 2008

The Federal Reserve has cut interest rates, bailed out a US bank for the first time since the Depression and announced that they are willing to swap US Treasuries for mortgage backed securities that no one wants. Yet the US economy is still in trouble and the liquidity in the money markets remains a problem which leads everyone to wonder what other things the Federal Reserve could have in their bag of tricks.

Greater Oversight Won’t Do Anything to Solve Today’s Problems

The best plan that the Bush Administration has put forth is one that will take years to complete. US Treasury Secretary Paulson has recently announced a proposal to give greater oversight power to the Federal Reserve. Until now, the Federal Reserve only had control on financial holding companies, bank holding companies and state chartered banks. This new proposal will allow them to monitor the risks across the entire financial system including investment banks. Basically imagine how happy Wall St will be about Bernanke breathing down the necks of CEOs like Jamie Dimon of JPMorgan Chase.

Paulson’s plan is ambitious but it is aimed at avoiding tomorrow’s problems without solving today’s first. Steve Walden gives the best analogy; Paulson’s proposal is like “responding to the Chernobyl meltdown by issuing three-ringed binders filled with better procedures about how to manage the plant.” The US economy needs solutions now rather than preventive measures with goals that may be almost impossible for the Federal Reserve to achieve. The proposal basically gives the Fed the responsibility to identify, avert and stop a financial crisis before it happens. Good luck Bernanke.

Is the Fed Considering Nationalizing US Banks?

The Federal Reserve is beginning to run out of options. Today’s UK Telegraph reveals that the US central bank is eyeing the Nordic-Style Nationalization of US banks as a temporary solution to the US financial crisis. Between 1991 and 1993, Norway, Sweden and Finland nationalized several institutions and their efforts have been touted as one of the most successful central bank rescues in recent history. Two weeks ago, the Fed committed to swap 60% ($420 billion) of its $700 billion balance sheet of safe and secure US Treasuries for risky and dubious mortgage backed securities. What more can they really do? With each bailout, they are committing public money for a firm that should be punished for its use of excessively high leverage and poor risk management. Of course, the currency market will probably not take a nationalization favorably, at least initially. Remember when the Bank of England announced that they were nationalizing Northern Rock back in April? The British pound fell 300 pips in 3 days.

How Much Lower Can Interest Rates Go?

With interest rates already at 2.25%, the market is wondering how much lower can the Federal Reserve go? Just from a mathematical perspective, they could cut rates another 225bp, but the Federal Reserve would never bring interest rates down to Japanese levels. The low point in in the past decade is 1 percent. But with the rise in rice prices on the front page of the NY Times this weekend, the Federal Reserve can only turn a blind eye to inflation for so long. Short of printing money, the size of the Federal Reserve’s balance sheet will limit what they can do. With 2 year US Treasury yields falling to 1.5 percent, the market is still risk averse and everyone believes that the worst is not behind us.

Can the Federal Reserve Print Money?

Yes of course, they can do whatever they want, but printing money increases inflation. With commodity prices already on the rise, Americans may not be able to handle even higher costs of living.

Bernanke will be testifying before the Joint Economic Committee this week and non-farm payrolls are due for release. Unless Bernanke reveals another trick, the dollar could fall to a new record low. I expect non-farm payrolls to be weak (keep an eye out for my Non-Farm Payrolls preview on Thursday).

Posted in Bernanke, Fed Rate Cut, Fed Rate Cut Expectations, Forex News, Housing Market, euro