Wednesday, January 14, 2009


Jim Hamilton says it better:

One of Bernanke's goals was to reassure the public that the many new loans that the Fed is extending and assets it is purchasing do not pose a significant risk to taxpayers. From Bernanke's remarks:

Importantly, the provision of credit to financial institutions exposes the Federal Reserve to only minimal credit risk; the loans that we make to banks and primary dealers through our various facilities are generally overcollateralized and made with recourse to the borrowing firm. The Federal Reserve has never suffered any losses in the course of its normal lending to banks and, now, to primary dealers.

Left unsaid here is the fact any private lender could equally well have also extended said overcollateralized loans to these same borrowing institutions, but decided that the compensation for absorbing such a risk was inadequate. Bernanke's core assumption is thus that private lenders are currently mispricing risk, but the Fed can do it correctly. I'm prepared to believe that's true-- there is some degree of overcollateralization that might be inadequate for markets but should be sufficient for the Fed, but what is it? Are the underlying assets really worth 99 cents, 90 cents, or 50 cents on the dollar? Should the overcollateralization therefore be 1%? 10%? 100%? The devil is in the details, and whatever details we know about this aren't coming from the Fed.

... and he throws in some comments on the "exit strategy" for good measure:

Bernanke also addressed the question of what's the exit plan for bringing the Fed's balance sheet back to normal size and safety:

However, at some point, when credit markets and the economy have begun to recover, the Federal Reserve will have to unwind its various lending programs. To some extent, this unwinding will happen automatically, as improvements in credit markets should reduce the need to use Fed facilities....

As lending programs are scaled back, the size of the Federal Reserve's balance sheet will decline, implying a reduction in excess reserves and the monetary base. A significant shrinking of the balance sheet can be accomplished relatively quickly, as a substantial portion of the assets that the Federal Reserve holds-- including loans to financial institutions, currency swaps, and purchases of commercial paper-- are short-term in nature and can simply be allowed to run off as the various programs and facilities are scaled back or shut down. As the size of the balance sheet and the quantity of excess reserves in the system decline, the Federal Reserve will be able to return to its traditional means of making monetary policy-- namely, by setting a target for the federal funds rate.

That sounds to me like an exit strategy for how to get out of this if everything works out just right and the problems all go away.

And what's the exit strategy if it doesn't work? I suppose more lending facilities.

It's really hard to see how we're not turning into Japan with all this. So much of what the US is doing now reeks of the same political denial of the scale of the problem that left Japan marooned for a decade. The Fed is over-confident, the stimulus is over-small, and the Congress is over-stupid -- putting on a show about $20k in back taxes that the new Treasury secretary has already over-paid.

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