Monday, March 9, 2009

Defending The Fed

Now that everybody is all over the Fed for all of our problems, I guess I shall be idiosyncratic and defend the institution. I think that they are struggling mightily, as well as the can, against an overwhelming tide that is now engulfing the entire world economy. They saw it coming, and at an early point engaged in very innovative wave of policymaking, including taking on the role of world central banker this past fall after the Minsky Moment of mid-September. It is easy to say, "well look how bad things are," but I think this is one of those situations where things would be far worse if they had not done what they had, and I am hard pressed to think of an alternative set of policies they could have done that would have made things better.

Now, I am not defending the Fed under Greenspan. Clearly there was an overly loose policy in 2003-2004 that aggravated the housing bubble. While Bernanke and others justified this on "complexity" grounds of worrying about asymmetries associated with a possible Japanese-style deflation (which we are now facing much more seriously), my cynical side says it was Greenspan wanting to help W. get reelected so that he, Greenspan, would not be on the receiving end of the sort of whining he got from W.'s dad after he supposedly was responsible for Clinton beating him in 1992 on an "It's the economy, stupid!" campaign. However, I think that in the last two and a half years, the leaders of the Fed have been aware that trouble was coming and were preparing for it, with their immediately rolling out alternative lending bodies and policy approaches immediately upon the eruption of troubles in the subprime markets in August, 2007.

A further piece of evidence is the speech that then New York Fed president, Timothy Geithner, gave in Hong Kong on September 15, 2006, "Hedge funds and derivatives and their implications for the financial system". While the opening part of the speech was pretty pollyannaish, the latter half of it was pretty scary, given the nature of Fedspeak, never wanting to spook the markets and trigger a crash that might be avoided. I shall close by simply quoting from it.
Understanding and evaluating “tail events”—low probability, high severity instances of stress—is a principal, and extraordinarily difficult, aspect of risk management. These challenges have likely increased with the complexity of financial instruments, the opacity of some counterparties, the rapidity with which large positions can change, and the potential feedback effects associated with leveraged positions.

Yes, folks, the Fed knew.


Anonymous said...

Memory does not serve, but didn't Paulson make a China trip shortly after being appointed? If so I wonder what he said to the Chinese. Maybe something like "all hell is going to break loose if you keep pegging to the dollar"? Not that changing the peg would have helped.
Maybe he said "all hell is going to break loose but you have to keep buying our paper or hell squared will break loose."
I wonder when he will publish his book?

TheTrucker said...

The current Fed is doing very well. But Allen Greenspan has a lot more to answer than just loose interest rates. Greenspan and Somers were the primary cheerleaders for the repeal of Glass Steagall and un-indicted co-conspirators in the CFMA (unregulated credit futures markets). The mixing of Fed supported depository institutions with Wall Street gamblers was a no-no at all times. Republicans blow bubbles. That is what they do. It's in the genes. So now we are being told that the latter day Fed has to rescue the gamblers or watch while Rome burns. I keep wondering when the Fed will create alternative credit sources and let the current hucksters suck on what they created. Why is the Fed buying a bunch of zombies?

Anonymous said...


It was my understanding that many of the perpetrators of this, i.e. Bear Sterns, Lehman Brothers among other would not have been subject to Glass-Steagall since they did not have a commercial side. I could be wrong. Maybe Prof. Rosser would like to comment? said...


Well, Paulson was Treasury Secretary and not in the Fed. Yes, when he was appointed much was made of his good relations with China. He certainly did not discourage them from buying US government securities, and I note that Hillary Clinton just encouraged them to continue doing so when she visited. Brad Setser says that they are, and if you want to get on a high horse about how undervalued the yuan/rmb is, well, Setser says the latest studies suggest it is only by about 5% or so. That is a bogeyman that should be put to rest.

BTW, on September 18 at the height of the worst crisis so far, it has been reported that "Gentle Ben" Bernanke got on a phone and was screaming into at Paulson to get off his duff and do a bailout.


Yes, Summmers was in on the general deregulation bug with Greenspan. In Greenspan's case it ran much deeper, given his Randian past.


You are right that some of the major action would not have been affected by the repeal of G-S, including all the seriously horrific mess at AIG.

Anonymous said...

Barkley Rosser:

Any link to the Setser comment?

Anonymous said...

You are very sensitive and clearly a deep thinker. But there's really no excuse or apology for the Fed to have been so slow to assess or act, despite it's 60 thousand foot
altitudinal view. Paulson was derelict by 9 months, and Bernanke was also out to lunch, even in terms of his willingness to accept and apprehend the depth and extent of the problem. These guys are Fluid Dynamics Engineers, and simply didn't get it. They were the same as the Captains of the Titanic. Quit cutting them slack...the F**d up.

Greg Hall said...

You are very sensitive and clearly a deep thinker. But there's really no excuse or apology for the Fed to have been so slow to assess or act, despite it's 60 thousand foot
altitudinal view. Paulson was derelict by 9 months, and Bernanke was also out to lunch, even in terms of his willingness to accept and apprehend the depth and extent of the problem. These guys are Fluid Dynamics Engineers, and simply didn't get it. They were the same as the Captains of the Titanic. Quit cutting them slack...they F**d up.

Barkley Rosser said...


Paulson was out to lunch until September 18 or so, but in fact the Fed was furiously scrambling and coming up with new policy tools basically from August 2007 on. It is easy to forget, but there was an ongoing string of crises, each of them responded to quite vigorously by the Fed. However, all of that now seems like nothing since the really big blowup in mid-September, since when basically everything has gone to hell in a handbasket.

As near as I can tell, the Fed was going all out and doing damn near all it could do. What should it have done that it did not? And, please do not tell us about something the Treasury or Paulson should have done, we are talking about the Fed here. Frankly, most people still have no idea how far they have gone, with their jumping ahead of the global crash in September by basically taking huge amounts of toxic waste from other countries onto their balance sheet. Things are bad, but they could easily be a whole lot worse.

TheTrucker said...

My little world of Glass Steagall said that the Fed was responsible for the value of the dollar and for the commercial banking system. In my little world that meant that "systemic risk" in the big casino in the sky was supposed to be 100% reserved bets among people who _HAD_THE_MONEY_TO PLAY already.

So based on my world with the Glass-Steagall walls in place, the Fed should not have bailed out any of these people and should have, instead, opened up a lot of new banks to loan money to people that needed it to carry on legitimate business enterprises. I am still not real clear on how the Fed and the Central bank becomes the AIG insurance company. Seems to me that a bunch of people got ripped off by paying premiums on insurance policies that were worthless. Too bad.

Unfortunately, it is now too late. In for a penny, in for a pound. We are stuck in the mother of all tar babies. We have now BOUGHT so much of the bad debts of all the gamblers and we stand to lose as much as they.

In my Glass-Steagall world, the regulation of the financial sector was the province of the SEC and the regulation of the credit swaps should have been the CFTC. The SEC was to insure that MARGIN requirements on asset acquisitions did not drop below 50% (brokerages) and the CFTC was to regulate the "insurance policies" called credit swaps again maintaining adequate margins on the "shorts" and the "longs". That area of regulation is not part of the Fed charter. All of that "NON_FED" regulation was cast aside by the deregulation Republicans and Greenspan on the ridiculous assumption that the Fed would then do the regulating even without any legislation to that effect. How Summers came to be such a Republican I know not.

But once the decision was made to "save the system" then the bridge had been crossed and the Fed is now doing as it must. They can't turn back the clock or attempt to retreat. That is much worse than full speed ahead. We will "inflate" our way out of it.

That's my story and I'm stikin' to it. said...

john c. halasz,

Sorry about not getting the Setser link sooner. It is possibly with a "/" on the end.


Two notes. One is that traditionally it is the Treasury and not the Fed that is supposed to manage the value of the dollar, to the extent that it gets managed, which varies over time, although in practice this is always done in conjunction with the Fed, especially when there is any "active" management, given that it is the New York Fed that actually carries out any interventions into markets to affect the value of the dollar. However, whenever that happens it is always under the direction of the Secretary of the Treasury, or more often and precisely, the Under Secretary for International Economics, of which we are currently lacking one.

The AIG situation is especially awful, and I am not surprised at the unusually heated remarks Bernanke made about it recently. In effect the scam that AIG pulled was to take advantage of its AAA rating as an insurance company to get better deals for its hedge fund subsidiary, AIG Financial Products, which was supposedly overseen by a small insurance regulatory in Connecticut, which was way out of its depth in dealing with this unit that basically ran its ops out of London and on a frightening scale and seriously opaque manner.