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The Financial Times reports Fed
mulls options in tacking liquidity problem. What options?
The possible steps range from the relatively orthodox
– a disproportionately large cut in the discount rate at which the Fed
lends directly to banks – to more unorthodox measures.
At issue is whether it
would be worth the Fed dusting down some rarely used tools – or
improvising new ones – to help it reach beyond the banking system and
channel liquidity to where it is needed most.
And it's not just the Fed. Bloomberg reports Australian
Central Bank Will Buy Mortgage-Backed Debt.
The article proceeds to describe
some of these tools:
·
"encourage
greater use of the discount
window"
·
"extending
the term of open market operations"
·
"lending
directly to non-banks against their collateral"
·
establish
currency swaps with European central banks
·
"creatiion
of a temporary special liquidity facility that would accept commercial paper
at a discount rate"
·
the
sale of call options on interest rates
These and similar measures have
been discussed by the Fed for several years. They were studied during the
bogus 2002 deflation scare and disclosed in a series of papers and speeches
that I have discussed
elsewhere. It was my view at the time that the only for the Fed to avoid
a total meltdown of the credit bubble is to monetize assets at prices
sufficient to maintain the solvency of the banks and funds that hold them.
Although this point is somewhat
obscured by the language of the article, a few of these measures are moving
in the direction of monetization of securities. This can be direct
monetization, if the Fed simply purchases the securities with newly created
money, or indirect, if the Fed loans money into existence, taking the
securities as collateral, valued at some fictitious non-market price, likely far
in excess of the actual market value of the securities (if indeed they have
any).
But don't worry; like all
emergency government measures, they will be strictly temporary. "Mr
Berner said the Fed’s main concern would be to ensure it did not end up
taking any credit risk and that any unorthodox arrangements were truly
temporary."
What is more likely is that
temporary measures only prevent this round of problems from blowing up for
long enough until the next round of problems occur. Temporary measures might
allow time for alternatives to emerge, but what if the securities really are
still worthless on the market a month or two months later? (Jim Sinclair has
some interesting thoughts along these lines in this MP3
interview which starts at the 34:00 mark in the file). Once the props are
removed from these assets, what is to prevent the fund or banks that own them
from becoming insolvent?
Robert Blumen
Robert Blumen is an independent
software developer based in San Francisco, California
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