Financial Markets

Federal Reserve Chairman Ben Bernanke has been much criticised for his actions over the last 10 months. In defense he has employed more than the customary set of tools to weather the most recent stresses in the financial markets.  Randall W. Forsyth in a Barron’s article “Hey, Bernanke Bashers: His Moves Have been the Right Ones” says:

Yet much of the criticism seems unfair and after the fact. Not only have Bernanke’s unorthodox moves staved off a full-fledged financial meltdown, but they also have done so while reducing the inflation risks inherent in the traditional policy response of merely slashing interest rates.

That’s not my opinion. It is the one rendered by the currency, credit, Treasury, equity and gold markets. Since the credit crisis peaked (or reached its nadir, depending on your point of view) on St. Patrick’s Day, the Monday after the Sunday night special with the Bear takeover by JPMorgan Chase, the extreme tensions in all those markets have eased.

It was not just the Bear deal per se. The Fed established the Primary Dealer Credit Facility, which let Wall Street investment firms to borrow from the central bank, a privilege reserved for commercial banks, except for the rarest instances in the Great Depression.

The PDCF joined other, new Fed instruments to funnel liquidity where it was needed most. Last December, the central bank began the Term Auction Facility, or TAF, which permitted banks to borrow anonymously for longer periods than via the traditional discount window borrowings, which were to cover overnight shortfalls. TAF also permitted borrowing against lesser-quality but still prime collateral.

The Fed also established the Term Securities Lending Facility, which allowed banks and dealers to swap their illiquid but high-quality government and mortgage-backed securities for Treasuries. It was like a pawnshop for the financial system, allowing Wall Street to exchange their (real, not fake) Rolexes for good-as-cash obligations of Uncle Sam.

From one point of view, these new facilities constitute a radical change in the conduct of monetary policy. Yet they arguably just attempt to bring policy up to date with the radically changed financial system.

My criticism is that the problems surfaced in August 2007 and the Fed looked on. Initially the Fed Funds rate was cut when the real problem was liquidity, as evidenced in many institutions/financial products not just commercial banks.

Read the whole article here.