The Fed's response to the open letter to Ben Bernanke

The previous post was a copy of the text from the Nov 15th open letter to Ben Bernanke.  A spokeswoman for the Fed responded via WSJ:

“As the Chairman has said, the Federal Reserve has Congressionally-mandated objectives to help promote both increased employment and price stability. In light of persistently weak job creation and declining inflation, the Federal Open Market Committee’s recent actions reflect those mandates. The Federal Reserve will regularly review its program in light of incoming information and is prepared to make adjustments as necessary. The Federal Reserve is committed to both parts of its dual mandate and will take all measures to keep inflation low and stable as well as promote growth in employment. In particular, the Fed has made all necessary preparations and is confident that it has the tools to unwind these policies at the appropriate time. The Chairman has also noted that the Federal Reserve does not believe it can solve the economy’s problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators, and the private sector.”
The problem with this line of thinking is that it is ominously similar to some of the responses that we heard from the big banks before the crisis.  The big banks during the crisis pretended that when things got tough, they could just sell at any time. 

The Fed relies on the same faulty logic.  Their risk strategy relies on repurchase agreements and other "tools" that make it easy to get out of a large Treasury position in good times. This exposes the Fed to counterparty risk that during good times could be controlled, but just when you need it it can dissappear.
If inflation were too pick up, would the Fed be OK with showing big losses on their balance sheet, or would they just keep holding and pretend like it didn't happen?  My bet is on the latter. 

Would they be willing to exercise the repurchase agreements, knowing that their forced sell would cause the value of their other balance sheet assets to fall?  I've seen how arrogant experts can be firsthand when they think they can "outsmart" the markets. 

Also, if they force an exercise of a repurchase agreement, who will take the hit for the loss.  If they have an agreed to exercise price, then the counterparty would.  Didn't the Fed just rescue these banks?  What would be the outcome if the Fed forced large scale losses at unhealthy banks? 


Popular posts from this blog

October retail sales come in strong, especially auto sales

Tea Party Buffalo Pictures

How to spot a fake Tea Partier