Dissent Divides the Federal Reserve...Again



Could it be that the Federal Reserve is falling apart from the inside? Ooh, ooh, please say this is not a dream - someone pinch me!

The Fed presidents, who in Greenspan's day took everything The Maestro said as gospel, are beginning to show signs of wear and tear, or better, awareness that the Federal Reserve may be overstepping its declared purpose as interest-rate-setter and lender of last resort. When no one is getting a piece of the debt pie, who do you think is doing all the lending? Well maybe the Fed needs to re-evaluate its purpose...

I'm smoking a fat cigar as I write this in honor of Paul Volcker and his Group of 30 (ok, so they're bastards and I'm lying, I don't smoke cigars) for releasing this document mid 2008 questioning the Fed's position in the economic clusterfuck that we found ourselves smack dab in the middle of.

I don't trust the G30 as far as I can throw them (into oncoming traffic) but there is some enlightening commentary to be found amidst the smoke and mirrors. Most notably, as Option ARMageddon pointed out, the call for regulation of central bank activities. But how can the government regulate the provider of money as we know it? That's like telling God when and where he can put rainbows - after all, don't we worship money in this country?

In a June speech by Richmond Fedhead Jeffrey Lacker, doubt peeps through the layers of smoke to reveal an understanding of liquidity that seems to be beyond Ben Bernanke's comprehension:

These two perspectives are clearly interrelated, since the loss of liquidity in asset-backed and related markets appears to have come about largely because of significant shifts in people's assessments of the underlying credit quality. Despite this intimate connection, emphasis on one or the other tends to lead to very different interpretations of recent events. An emphasis on liquidity is often associated with a view that financial market instability represents a breakdown in the functioning of markets, while an emphasis on credit quality suggests the view that such disruptions are simply the natural way that markets (even well-functioning markets) adjust to large changes in peoples' beliefs about fundamentals.

In his January 2009 speech to the Maryland Bankers Association Annual Economic Outlook Forum, Lacker openly admits to showing disdain for current Fed policy, saying as always that his opinion does not necessarily represent that of his Fed colleagues. Could it be? A dissenter among the Fed ranks?

The monetary liabilities of the Federal Reserve Banks have more than doubled over the last several months, from around $840 billion the week ending September 11, to around $1.7 trillion the week ending December 31. Virtually all of this increase was in the form of bank reserves – the deposit balances that banks hold at their Federal Reserve Banks – which went from $8 billion to $848 billion over that period. (The rest of the monetary base consists of paper currency.) This increase in the Fed’s money supply was a consequence of the collection of credit programs initiated last fall.

But monetary policy and credit programs do two different things. Monetary policy stabilizes the purchasing power of money over time by keeping the price level stable and relatively predictable, and by doing so, contributes to maximum sustainable economic growth. Credit policy is also aimed at promoting growth, but it is more a form of fiscal policy in that it uses the public sector’s balance sheet to alter the allocation of resources. In this instance, credit market interventions have been financed to some degree by the issue of new monetary liabilities, but they could just as well be financed with non-monetary liabilities, such as U.S. Treasury securities.

Both the short-term benefits and the long-term costs of central bank credit have been and will no doubt continue to be debated for some time to come. But no matter how one assesses the overall merits of such programs, it is important to recognize that these are fiscal measures that are distinct from monetary policy. While at the present time, credit programs do not conflict with our monetary policy strategy, there could well come a time at which monetary stimulus needs to be withdrawn to prevent a resurgence of inflation, even though credit markets are not deemed fully healed. At that time, containing inflation may require closing down credit programs, or finding an alternative, non-monetary financing arrangement for them. Price stability, after all, is the vital first ingredient in financial market stability.

I love you, Jeffrey Lacker. Don't stop. Smack Bernanke upside his bald little head next time you see him in the halls of the Federal Reserve. QUESTION Fed policy, PLEASE, for the greater good of this country. Are you a sheep or a diabolical bastard who wants to destroy American sovereignty or are you first and foremost an American? Oh so dramatic.

Save us, Jeffrey Lacker! We need you!

Lacker may be the only prick over there who "gets" it - with such enlightened statements as these, I can't imagine he'll last much longer over at the First National Central Bank of FAIL:

The striking feature of central bank lending and other government financial support during the recent turmoil is the extent to which it has extended well beyond the boundaries that previously were understood to constrain such lending, both in the range of institutions and the contractual terms on which credit has been provided. Intervention has been driven by a desire to prevent damaging disruptions to financial markets, and thus reduce the overall costs of the turmoil. While this objective is clearly understandable, central bank lending can create the expectation that similar support will be forthcoming when market disruptions occur in the future. Such expectations can themselves be very costly, because they can distort the incentives faced by, and as a result, the choices made by private-sector participants. For example, in the past year, expectation of official support may have induced some firms to take the risk of turning down capital infusions or merger offers in hopes of finding better terms in the future. Prospective equity investors may have demanded stiffer terms to compensate for the possibility of dilutive government intervention. Clearly, these recent examples of the moral hazard effects of official intervention are detrimental to broader public policy objectives, and place a significant burden on the supervisors of financial institutions to constrain such risk-taking.

I love it when you talk like that, Lacker. Someone has to remind these guys at the Fed what exactly their job description consists of - who better than one of their own?

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.

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