Tuesday, March 11, 2008

Exhausted Fed.

Fed Chairman Ben Bernanke was an academic before and studied at length the issues of monetary policy in general and dedicated a lot of time to The Great Depression in particular. Krugman notes in his blog that during his research Bernanke came up with two non-traditional emergency tools that Fed could use, and that Fed has already started to use them. TAF was the first one and today's TSLF is the second.

What this implies (and Krugman doesn't quite say it, which is understandable considering who he is) is that not only is Fed out of its traditional ammo, but even all the emergency tools are used up.

I do not want to underestimate Bernanke, he may yet pull another rabbit out of the hat, but to me it looks like matters are now outside of the Federal Reserve's power to influence. Fed is reduced to sitting there and praying that TSLF works. If it doesn't, the only thing that can save the banks is a direct donation of money to the banking system from the Congress - but good luck doing that quickly enough. Or maybe Chinese could donate us some of their reserve money - but I doubt that too.

At some point we should face the fact that financial system is looking at around 1 trillion USD of losses - so how much money are we prepared to spend saving the banks? It may well be cheaper to just let the banks fail and instead spend some of that money on unemployment benefits to the resulting masses of laid off people. But again, that would involve Congress.

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