Desperation may be too strong a term, but certainly there’s growing alarm at the Federal Reserve these days, as a sense of gloom and fear seeps through financial markets like some poisonous gas. The strain is telling at the Fed, as it comes under increasing criticism for a) not preventing the mortgage crisis and b) not doing enough to resolve it. Few Fed officials bargained for the kind of economic and financial nightmare they are now dealing with, a situation much worse than anyone expected and which is subject to those almost euphemistic “downside risks.”
Or, as Fed Governor Frederic Mishkin stressed in early March, “SIGNIFICANT downside risks.”
One senior official confided with a nervous laugh that he is ready for a break from the constant stress that has been his and his colleagues’ lot since the subprime mortgage crisis broke on their heads last August.The pressure has been unrelenting over the past seven months, and it’s beginning to show in even officials’ public comments. A subdued Vice Chairman Donald Kohn, subjected to the most withering line of questioning in years by the Senate Banking Committee, admitted, “It looks very shaky; every day there is some more bad news.”
A day before the Fed took the dramatic step of greatly increasing its liquidity provisions through the Term Auction Facility (TAF) and extended term repurchase agreements, New York Federal Reserve Bank President Timothy Geithner warned the credit crunch could have “an outsized adverse impact” on the economy and said the Fed needed to move “proactively.”
Geithner’s comments were just the latest in a series of remarks by Fed officials that betrayed a heightened sense of urgency which hinted strongly at additional, aggressive monetary easing – and an extended period of low rates. Earlier, Fed Chairman Ben Bernanke had said subprime mortgage problems and foreclosures called for “a vigorous response.” Cleveland Fed President Sandra Pianalto, a Federal Open Market Committee (FOMC) voting member, said the economy is “highly vulnerable” to a “significant credit crunch” and said the Fed has to be ready to act in an “aggressive and timely manner.” And Boston Fed President Eric Rosengren warned of the “significant cost” of delay in dealing with the fall-out from the subprime debacle.
Not that it will get much sympathy from many quarters, but the Fed feels the weight of the world on its shoulders. Kansas City Fed President Thomas Hoenig, in fact, was quite explicit about it: “We are placing too much burden on monetary policy in dealing with financial crises.” With the Fed facing “significant headwinds” from market credit constraints, he called for more fiscal stimulus. In short, it hasn’t been much fun working for the Fed lately. But when the going gets tough, the tough get going.
And indeed, the Fed has shown some intrepid qualities these past few months. It has launched innovative new liquidity provisions, and it has not been above admitting that it had gotten behind the curve. Its 125 basis points of easing in an eight-day period in January, including a 75 basis point inter-meeting rate cut, was unprecedented. In cutting the federal funds rate a cumulative 225 basis points to 3% since last September, it eased at least as much proportionately as it did in the first half of 2001.And the Fed is prepared to do a lot more if necessary, and that seems increasingly likely. It may be whispering past the graveyard, in a sense, but the Fed believes that relatively well contained inflation expectations give it latitude to fight recession and worry about price pressures later. And the dollar be damned for now.
It’s hard to say how low the funds rate will go, but despite previous promises that the Fed will eventually reverse its rate cuts with as much speed as possible to head off inflation, officials have lately been signaling that the Fed will hold rates down for quite awhile.
“We cannot know with confidence today what level of the short-term real funds rate will be consistent with our objectives of sustainable growth and low inflation, but if turbulent financial conditions and the associated downside risks to growth persist, monetary policy may have to remain accommodative for some time,” Geithner said.
The latter comment has a familiar ring. After the FOMC cut the funds rate to 1% in June 2003, it repeatedly said “policy accommodation can be maintained for a considerable period” and did not begin raising the funds rate until June 2004.
Here we go again, folks. Hang on.
Steve Beckner is senior correspondent for Market News International, which sponsors his Web site “The Beckner Report.” He is regularly heard on National Public Radio and is the author of Back From the Brink: The Greenspan Years (Wiley).