I like writing about the Federal Reserve because I understand it well, but this is beginning to make me tired. Here goes:
- There are some who believe that the Fed will not cut rates soon. I half agree with them, because the Fed should not cut rates here. Let bad loans get their due punishment. That said, that ‘s not the way the Fed has acted for almost 80 years. Given that the Fed has to interact with politicians and businessmen, they are going to get a lot of negative feedback if they don’t loosen the fed funds rate. I general, the Fed caves to political pressure. This Fed is doing it now, but just in small steps, while they console themselves that they haven’t moved yet.
- On the surface, not much happened with the reduction in the discount rate. But the real story boils down to a willingness of the Fed to accept classes of securities that previously they would not. This includes ABCP. Beyond that, the Fed is allowing several large banks to lend beyond prior limits to their securities affiliates. This allows the banks to lever up more, and in relatively risky business. I am waiting to hear of charges of favoritism; failing that, of irresponsibility of the Fed in overseeing bank solvency of some of the largest banks.
- The actions that the Fed takes now will shape the next financial crisis. Where it loosens, leverage will flow to healthy areas that can absorb it until they become glutted as well.
- US T-bills have righted themselves, but i was surprised to see that Canadian T-bills went through a similar mishap. Oh well, they had ABCP also.
- SIVs are one issuer of ABCP, and many of them are doing badly now. I would not be too quick to rescue them, or be too optimistic about their ability to make good a maturity. The assets in the SIVs that have gone bad are not likely to turn around quickly. Next cycle, we will be more careful about what we lend against, until we commit the same error in a new way.
I hope the Fed’s actions so far will be enough, but I believe that they will have to do more.