23 October 2008

The New Deal for the Banking System as the Financial Storm Intensifies

"Do you think he is so unskilful in his craft, as to ask you openly and plainly to join him in his warfare against the Truth? No; he offers you bait to tempt you. He promises you civil liberty; he promises you equality; he promises you trade and wealth; he promises you a reduction of taxes; he promises you reform... He prompts you what to say, and then listens to you, and praises you, and encourages you. He bids you mount aloft. He shows you how to become as gods. Then he laughs and jokes with you, and is familiar with you; he takes your hand, and gets his fingers between yours, and grasps them, and then you are his."
J.H. Newman, The Times of AntiChrist, 1889

We are seeing an enormous parody of Roosevelt's New Deal being rolled out in a hurried fashion for the bankers and the wealthy under the cloak of dire necessity prior to the likely change in political Administrations.

If we follow the political pattern of the 1930s, we will see a minority of Republicans and a sympathetic majority at the Supreme Court attempt to maintain the disbursal of liquidity largely to the corporations and banks, and to fight any progressive tax increases and social programs designed to push that liquidity directly to the public without passing through the tollgates of the financial system.

If this happens, we may see a powerful polarization in the country between a minority that will attempt to embrace state control to halt those programs and the encroachment on 'true American principles' and a suffering public, with a middle class pinned between them.

The corporatist appeal will be made to social conservatives, small businessmen, the banks and the corporations that spring up around them, and the lowest elements in the hatreds and prejudices and fears in the public, particularly the older middle class, to retrieve our national honor.

And if against all safeguards and probability this succeeds in gaining power, and burning the Constitution to preserve our freedom becomes a popular slogan, and a slyly articulate but otherwise inexperienced, almost mediocre, leader arises, and the corporate powers support this person in order to achieve their ends, then it will be time to leave, without looking back, before the storm breaks, and madness is unleashed, and a darkness falls over the land.

Bernanke May Seek New Ways to Ease Credit as Fed Rate Nears 1%
By Craig Torres

Oct. 23 (Bloomberg) -- Federal Reserve officials are likely to bring interest rates down so aggressively over the next few months that they will have to search for fresh tactics to continue easing credit.

The Fed's Open Market Committee will probably reduce the benchmark federal funds rate by half a point next week to 1 percent, the lowest since May 2004, according to futures trading. The official rate has never been lower since the Fed made it an explicit target in the late 1980s.

Further cuts below 1 percent could turn Fed Chairman Ben S. Bernanke's focus away from the main rate and toward more use of alternative tools. Those might include increasing its holdings of mortgage bonds to lower costs for homebuyers and purchasing securities directly from the Treasury in order to pump more cash into the economy, Fed watchers said.

``If there is need for more stimulus, the Fed will buy up government debt to keep borrowing costs low," said Adam Posen, deputy director at the Peterson Institute for International Economics and a co-author with Bernanke. That's tantamount to ``turning government debt, as it is issued, into money.'' (That is pure monetization and they can do it if they have the will and the need - Jesse)

Bernanke, 54, has already thrown the central bank's balance sheet into action in unprecedented ways. Working with the New York Fed, the Board of Governors has rolled out 11 new programs aimed at absorbing risk or making dollars available when banks don't want to loan. (A New Deal for the Banking System - Jesse)

Assets Doubled

The result: The central bank's assets, which include a loan to insurer American International Group Inc. and a pool of investments once held by Bear Stearns Cos., more than doubled to $1.772 trillion last week from a year-earlier total of $873 billion that comprised mostly Treasuries. The latest weekly figures are scheduled for release at 4:30 p.m. in Washington.

There's more to come. The Fed announced this week a backstop for money-market mutual funds to which it will commit another $540 billion. A commercial-paper program approved Oct. 7 could buy up to $1.8 trillion of securities.

``The net effect of these facilities has been a truly staggering pace of growth in the Fed's balance sheet,'' said Jan Hatzius, chief U.S. economist for Goldman Sachs Group Inc.

When the Bank of Japan fought deflation and a banking collapse earlier this decade, its balance sheet ballooned to more than 30 percent of gross domestic product as it pumped money into the economy, Hatzius said. He predicted ``further rapid growth'' in the Fed's, which is now equal to 12 percent of U.S. GDP. (The policy error is that they pumped the money into foolish projects and into an unreformed financial system, hopelessly compromised by the keiretsu corporatism of interlocking insider dealing. One does not start an engine that is broken by pouring more fuel into it. - Jesse)

`Helicopter Ben'

As a Fed governor, Bernanke did research on alternative policy tools between 2002 and 2004, when U.S. central bankers last cut the benchmark rate to 1 percent. Traders nicknamed him ``Helicopter Ben'' after a 2002 speech that referenced Milton Friedman's comments comparing such unorthodox methods to dropping money from a helicopter.

Vincent Reinhart, the Fed's director of monetary affairs at that time, said Bernanke's policy activism, which contrasts with his predecessor Alan Greenspan's almost exclusive use of the federal funds rate, derives from the chairman's research on policy errors in the Great Depression and during Japan's rolling recessions of the 1990s.

``He saw what we viewed as an obvious policy failure and it was in the ability of human reason'' to fix it, said Reinhart, now a scholar at the American Enterprise Institute.

`Quantitative Easing'

The Bank of Japan, struggling against deflation, slow growth and consumers' reluctance to spend, brought its policy rate close to zero before turning in 2001 to a so-called quantitative easing strategy of increasing money in accounts held for commercial banks. The policy lasted for five years, before the central bank began to draw down reserves and raised its benchmark rate to 0.5 percent, where it has been since February 2007.

The Fed has flooded the economy with so much cash that excess reserve balances at banks, or cash surpluses beyond what banks are required to hold against deposits, soared to $136 billion for the two-week period ending Oct. 8 compared with an average of $1.4 billion in the same month last year. (We showed this in a chart the other day. They are stuffing the banks with liquidity, and the banks are holding the reserves against writedowns and credit risk. At some point this will spill over and perhaps even break out, into what contrivances who knows. We may see a rise of 'superbanks' through acquisition. These will have to be taken apart in the coming years. - Jesse)

``The Federal Reserve has already entered a regime of quantitative easing,'' said Brian Sack, vice president at Macroeconomic Advisers LLC who also worked with Bernanke as an economist in the Monetary Affairs Division.

As their liquidity programs dump excess funds into the banking system, it's become more difficult for the Fed to keep the rate at which banks lend overnight to each other in line with policy makers' 1.5 percent target. (This is an absolutely key point to keep in mind - Jesse)

Below Fed Target

In an effort to put a floor under the overnight rate, the central bank started paying interest on the reserves banks deposit with it. That hasn't stopped the so-called effective federal funds rate from falling below the target every day since officials lowered their benchmark by half a point in an emergency move on Oct. 8.

In the two weeks since then, evidence of a deteriorating economy has mounted and will likely push Fed officials toward a further rate cut when they meet Oct. 28-29, economists said.

Industrial production in the U.S. fell in September by the most in almost 34 years, and retail sales dropped by the most in three years. Inflation pressures are easing as oil prices fall to a 16-month low, and nine months of job losses eliminates any pressure from wage increases.

Whether the target rate ends up below 1 percent depends on how fast consumers and businesses gain more access to low-cost credit. Economists at HSBC Holdings Inc. said the Fed would like to avoid cutting to zero. Still, if the economy doesn't improve, it ``could be at zero'' by the middle of next year, said HSBC economist Ian Morris.

``There is this understanding at the Fed that the worst thing you can do is save your ammunition,'' said Ethan Harris, economist at Barclays Capital Inc. ``You move fast -- that is the whole lesson of past crises in Japan and during the Great Depression.''