Sunday, November 25, 2007

God of the Sea, Master of Liquidity

In the pantheon of economic celebrities Ben Bernanke (Chairman of the US Federal Reserve) most likely occupies the seat of Neptune. God of the Sea; Master of Liquidity; Protector of sailors (see "markets") at times of tumult. And even though he is not as moody as the Greek god and, as far as we know, he does not share his rampant sex life, he does carry a beard and, critically, a powerful trident.

Beranke’s trident has three sharp spears—each with a name and with the power to affect the availability and the cost of money and credit. They are called "discount rate", "reserve requirement" and the "federal funds target rate". This latter is Bernanke’s favorite tool for steering the economy to smooth waters, at a good speed and with that monster called Inflation at bay. (It is also what people refer to at parties when they tatter about “the Fed cutting interest rates.”)

Yet, for three months now, the economy has been sailing in uncharted waters. Main Street is getting killed, and so is Wall Street. Subprime mortgage borrowers are going bust; their homes are repossessed. Banks that lent them money are losing money. And new lending is drying out—for you, me, the corner deli or even blockbuster names like Sallie Mae and Citibank. Stock markets are nervous; stock prices falling; house prices crumbling; gas prices biting. That’s quiet a bit to add to our already high stress levels from by the writers’ guild strike and its havoc on our night lives.

So will Neptune sway his trident? Thus far, markets pleaded and Bernanke delivered: Two rate cuts in two months, and other measures to increase the availability of money and credit (call that “liquidity”). The idea being to ensure the seas are high enough for the economy to cruise without hitting a shoal.

But, though powerful, Bernanke is not omnipotent. And while the markets are crying for more cuts, it’s unclear whether that’s what the economy really needs. Don’t get me wrong, lower interest rates would be nice! Yet, what is largely holding back credit these days is not so much its cost, as is nervousness over the next piece of bad news and uncertainty over the size of mortgage-related losses—so the solution is not necessarily another flood of liquidity.

Neptune himself learnt better: When Athenians were trying to choose between him and goddess Athena as their city patron, they asked each god to offer them a gift. With Athens an important sea power, Neptune gave the Athenians what he thought they wanted: Water. But that was not what Athenians needed! Instead, they picked Athena’s olive tree, with its food and wood and olive oil. And the city is named after her.

Glossary: liquidity, federal funds rate, subprime, Neptune, trident, wants, needs.

Useful links:
Rate cuts not the answer, says fund chief
The Long Johns on the Subprime Mess

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