The more I think about it, the more I end up concluding that Ben simply lacks cojones. I mean, this is a guy who has made a career writing about the Great Depression; a guy who knows inside-out the menu of policy options available to a Central Bank, when there is not much of an interest rate left to cut; and a guy who is fully aware of the importance of shaping market expectations with clear communication of policy intentions. So, what’s going on with him?
But let us first define cojones. A potent Spanish word, applicable to a wide range of situations and personalities, be it a scene in 007 (“Señor Bond, you’ve got big cojones!”) or Hillary Clinton (well…). In Fed speak, cojones means going “unconventional”. As in, taking any (unconventional) policies necessary to meet the Fed’s growth and inflation objectives. Here are a few ideas, thrown around by Ben himself, among others:
(1) “Quantitative easing” (QE), meaning the massive expansion of Fed lending to financial institutions and non-financial companies;
(2) Changing the relative supplies of specific securities in the market (e.g. Treasuries, mortgage backed securities, etc) by using the Fed's balance sheet to buy or sell those securities accordingly;
(3) Shaping market expectations, say by providing credible assurances to investors about future policies.
So where are we on those fronts?
Behind the curve… True, Ben has gone easing, big, doubling the Fed’s balance sheet within six weeks to more than two trillion dollars. True, Ben has been pushing the Fed’s mandate towards the limits, setting up SIV-equivalents with acronymed names (MMIFF, CPFF) that compete with those of their toxic predecessors.
But that’s not enough. It has been piecemeal and reactive. It has picked the “beneficiary” securities on an ad hoc basis. It has targeted new lending, which is ok, but skipped the illiquid “skeletons” that are clogging the pipes of financial intermediation. It has taken weeks to implement each one. And it has lacked a vision as to what the end point is—except perhaps from some secret hope that Martians will be landing in the near future to eat up the entire stock of toxic assets.
The financial system is broke. Unless it’s fixed—unless someone plugs the hole—Fed interventions of any size will fail to be a catalyst for the (quick) resumption of private sector lending. Indeed, it was Ben himself who observed that one reason why the impact of QE in Japan was relatively limited was because of “the poor condition of banks’ and borrowers’ balance sheets, which makes profitable lending difficult and induces banks to hold large quantities of idle balances.”
Who’s gonna plug the hole? The market is screaming for direction. Hank scr&^ed up on that one, playing around with the TARP, but Ben has added to the communication-fiasco with silence. So much for “shaping market expectations.”
What’s needed at this point is a Fed with cojones. A Fed coming out (SOON) with a clear and credible Big-Bang announcement that it’s going to start buying large quantities of specific securities in order to clean up the financial system. Repeat, “clean up.”
Yes, we may well continue to need facilities like the CPFF, the MMIFF or (how about that?) the ABCPMMMF in the short run, to keep the financial system from falling into a complete coma.
But ultimately, what these facilities do is to supply the system with as much credit as the Fed is ready to provide. Banks will not lend unless they have a better sense of how big a hole they have in their books, how big a hole exists in other banks’ books, not to mention the holes in their potential borrowers, firms or households.
Can the Fed do it? Well, for a start, it can always buy Fannie and Freddie mortgage backed securities (MBS). That’s already in its mandate, stark and clear. Yes, the Fed had hesitated in the past, out of fear it might validate market perceptions of an explicit government guarantee. But after Hank’s bazooka… give me a break!
But why stop with MBS? The recently established “SIVs” (under the CPFF and MMIFF) have set (admittedly “creative”) precedents for the Fed to become more, let’s say, adventurous. Like, start buying up less "conventional" assets from banks’ balance sheets to free up some capital. Ideally, this should come along with a commitment from the Treasury to plug any eventual hole in the Fed’s own balance sheet, likely preceded by a crash-course on finance for Congress, including the definition of “exigent conditions.”
So, Señor Ben, show us some cojones… you know, the unconventional type!
Glossary: SIVs, ABS, CPFF, MMIFF, EIU$^#ITY$%, cojones.
Policy Adrift, by Tim Duy
Deflation? Quantitative Easing? by Mark Thoma