29 Dec 2009

Bernanke Will Be Revered By Future Fed Chairs

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Afraid to ask Congress* last year for the authority to issue the Fed’s own debt to the public, Bernanke decides it’s better to seek forgiveness than ask permission:

The U.S. Federal Reserve on Monday pressed ahead toward the creation of a new mechanism it says could be used to withdraw money from the banking system once policymakers decide to tighten monetary policy.

The program, called the term deposit facility, would allow financial institutions to earn interest on loans of longer maturities to the central bank. The Fed already pays interest on banks’ overnight reserves.

“Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy,” the Fed said in a statement that was the Fed’s first detailed proposal for the new facility.

Rates on term loans, whose maturity would likely range between one and six months and would not exceed a year, could be determined via competitive bidding at auction, the Fed said. They would be available only to financial institutions eligible for federal deposit insurance, not the general public. Once lent to the central bank, the money cannot be withdrawn.

Excess Problem

In its effort to battle the worst financial crisis since the Great Depression, the Fed has deployed an extraordinary array of emergency measures, leading to a surge in outstanding credit to the banking system to more than $2.2 trillion.

The amount of money sloshing around has fueled concern about the possibility of high inflation. Withdrawing the reserves at just the right time is seen as crucial to keep consumer prices under wraps.

“They have a big problem with excess reserves and this is one of the ways to deal with it,” said Raymond Remy, head of fixed-income at Daiwa Securities.

At the height of last year’s financial meltdown, the Fed had been discussing going to Congress to request the authority to issue its own bills. The term deposit facility achieves a similar purpose, but can be undertaken within the Fed’s existing authority and does not require congressional approval.

“This is more of a politically acceptable way of getting the same thing done,” said Tom Simons, money market economist at Jefferies.

Those readers who have read my opinion on the “tool” of paying interest on overnight reserves can probably guess what I think of this: At best it simply pushes back the problem, and only for six months to a year. Really, this isn’t too hard, and I am astounded that nobody says this except in non-mainstream articles or in comments on official news stories. How in the world is it a “tool to drain liquidity,” to implement a strategy that results in more reserves in a few months’ time? I mean, that would be as crazy and Orwellian as the president of the United States calling for fiscal responsibility while he runs up the biggest budget deficit in histor–oh wait.

More serious, Bernanke is doing what all good political leaders do, in that he is exploiting a crisis to expand the powers of his organization. At the very least, this gives the Fed more options, similar to an individual getting a huge new line of credit. But someone (maybe one of the GMU bloggers?) said something like, “If I have a printing press, why do I want the ability to borrow money?” and I confess I am perplexed by this move as well. For all I know, this really is just a pointless accounting gimmick that Bernanke wants the bloggers to focus on this week, while he somehow takes assets away from Freddie and Fannie behind the scenes.

* At least, that was my recollection–that the Fed discussed the plan to issue its own debt, but never actually approached Congress and formally asked for this power. Please correct me someone if I’m wrong.

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