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Should the Fed's $800 billion plan be the cause for any concern?

Created by : Varun Sood, Associate, JP MorganChase  | 11 29 2008 02:50:50 +0000
Industry : Investment BankingFunctional Area : Movers & Shakers(Markets)
Keywords : Plan Cause Billion Concern Fed Bailout Plan FED'S
Activity:  429 views;  last activity : 07 06 2010 20:18:09 +0000

While all eyes are on Treasury Secretary Henry Paulson and his $700 billion bailout plan, Federal Reserve Chairman Ben Bernanke is conducting his own economic recovery program—and his is measured in trillions, not billions. So is this taking us nowhere?

  
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This is what happened on Nov. 25. The Federal Reserve announced another buying-and-lending program that will probably boost the central bank's assets to around $3 trillion. That's triple the level in mid-September, when the Fed began its expansionary campaign. The Fed is trying to kill two birds with one very large stone, namely a drastic expansion of its balance sheet. One of its twin objectives is to get more money circulating in the economy. The other is to prop up weak financial institutions to avoid a cascade of failures. If the Fed succeeds it will appear both brilliant and efficient. The risk is that by trying to accomplish too much, the central bank will fall short of one or both of its objectives.
By Varun Sood, Associate, JP MorganChase  11 29 2008 02:50:50 +0000
 
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I think the situation demands such a step to be taken. The credit crunch is so severe that the Fed has been forced to go beyond its peacetime role of guiding the economy by steering short-term interest rates. With banks weakened and afraid to lend, it is making or guaranteeing loans to particular institutions and in some cases outright buying assets. On Nov. 25 the Fed waded deeper than ever into a kind of monetary industrial policy. It announced it would directly buy $500 billion worth of mortgage-backed securities backed by Fannie Mae (FNM), Freddie Mac (FRE), and Ginnie Mae, as well as $100 billion of the corporate debt of Fannie, Freddie, and the Federal Home Loan Banks
By Alok Kumar Singh, Sr. Associate, UBS  11 29 2008 02:51:43 +0000
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I believe this is going a bit too far. Fed is buying, or accepting as loan collateral, assets that no one else wants. The danger of this approach, he says, will become clear when the economy starts to strengthen. At that point the Fed will need to drain away lots of excess money in the financial system. Ordinarily it does that by selling securities on its balance sheet and calling in loans. But it won't be able to do that if the assets are so toxic that no one wants them or dumping them would destabilize weak institutions. It's tricker because the Fed has exposed itself to risks.
By Gandhi Rajan, Sr. Associate, ICICI Securities  | 11 29 2008 02:51:29 +0000
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I think that Fannie and Freddie debt should be easy to sell, while the loans to holders of asset-backed securities are temporary by design. Plus the Fed has to act boldly: This shock is in many ways more complex and harder to deal with than the financial shock that occurred during the Great Depression.
By Ashim Chowdhury, Associate, ICICI Securities  | 11 29 2008 02:52:01 +0000
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