Federal Reserve & Interest Rates

It almost seems like the government is on a runaway train and has no idea where it’s headed.  Right now the government is pretty much throwing money at a lot of different places and seeing what sticks.

We’ve seen some big names need bailouts from the government in order to avoid bankruptcy.  We’ve seen many of those companies come back for more money as conditions worsen.

The government is in bed with these companies for the long term, despite the fact that it almost seems like throwing good money after bad.  No one knows if these companies will be able to stay afloat even with government help because right now there is no end in sight to the economic downturn.

The government has already spent trillions and it will probably spend trillions more as it tries to spend it’s way out of this recession.  As history has shown this is what the government does when nothing else works.

There are long term repercussions to all this spending, the national debt was already a big weight hanging over this country before this whole mess started and I’m probably not the only one who thinks it could very well double by the time everything is said and done.

In the mean time, I will join the millions of other Americans and pray that this bailout or that stimulus package will be enough to finally turn things around.

It seems that the companies the government has already bailed out, share one thing in common, they want more money.  As the financial crisis grows worse, companies are lining up to Uncle Sam once again.

Whether it’s Citigroup, the auto makers or AIG, massive losses expected this quarter have them scrambling for more capital.  Compared to the amount of money pouring into the banking system, the amount the auto industry is looking to get almost seems paltry.

AIG is expected to report the largest loss in U.S. corporate history this quarter, somewhere in the neighborhood of $60 billion.  The likely credit downgrade that is sure to follow could leave it dangerously short of cash and it will need to rework it’s bailout plan, which has been revised once already from it’s initially unfavorable terms.

No one knows what to do with the banking system and any choice they make is going to be expensive.  Investors are running scared because of the off chance that some of the nation’s largest banking institutions could be nationalized, completely wiping out shareholder equity.

The solution that people know will work, the plan to clear the banking system of toxic assets is of course the most expensive and could cost the government trillions if they go that route.  Needless to say they would like to try some cheaper alternatives first.

For the time being they’ll give Geithner’s financial stability plan a chance to stabilize a banking system that has been in free fall ever since the bankruptcy of Lehman brothers.  It will take a few months to put in action and it remains to be seen whether the banking system will be better or worse off when it’s all said and done.

 In a speech today, Fed Chairman Ben Bernanke discusses the central bank’s policy initiatives and the impact it has on it’s balance sheet.  In recent months, there has been quite a bit of discussion on the explosive growth of the Federal Reserve’s balance sheet during the financial crisis. 

Finally, the expansion of the Federal Reserve’s balance sheet has raised some concerns–and led to some misconceptions–about the credit risk being taken by the Fed. I will address the issue of credit risk today. And I would also like to talk about steps that the Fed is taking to improve the transparency of its programs to the public, consistent with our obligations in a democracy.

It does seem that the Fed has taken a much smaller profile since the start of the year, perhaps to give the new administration a chance to coordinate policy goals and agree on a concerted plan of action to deal with the current crisis.  That being said, the Fed today also released the minutes of it’s most recent FOMC meeting in an effort to become more transparent to the public.

The Fed has taken extraordinary steps in trying to deal with the worst financial crisis since the Great Depression.  It has been estimated that the Fed has pumped in over $8 trillion in liquidity so far into the money supply which has raised concern over the increased credit risk the central bank has opened itself to as well as the prospect of inflation in the future.

Bernanke sought to calm some of those fears today, explaining that Fed’s assets are mostly short term in nature and that they can be quickly reduced as the economy normalizes.  According to the recently released economic forecasts reveal that the Fed is estimating long term inflation at a modest 2%.

This is of course a far cry from estimates over the summer, commodity prices started to take a nosedive.  However, a major reason for the decline in long term inflation estimates has to do with credit creation.

Although the Fed has sought to expand the monetary base of the economy, there is not the corresponding growth in credit that we would have seen in years pasts.  You can think of credit creation as a multiplier of the money supply and that number has shrunk significantly since the financial crisis began.

In fact, without the Fed’s balance sheet actions, we could very well be talking about the risk of deflation right about now.