Questions to be taken to the Federal Reserve of Dallas

[gonegolfin]

My father-in-law is having lunch with some Dallas Fed officials in October. He is taking my questions with him (highlighted in red).

--
My questions ... sent to my father-in-law ...


Being that I am sure they would not be very receptive to my complaints against the Federal Reserve leadership, I won't have you ask any questions steeped in these complaints. However, I do have an interesting one concerning how they view monetary policy will be conducted from this point forward ...

First, some background ...
It would be a lot easier to predict the Fed's intentions (w/respect to monetary policy) if they simply funded the bailout plan (whichever one passes) via quantitative easing. That is, It would be much more clear if the Fed simply came out and said that they are going to replenish their balance sheet and buy treasuries. This would result in newly created money to fund the bailout, instead of using treasury debt sales. Then we would know that we are headed down the path of inflation.

But using treasury debt to fund the bailout, as is being proposed, does not increase the monetary base. Now, if investors (especially foreigners holding big US Dollar stashes) revolt, we are going to have serious price inflation on our hands, despite the money supply not growing (no inflation, just price inflation). Even if that does not happen, if investors refuse to swallow all of the debt being offered, the Fed will then be forced into quantitative easing (monetization of debt/create money) to fund the balance. This obviously is inflationary and the monetary base will increase. But if the Fed is successful in funding the bailout solely through selling treasury debt, we still have a serious chance of deflation occurring (as happened in the Great Depression era).

Do you follow me thus far?

Now for the questions ...

Does the Fed truly believe that this is just a liquidity crisis and not jointly a solvency crisis? If it is just a liquidity crisis, then that can be cured by the alphabet soup of loan programs they have used over the past nine months (including the TAF and TSLF) up to the limit of their balance sheet (because they sterilized the loans). If they need more than their balance sheet allows, of course they can petition the people for taxpayer loans (as they are). But what is being presented is not simply a set of loans. The proposal is for the government to purchase real assets at above market prices (obviously they must be else they could be sold now at market prices). Nobody with any sense believes that the assets behind these purchases will recapture their original investment price paid by the government (or they are lying). Thus, I believe you can reasonably assert that the bailout plan is not a loan. So, if you believe that premise, this is not just a liquidity crisis. It is a solvency crisis as well and it will cost the taxpayer.

Given the above ... I would be interested in knowing why they decided to fund the bailout via the sale of treasury debt vs. quantitative easing/creating new money. This (creating new money) would give them the opportunity to rebuild their balance sheet somewhat. And it would lessen the risk of a deflation. The Fed has maintained for some time that this is all a liquidity crisis, which is why they sterilized their loan facilities all of this time. If they still believe this, this can explain the sale of treasury debt (there still may be another reason). But I simply cannot imagine that they really believe this, when everything else points to a solvency crisis. These banks are not failing because of accounting rules or inadequate access to credit. Washington Mutual just got wiped out/failed tonight (with assets snatched by JP Morgan) because they were insolvent ... as were the other failures with the likely exception of AIG. Might they be thinking that it makes sense to appropriate the first set of funds ($700 billion) from Congress and obtain it via sales of treasury debt? Because if they need a second round of funds, they can always print it themselves (without approval from Congress)? I am postulating that it would be harder to get Congressional approval for funds (in a second round of funding) after an initial round of $700 billion of money creation by the Fed. Thus, you get money from the Treasury first and print money if you need to second. But I think this is very dangerous as it risks a deflation. My only other explanation here may be that one or more Asian countries strongly offered a preference.

These are very important questions because it helps provide a clue as to where monetary policy is heading and how it will affect our investments. Thanks for carrying these questions. If I was not clear and we need to talk, let me know.

Thanks,
Brian

 

[Chris]

This is NOT a liquidity crisis.

Interest rates are low, and the Fed has plenty of money to lend.

Two million homeowners lose their homes, and Congress does nothing. Their fat cat friends on Wall Street are threatened, and it's, "OH MY GOD!!! SUSPEND THE CAMPAIGN!!! RUSH BACK TO WASHINGTON!!! THE FAT CONTRIBUTORS ARE IN DANGER!!!"

 

[gonegolfin]

This is NOT a liquidity crisis.

I agree. But you must understand that the Fed (throughout this crisis) has repeatedly stated that we have a liquidity crisis, not a solvency crisis. And that the way they have managed their lines of credit (sterilizing all outgoing funds) enforces the assertion that they believe it is just a liquidity crisis. And now the issuance of treasury debt instead of creating new money to fund the bailout. If you had a solvency crisis with the deflationary pressures that come along with it, the logical choice would be to create new money, not issue treasury debt.

Unless ...

You wanted a deflation ... as the Fed put in play (purposefully) immediately before the Great Depression.

The Fed has not created new money in all of this ... except for a modest amount of open market injections that brought the Fed funds rate down to 2.0%. The monetary base has increased less than 3% in the last year.

Brian

 

[Chris]

I am a realtor.

Believe me there is plenty of mortgage money available. I have had no problem getting people financed. Let the cheaters go broke.

This is a last minute attempt by the Bush administration to raid the Treasury for their masters, before they ride out of town.

 

[dilloduck]

I agree. But you must understand that the Fed (throughout this crisis) has repeatedly stated that we have a liquidity crisis, not a solvency crisis. And that the way they have managed their lines of credit (sterilizing all outgoing funds) enforces the assertion that they believe it is just a liquidity crisis. And now the issuance of treasury debt instead of creating new money to fund the bailout. If you had a solvency crisis with the deflationary pressures that come along with it, the logical choice would be to create new money, not issue treasury debt.

Unless ...

You wanted a deflation ... as the Fed put in play (purposefully) immediately before the Great Depression.

The Fed has not created new money in all of this ... except for a modest amount of open market injections that brought the Fed funds rate down to 2.0%. The monetary base has increased less than 3% in the last year.

Brian

So the Fed injected money resulting in a Fed fund rate of 2% ? Why ?

 

[editec]

I THINK the answer to why selling Tbills to fund THE PLAN isn't on the table is that they are having trouble selling T-BILLS.

BAILING OUT the bondholders and banks while leaving the homeowners in a lurch encourages the NEXT crises.

TICKLE UP economics is the solution.

TICKLE DOWN economics will be shown to the the root cause of this problem when the story is finally written about what REALLY caused this mess.

This UNDECLARED BUT OBVIOUS CLASS WAR against AMERICA WORKERS that we've been fighting for the last 30 years has got to end if we want AMERICA to contine to be a wealthy and powerful nation, folks.

Yes that measn that the SUPER-DUPER RICH are going to have to squeek by on merely being SUPER RICH.

Poor sods, eh?

Nothing in their lives will change except they won't own the whole forking world.

I think they're survive, don't you?

 

[Paulie]

I THINK the answer to why selling Tbills to fund THE PLAN isn't on the table is that they are having trouble selling T-BILLS.

BAILING OUT the bondholders and banks while leaving the homeowners in a lurch encourages the NEXT crises.

TICKLE UP economics is the solution.

TICKLE DOWN economics will be shown to the the root cause of this problem when the story is finally written about what REALLY caused this mess.

This UNDECLARED BUT OBVIOUS CLASS WAR against AMERICA WORKERS that we've been fighting for the last 30 years has got to end if we want AMERICA to contine to be a wealthy and powerful nation, folks.

Yes that measn that the SUPER-DUPER RICH are going to have to squeek by on merely being SUPER RICH.

Poor sods, eh?

Nothing in their lives will change except they won't own the whole forking world.

I think they're survive, don't you?

Once again, an opinion lacking any facts. You do a lot of that these days.

I'd love for you to go into factual detail.

 

[gonegolfin]

I THINK the answer to why selling Tbills to fund THE PLAN isn't on the table is that they are having trouble selling T-BILLS.

You misunderstand. Selling treasury debt is on the table. It is the proposal.

Thus far, quantitative easing is not on the table. It may be forced at some point, but it is not part of the plan at present.

Now, there has been an increase in the monetary base recently with the injection of US Dollars into foreign central banks (to meet US Dollar needs in those countries). This is the biggest move in Fed Reserve Credit I have seen in some time. But an overwhelming amount of overall Dollars being provided in this crisis by the Fed has been money supply neutral (total is roughly $1.8 trillion thus far).

Brian

 

[gonegolfin]

So the Fed injected money resulting in a Fed fund rate of 2% ? Why ?

This is how the fed funds rate is managed to its target. If the fed funds rate is trading above its target rate (as is the case in a liquidity crunch - this has happened several times in the last week), the Fed will inject reserves into the system to bring the fed funds rate back down to its target. The opposite occurs if the fed funds rate is below its target. These injections or drains to/from bank reserves are executed via what are called temporary open market operations (TOMOs).

Brian