Post by unlawflcombatnt on Aug 22, 2007 11:49:18 GMT -6
Below is an explanation by Irwin Kellner of the Fed's recent moves to inject liquidity into the market. It's a pretty good explanation of the effects of the recent liquidity "injection," the discount rate cut, and the effect of cutting the target rate. I disagree with his final recommendation of a Fed rate cut, but otherwise this is a pretty good description of Fed action.
from Market Watch:
Why the Fed needs to drop the other shoe
8/21/07
By Dr. Irwin Kellner, MarketWatch
"If the Federal Reserve is to truly fulfill its role as lender of last resort, it must do more than cut its discount rate - it must lower its federal funds rate as well.
By now, it is generally recognized that last week's cut in the discount rate was limited in scope. It did not represent the easing of monetary policy that the markets were clamoring for, nor did it do much to ameliorate the underlying cause of today's credit squeeze - the deterioration in a growing number of subprime loans.
While fed funds were trading well below the central bank's target rate of 5.25% when the Fed said it was reducing its discount rate, the Fed chose not to formalize this by announcing that it was cutting this rate as well.
As you know, it is the fed funds rate that matters for the pricing of loans - not the discount rate. All the discount rate deals with are requests by member banks for temporary loans from the Fed - loans that for one reason or another they cannot obtain from other banks in the federal funds arena.
The fed funds rate, on the other hand, is the basis for pricing loans ranging from those that the banks make to blue chip firms for short periods of time to those at the opposite extreme - subprime borrowers financing a home mortgage. It is this rate that needs to be cut if the credit markets are to relax their squeeze.
Remember as I said back on August 7, there is no shortage of credit out there - just a lack of confidence. For reasons you are well aware of by now, lenders have suddenly discovered that with generous returns comes a hefty dollop of risk.
The credit squeeze represents a re-pricing of such risks. Unless and until these risks are reduced, the credit squeeze will continue, thereby threatening not just the housing industry - but the rest of the economy as well.
You can see the effects of this squeeze in the rates on Treasury bills. Reflecting a collective refusal to invest in anything other than the safest instruments, investors yesterday piled into short-dated Treasuries, sending their yields down by the most for any day since the stock market crash of 1987.
Those who argue against the Fed lending a helping hand do so on the grounds that this would create a so-called "moral hazard," in effect bailing out those who made risky bets or bad decisions...."
________
In my opinion, the "moral hazard" dangers from an early Fed rate cut outweigh the benefits of leaving the target rate unchanged. The risk takers need to take their medicine and learn from their mistakes. And greed-blinded risk taking deserves no bail-out whatsoever.
from Market Watch:
Why the Fed needs to drop the other shoe
8/21/07
By Dr. Irwin Kellner, MarketWatch
"If the Federal Reserve is to truly fulfill its role as lender of last resort, it must do more than cut its discount rate - it must lower its federal funds rate as well.
By now, it is generally recognized that last week's cut in the discount rate was limited in scope. It did not represent the easing of monetary policy that the markets were clamoring for, nor did it do much to ameliorate the underlying cause of today's credit squeeze - the deterioration in a growing number of subprime loans.
While fed funds were trading well below the central bank's target rate of 5.25% when the Fed said it was reducing its discount rate, the Fed chose not to formalize this by announcing that it was cutting this rate as well.
As you know, it is the fed funds rate that matters for the pricing of loans - not the discount rate. All the discount rate deals with are requests by member banks for temporary loans from the Fed - loans that for one reason or another they cannot obtain from other banks in the federal funds arena.
The fed funds rate, on the other hand, is the basis for pricing loans ranging from those that the banks make to blue chip firms for short periods of time to those at the opposite extreme - subprime borrowers financing a home mortgage. It is this rate that needs to be cut if the credit markets are to relax their squeeze.
Remember as I said back on August 7, there is no shortage of credit out there - just a lack of confidence. For reasons you are well aware of by now, lenders have suddenly discovered that with generous returns comes a hefty dollop of risk.
The credit squeeze represents a re-pricing of such risks. Unless and until these risks are reduced, the credit squeeze will continue, thereby threatening not just the housing industry - but the rest of the economy as well.
You can see the effects of this squeeze in the rates on Treasury bills. Reflecting a collective refusal to invest in anything other than the safest instruments, investors yesterday piled into short-dated Treasuries, sending their yields down by the most for any day since the stock market crash of 1987.
Those who argue against the Fed lending a helping hand do so on the grounds that this would create a so-called "moral hazard," in effect bailing out those who made risky bets or bad decisions...."
________
In my opinion, the "moral hazard" dangers from an early Fed rate cut outweigh the benefits of leaving the target rate unchanged. The risk takers need to take their medicine and learn from their mistakes. And greed-blinded risk taking deserves no bail-out whatsoever.