JIM LEHRER: This day in the financial crisis began with the Federal Reserve. It took the unprecedented move to buy short-term debt to thaw out frozen credit markets. Fed Chairman Ben Bernanke laid out just how bad those conditions are during a speech today.
BEN BERNANKE, Federal Reserve Chairman: Even households with good credit histories are now facing difficulties obtaining mortgage loans or home equity lines of credit.
Banks are also reducing credit card limits. And denial rates on automobile loan applications are reportedly rising.
Businesses, too, are confronting diminished access to credit. To support growth and reduce the downside risks, continued efforts to stabilize the financial markets are essential. The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity.
JIM LEHRER: Judy Woodruff has more about the Fed’s action.
JUDY WOODRUFF: And for some explanation and analysis, we are joined now by Lee Hoskins, former president of the Federal Reserve Bank in Cleveland. He’s now a senior fellow at the Pacific Research Institute.
Alan Blinder, former vice chairman of the Board of Governors of the Federal Reserve, he is a professor of economics at Princeton University.
And Greg Ip, U.S. economics editor for the Economist magazine.
Gentlemen, thank you all three for being with us.
And, Greg Ip, I’m going to start with you. First of all, help us understand, what was the problem the Federal Reserve was trying to solve today?
GREG IP, The Economist: OK, Judy. Well, a little bit of sort of a primer here.
Commercial paper is an IOU that corporations of all types and sizes issue on a routine basis to fund things like their inventory, their payroll, and their working capital. It’s very common; it’s very safe; and there’s a lot of it.
As of just a month or two ago, there was $1.8 trillion of commercial paper outstanding. And it was primarily purchased by money market mutual funds precisely because it’s so safe. Historically, there are very few defaults on this type of paper.
What happened, Judy, was a couple of weeks ago, when Lehman Brothers failed, many money market mutual funds found themselves holding short-term debt issued by Lehman. That caused them to register losses, and investors started to yank money out of those funds.
The funds became very reluctant or unable to purchase commercial paper at that point. And banks themselves, because they’ve been so much under stress, were not able to take up the slack.
As a result, many companies have been either unable to issue commercial paper at all or have only been able to issue it with maturities of one or two days at the most.
And with time, this could be a real problem, because companies will start to find it difficult to run their operations.
JUDY WOODRUFF: So, again, commercial paper, very short-term loan. So what exactly is the Fed doing about this?
GREG IP: Well, the Fed takes the view that companies that issue this paper are mostly quite healthy and they have good cash flow and there really isn’t an issue of their ability to repay the money as it comes due.
What they think is going on is that many of the money market mutual funds and banks that would ordinarily purchase this paper don’t want to, not because they think the company is going to default, but because they’re not sure if in 90 days’ time, when it comes time to basically reissue the paper, they won’t find someone to do that.
And so they don’t want to be the ones stuck holding the paper that cannot be rolled over.
The Fed has come out and said, if you can’t roll over that paper, if you can’t find someone to reissue it to, you can reissue it to us. We’ll be the backstop. And they hope that creates some confidence.
Fed risks inflation, printing money
JUDY WOODRUFF: And where does the Fed get the money to create this backstop vehicle?
GREG IP: Well, the unique thing about being a central bank is that they can — putting not too much of a fine point on it — they can essentially print the money. The Fed can essentially create the money and use it to invest in this commercial paper.
Now, if they printed too much money, you would obviously have an inflation problem. But that’s not an issue in this case, because all they’re doing is creating loans that take the place of other loans in the private sector that are disappearing.
JUDY WOODRUFF: And, Greg, to what extent are the taxpayers on the hook here?
GREG IP: Well, there is a little bit of risk here, Judy, but this paper has historically been extremely safe, so the odds of default are quite low.
That said, it is outside the conventional historical mission of the Fed to be making loans to specific companies. That is properly the decision of Congress or the administration.
So, in this case, the Fed is doing this in conjunction with the Treasury. And in fact, the Treasury is providing the Fed with some money to begin the financing of this program.
JUDY WOODRUFF: All right, well, let’s bring in Alan Blinder and Lee Hoskins now.
Alan Blinder, to you first. What would you add, if anything, to our understanding of what’s going on now as of today?
ALAN BLINDER, Former Economic Adviser to President Clinton: I would make one amendment to what Greg said. I think he said something like all kinds of companies do this.
These are the cream of the crop. Only the best and presumably that means least risky companies have access to the commercial paper market. This is for the big players.
A lot of those players have been financial players. And, as you know, markets are very, very wary of lending to other financial institutions. But the Fed has many ways of lending to financial institutions, and it’s using them.
This was aimed at the non-financial institutions, industrial companies, many of which are household names to people that, as Greg did say, are very good credits. So presumably the risk of loss on any of this is very low.
But as Greg also said — and I would underscore this — this is quite unprecedented behavior. The Federal Reserve has always viewed itself as the guardian of the financial system. Indeed, it was created for that purpose. And this is now serving as the guardian of at least some parts of the non-financial system.
JUDY WOODRUFF: But I guess what you just said raises at least one question. If these companies are so sound, why was this step — why wasn’t the — why weren’t companies willing to loan, to lend to them?
ALAN BLINDER: It’s an excellent question. I think the answer is the financial markets are in utter panic right now. You have major financial institutions unwilling to lend to each other, banks and others, even overnight. You have a pullback everywhere.
You have even some risk, according to the derivatives market, perceived in U.S. treasuries, which I find amazing. So you’ve just got this — everybody is trying to get inside their turtle shell, and that includes even lending to some, you know, really good credits, AT&T, IBM, Goodyear, companies like that.
JUDY WOODRUFF: So, Lee Hoskins, was this necessary?
LEE HOSKINS, Pacific Research Institute: Well, I believe it was. I’ve been critical of some of the Fed moves in the past, but I think the move today is what I would call a classic central bank action, in terms of its lender of last resort function.
Nobody else is lending. It’s time for the Fed to lend. And that’s basically what they’re doing in support of this market.
They’re not supporting a particular institution. They’re supporting the market overall. I think the only thing that I would have wanted is a little stronger statement by the Fed that they’ll provide whatever liquidity is necessary to keep markets functioning.
Depending on Fed assuming risk
JUDY WOODRUFF: But, Lee Hoskins, do you see drawbacks here? What are the risks?
LEE HOSKINS: Well, the risk is that we get addicted to the Federal Reserve supplying liquidity to the market and ending up owning and supporting a lot of bad assets.
As Alan said, what the Fed is taking in terms of assets now are very high quality. So I don’t think that’s a major problem. But you do not want the central bank, in times other than panic, being involved to the extent that they’re involved today.
JUDY WOODRUFF: And, Alan Blinder, back to you. Is there anything else you can say to help us understand exactly how the Fed is doing? As we heard Greg Ip say, they’re printing the money. Then how do they get this money into the system?
ALAN BLINDER: Well, when the Fed first starts these operations, including the other ones they do, what they try to do is re-jigger their balance sheets, sell one asset, and that for the Fed has been mostly been treasuries, and buy something else.
As that capacity gets used up, the Fed can no longer swap one asset for another. And then it has to, as Greg said — we use the euphemism “print money.” What that really means is somebody is on a keyboard creating electronic images of money. Large amounts of money are not cash.
So these are credits at the Federal Reserve system basically. A central bank can do that; a commercial bank cannot do that.
JUDY WOODRUFF: And Lee Hoskins just said one drawback is that — you know, we see an addiction to this kind of money. Alan Blinder, do you see a drawback there, too?
ALAN BLINDER: Absolutely. I mean, you want to do this, I think, as long as the emergency lasts and not longer. You’ll note that the Fed promulgated this with an April ’09 deadline, unless, of course, we’re still in a — hopefully we won’t be in such a crisis at that point.
So you do want to limit this. After all, private parties should be engaging in voluntary transactions, assessing the riskiness, and charging interest rates accordingly. That’s the way markets usually work when they work. Unfortunately, right now, they’re just malfunctioning completely.
JUDY WOODRUFF: Now, Greg Ip, we did hear Federal Reserve Board Chairman Bernanke say today there may be other arrows in the quiver down the road.
GREG IP: Yes, well, they’ve got a couple of things they can do. First of all, they could cut interest rates. And, indeed, I am expecting that they will possibly in a matter of days and possibly in coordination with other central banks. But they’ve only got 2 percentage points of room left to do that.
Also, the structure they’ve used to do this lending to the commercial paper market could be in theory adapted to do all sorts of other kinds of lending. For example, if state and local governments run into a funding crunch because of an inability to sell bonds, then, in theory, the Fed could adapt this mechanism to help them out.
JUDY WOODRUFF: So, Lee Hoskins, do you see those steps and others like them potentially down the road?
LEE HOSKINS: Yes, I think there could be more trouble in the near future. I don’t think this is the silver bullet or is there a particular silver bullet.
The basic problem is that there are some bad loans on the books of financial institutions. And until those become more transparent, and written down, and more capital goes into the banking system, counterparties — that is, customers — are going to be concerned about doing business with these institutions.
So until we can make it transparent that all these banks are basically solvent and the ones that aren’t solvent we close up or merge, I think that will then finish off our credit crisis, so to speak.
Attempt to shore up confidence
JUDY WOODRUFF: So how much difference, Lee Hoskins, do you think this step today by the Fed will make?
LEE HOSKINS: Well, I think this was a patchwork step, an important one, in the sense that you do want, as Alan said, you want this market working. It’s basically a market that corporations use to fund themselves over the short term. And if they can’t get money, it begins to impact their business activity and the economy overall.
So you want to make sure that these markets are functioning. And I think the Fed took a step in that direction today and calmed down to some extent the commercial paper market or the short-term debt market for corporations. I think there’s more to do out there.
JUDY WOODRUFF: Alan Blinder, how confident are you this is going to make a difference? And what more may need to be done?
ALAN BLINDER: Well, it will make some difference. The $700 billion bailout, so-called bailout program, once it’s promulgated, will make some difference and, I hope, a large difference.
Like Greg, I think the Fed should be — I’m not sure Greg said should be, he said will — I think the Fed will, but I also would urge them and the ECB and the Bank of England and the others to cut interest rates.
You cut interest rates because you’re worried about weakening economies. And if central banks around the world are not worried about weakening economies right now, I don’t know what they’re thinking.
It’s clear that Chairman Bernanke in his speech today was worrying about the weakening of the U.S. economy, which is the one he’s responsible for, and pretty much saying that interest rate cuts are coming. I think they should do it instantly.
JUDY WOODRUFF: All right, a grim picture yet again. Alan Blinder, thank you. Lee Hoskins and Greg Ip, we thank you, all three.