The Fed won’t relinquish its bigger role
SAN FRANCISCO (MarketWatch) — Financial analysts have been parsing Federal Reserve Chairman Ben Bernanke’s speech at the August meeting of central bankers in Jackson Hole, Wyo.
More worthy of attention, however, is the statement made earlier in August by the Fed’s Federal Open Market Committee. It not only represented a reversal of previous policy but provided further proof that our monetary wizards can’t be trusted to fix the economy or maintain the dollar.
Recall that the worldwide recession degenerated into an outright financial panic in September 2008. At the time, then-Treasury Secretary Henry Paulson said he needed $700 billion to bail out banks.
It was also when the Fed launched its major operations. In the course of about three months, the U.S. central bank more than doubled its balance sheet, spending more than $1 trillion acquiring financial assets at above-market prices.
Critics were shocked by the audacity of the Fed’s moves. Bloggers posted charts documenting the incredible spike in the monetary base and other indicators.
Commentator Glenn Beck even discussed the graph on his TV show in January 2009. Many people warned of hyperinflation and began stocking up on gold coins, canned goods, and even ammunition.
Fed officials and their apologists pooh-poohed the growing alarm. They assured everyone that these extraordinary interventions were temporary.
Most of the programs, they said, would unwind automatically as the credit markets recovered. Banks would stop emergency borrowing from the Fed once they could borrow from the private sector. And the mortgage-backed “toxic” assets would wither away as homeowners made their monthly payments.
In short, the Fed led everyone to believe that the sudden injection of massive amounts of “high-powered money” into the financial system was not a permanent change in policy. Those new dollars would be sucked out of the system gradually, before price inflation got out of control.
Fed officials eventually claimed a partial victory, saying they had rescued the world from another Great Depression. They led everyone to believe that things would start returning to normal.
For example, in February 2010, Bernanke testified to the House Committee on Financial Services that the “exit from these [temporary lending] programs is substantially complete: Total credit outstanding under all programs … has fallen sharply from a peak of $1.5 trillion around year-end 2008 to about $110 billion last week.”
More important, Bernanke went on to say that “to help reduce the size of our balance sheet and the quantity of reserves, we are allowing agency debt and [mortgage-backed securities] to run off as they mature or are prepaid,” adding that “in the long run, the Federal Reserve anticipates that its balance sheet will shrink toward more historically normal levels.”
But this isn’t happening.
The Fed announced a complete shift in policy after its meeting in early August. Now, instead of allowing its balance sheet to shrink gradually to pre-crisis levels, the Fed has begun buying more Treasury bonds to replace the maturing and prepaid mortgage-backed securities.
In other words, the Fed will maintain its bloated balance sheet — more than double its original size — by indirectly lending more money to Uncle Sam.
It’s amazing that things have reached this level. Back in the winter of 2008, if Bernanke had said that the Fed’s massive injections of newly created dollars would still be sloshing around in the system, with no end in sight, by the fall of 2010, people would have been alarmed.
If the people had known that even with all the Treasury and Fed “rescue” efforts, unemployment would be hovering around 10% throughout 2010 and into the following year, and that the total value of bank loans to businesses would steadily decline during the entire period, surely they would have demanded an abrupt change in policy. The protests against the TARP bailout and secret Fed purchases of “toxic” assets would have been even more vociferous.
If the economy had quickly recovered, and the Fed had actually returned to its normal operations, then public anger would have quickly subsided.
Yet the economy is still in awful shape, and the Fed shows no sign of relinquishing its new role.
As a general rule, government agencies expand their power during a crisis. The Fed has done so with the financial crisis.
Ben Bernanke has gradually eased investors and the public into accepting an activist Fed that they never would have endorsed had they seen what the end result would be up front.