Tuesday, December 02, 2008

Fed and tresury officials on why they did what they did

I am a "glass is half full" person who on top of that thinks that we will probably find more water before even that is gone. But I do get a tad concerned when smart people who have informational advanatges get worried. We had two examples of this today.

FromTreasury Secretary Henry Paulson as quoted at Bloomberg.com: Worldwide:
"Treasury Secretary Henry Paulson said his actions bailing out some U.S. companies to help strengthen capital markets, while “objectionable,” were necessary to prevent a deeper collapse of the global economy.

“Some of the things that I’ve been part of have been very, very objectionable decisions, but they haven’t been difficult decisions” because the alternative would be “much worse,” Paulson said, responding to questions after a speech in Washington. “I’ve looked at some of the things I’ve done as being essential to preserve the free market system.”"

And from Ben Bernanke the Fed chairman in a speech in Texas:
"..this extraordinary period of financial turbulence is now well into its second year. Triggered by the contraction of the U.S. housing market that began in 2006 and the associated rise in delinquencies on subprime mortgages, the crisis has become global and is now affecting a wide range of financial institutions, asset classes, and markets. Constraints on credit availability and slumping asset values have in turn helped to generate a substantial slowing in economic activity.

The Federal Reserve's strategy for dealing with the financial crisis and its economic consequences has had three components. [1]First, to offset to the extent possible the effects of the crisis on credit conditions and the broader economy, the Federal Open Market Committee (FOMC) has aggressively eased monetary policy. ...The Committee's rapid monetary easing was not without risks. Some observers expressed concern at the time that these policies would stoke inflation, and, indeed, inflation reached high levels earlier this year....[but] As you know, commodity prices peaked during the summer and, rather than leveling out, have actually fallen dramatically with the weakening in global economic activity. As a consequence, overall inflation appears set to decline significantly over the next year toward levels consistent with price stability.

[2]... the second component of the Federal Reserve's strategy has been to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector--that is, by lending cash or its equivalent secured with relatively illiquid assets.

To ensure that adequate liquidity is available, consistent with the central bank's traditional role as the liquidity provider of last resort, the Federal Reserve has taken a number of extraordinary steps. For instance, to provide banks and other depositories easier access to liquidity...Judging the effectiveness of the Federal Reserve's liquidity programs is difficult. Obviously, they have not yet returned private credit markets to normal functioning. But I am confident that market functioning would have been more seriously impaired in the absence of our actions.

and finally:

"...the third component of our policy response has been to use all our available tools to promote financial stability, which is essential for healthy economic growth. At times, this has required working to preserve the stability of systemically critical financial institutions, so as to avoid further costly disruptions to both the financial system and the broader economy during this extraordinary period. In particular, the Federal Reserve collaborated with the Treasury to facilitate the acquisition of the investment bank Bear Stearns by JPMorgan Chase and to stabilize the large insurer, American International Group (AIG). We worked with the Treasury and the Federal Deposit Insurance Corporation (FDIC) to put together a package of guarantees, liquidity access, and capital for Citigroup. Other efforts include our support of the actions by the Federal Housing Finance Agency and the Treasury to place the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac into conservatorship and our work with the FDIC and other bank regulators to assist in the resolution of troubled depositories, such as Wachovia. In each case, we judged that the failure of the institution in question would have posed substantial risks to the financial system and thus to the economy."

As CNN points out, these programs do come with big downsides:
"...there is a downside to all of the Fed's programs. Fed lending has ballooned. Bernanke said that the central bank's balance sheet will need to be brought back to a sustainable level in the future. The government does not want financial institutions to become reliant on the Fed for liquidity, and an enormous balance sheet could result in high inflation down the road.

"That is an issue for the future," Bernanke said. "For now, the goal of policy must be to support financial markets and the economy.""

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