Monday, January 5, 2009
Policy toils to get ahead of events
--Risk case laid out by Benanke might be a base case outlook for the economy --Obama administration had the opportunity to reframe the strategy, drawing on the lessons in the past 1.5 years --US has done in 17 ms what took Japan a decade to push the interest rate beyond zeros to unconventional measures while recapitalzing banks --the reason we will not turn into a recession is because of the vigor of the policy response, espcialy by Fed. --do not addres issues they are presented. more comprehensive systematic approach. New Admin promise strategic approach. Attension has been focused on sustaining demand and limit unemployment. --ultimate success will rest on the ability of authority to fix financial system --equity alone will not solve the issue, we still need to clean banks balance sheet. By Krishna Guha in Washington Published: January 5 2009 02:00 Last updated: January 5 2009 02:00 When Ben Bernanke, US Federal Reserve chairman, and Hank Paulson, Treasury secretary, went to leaders of Congress on September 18 to ask for a $700bn bail-out fund, Mr Bernanke warned what would happen if Congress did not act. The stock market would fall another 15 per cent, he said. Unemployment would rise to 8 per cent. Two of the big automakers would go bankrupt and the US would face a severe recession that would extend long into 2009. Congress did eventually pass the bail-out. But the risk case laid out by Mr Bernanke in September is now the base case outlook for the US economy. Analysts blame the political fight over the bail-out and the management of the fund by the Treasury. Still, the fact that the US now faces with a bail-out fund what Mr Bernanke feared would happen without one highlights how difficult it has been for policy to get ahead of the curve and turn round the credit crisis. Now the Obama administration has the opportunity to reframe the US approach, drawing on the lessons of the past year and a half. The US has done in 17 months what it took post-bubble Japan a decade to do - pushing interest rates beyond zero into unconventional monetary easing while recapitalising banks. But it does not yet have much to show for its efforts. Policymakers blame the adverse feedback between a crippled financial sector and a wounded economy, plus the global nature of the problem, the size of the economic adjustments under way and uncertainty over how large these will be. "We are dealing with something that is really historic and we have not had a playbook," Mr Paulson told the Financial Times. "These excesses have been building up for many, many years." Policy works with a lag and, with some recent easing of purely financial stress (see charts) and mortgage rates, the efforts of 2008 might bear fruit in 2009. They could already have succeeded in averting still worse outcomes. "This shock as a purely financial shock is worse than the one that led to the Great Depression," said Frederic Mishkin, a former Fed governor. "The reason this will not turn into a Great Depression is because of the vigour of the policy response, primarily by the Fed." However, many see the uncontrolled failure of Lehman Brothers as a US policy error of historic proportions. Experts also see wider shortcomings, with an inconsistent and unpredictable framework for government intervention and excessive reliance on the Fed - a view widely held inside the central bank. Some fault the Fed for taking a measured approach to easing in late 2007. Since then it has been exceptionally aggressive, while innovating endless new liquidity programmes. But, while it set out to be pre-emptive, all it was able to do was cushion the blow. Since October the US central bank has pushed deep into unconventional territory, creating money on a gigantic scale to expand credit operations aimed at reducing actual borrowing costs, including outright asset purchases. While some see the Fed's actions as risky, Mr Bernanke argues that the danger lies in sticking too rigidly to normal practice in the face of crisis. "One of my conclusions from my study of the Great Depression is that people tend to think of orthodoxy as safe," he told the FT. "But strategy should depend on the situation. In a severe crisis, orthodoxy can prove to be a very bad strategy." The force of the credit crisis has been too great for the Fed to turn back with the powers at its disposal - which include the ability to provide debt but not equity. Fed officials see themselves as providing the defensive line, and want the government and bank regulators to play their part in the offensive line. Some officials in the Paulson Treasury agree that it focused too long on ad hoc interventions, though they blame this on a lack of legal authority before the bail-out bill was passed. "We were trying to address problems as they were presented," said a senior official. In reality, the authorities faced not individual firm-level crises but "an inter-related series of issues". In the final months of Mr Paulson's tenure, a more comprehensive approach began to fall into place. After the U-turn on the troubled asset relief programme, Mr Paulson allocated $250bn (€180bn, £171bn) for bank equity and provided the Fed with risk capital to underpin risky lending programmes, while regulators guaranteed bank funding. Mr Paulson told the FT "there is just a lot more that is going to need to be done here and around the world". Incoming top economic officials Tim Geithner and Lawrence Summers promise a more strategic approach to battling the crisis. Attention has focused on plans for a large fiscal stimulus to sustain demand and limit the rise in unemployment. Big initiatives are likely in housing too. These policies may help the financial sector. But success will ultimately rest on the ability of the authorities to fix the financial system. More equity injections will probably be needed, and a more predictable framework for rescues that inspires market confidence. "The root of this crisis is fear of counterparty insolvency," Alan Greenspan, the former chairman of the Fed, told the FT. "Much more equity needs to be added." Without accompanying efforts to clean up bank balance sheets, even more equity might not produce a revival in lending but rather sustain "zombie banks" kept artificially alive but unable to perform their proper economic function. This could force Mr Summers and Mr Geithner to revisit the question Mr Paulson twice tried and failed to resolve: how to ringfence and price the unwanted assets clogging up the banking system.