Snow Storm Bails Out Bernanke
This post by Jill Schlesinger originally appeared on CBS' MoneyWatch.com.
Bank bailout, auto bailout, PIIGS bailout and now we have the Bernanke bailout. Federal Reserve Chairman Ben Bernanke was supposed to testify before a House panel on the Fed's plans to withdraw emergency stimulus money from the economy, but luckily a brutal snow storm bailed him out.
Instead of watching the political theater of lawmakers grilling Bernanke, we have to satisfy ourselves with the written statement. Bernanke reiterated what the Federal Open Market Committee has been saying for months - that low interest rates are warranted "for an extended period" in order to combat the "intense panic and dysfunction" that resulted from the financial crisis. But the Fed can't keep the spigots open for ever, lest it fuel inflation. To that end, Bernanke endeavored to roll out his "exit strategy."
From his statement, it seems unlikely that we'll see any increase in short-term interest rates in the near term. The fragile "U.S. economy continues to require the support of highly accommodative monetary policies," but Bernanke then acknowledged that "at some point the Federal Reserve will need to tighten financial conditions by raising short-term interest rates and reducing the quantity of bank reserves outstanding." Who knows when "at some point" means, but I'm guessing end of this year and maybe even beginning of 2011.
Bernanke also noted that other tools may be a more reliable indicator of the Fed's intentions during this freaky, transitional period in US economic history. The central bank may communicate its policy stance "in terms of another operating target," such as "the interest rate paid on reserves," but "no decision has been made on this issue."
This basically refers to the Fed rate of interest it pays to banks on the money they leave on deposits with the central bank. The deal is that if the Fed pays an effective rate of zero, banks are inclined to lend more and conversely, when the Fed pays more, banks leave money on deposit. Given that the government is trying to incent banks to lend, higher rates on deposits isn't happening any time soon.
What else is the bank planning to do eventually? How about unloading the $1.43 trillion of mortgage-backed securiities it will have accumulated by the end of next month. Those purchases have helped keep mortgage rates down as the housing market recovers and the Fed won't sell the securities "at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery." In other words, not for a while.
While Bernanke is "fully confident" that the central bank will remove liquidity "at the appropriate time," I'm not so sure. The Fed's track record is abysmal when it comes to market timing. We now know that the Fed was slow to raise interest rate policy earlier in the decade, which helped fuel the housing and credit bubble. In fact, going back two decades, the Fed is notorious for being late on when it comes to tightening.
Side note about the market reaction to the Bernanke release: the bears came out and stomped on yesterday's party. Investors don't much like the idea of higher interest rates, despite knowing that the liquidity-fueled rally has to end at some point.
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