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The Fed’s Failures

Posted By Tait Trussell On October 25, 2011 @ 12:01 am In Daily Mailer,FrontPage | 2 Comments

The Federal Reserve is considering trying to play God again. This time the central bank is about to buy more mortgage-backed securities in hopes that this will help boost the economy. The action was reported Oct. 21 by the Wall Street Journal.

It’s no wonder only one-third of the country’s voters view the Fed favorably, as was found by the Rasmussen Reports polling organization in its Oct. 21 report.

When the Fed meets again Nov. 1, it is bound to face fiery opposition from those who think the central bank has done all it can do—and probably quite a bit more—to revive our slumped economy, including printing lots of money.

Supporters of mortgage-bond buying are emerging, the Journal wrote, particularly Federal Reserve Governor Dan Tarullo, who was appointed by President Obama in 2009. Tarullo appears to be “firmly in the camp of activists…who want the Fed to do more to spur growth.” It has hardly been a roaring success so far.

The Fed itself caused our financial crisis, in the judgment of some Fed watchers, by driving interest rates down and expanding the money supply. A few weeks ago, the Fed tried what some called “operation twist.” It was an attempt to push down creeping interest rates by buying long-term Treasury debt and selling short-term debt.

Markets went into a tailspin after the Fed’s new policy was announced. Stocks and bonds, as well as commodities, fell in price. It was the most dramatic drop since 2008.

“Because of continued rising inflation and the Federal Reserve’s suppression of interest rates, investing in traditional safe havens such as savings accounts, mutual funds and Treasury bonds has become unprofitable,” Rep. Ron Paul (R-TX) wrote in the Daily Bell. Although Paul may have some screwy foreign policy ideas, he understands Fed deficiencies. “Desperate investors” move their money around searching for long-term profits and stability. Investors will continue to shift their money until the Fed stops its intervention and “lets interest rates be set by the free market.” Small business people, Paul explains, “are misled by the Fed.”

As for purchasing mortgage-backed securities, this is nothing new for the Fed. To further reduce long-term rates, it has amassed more than $2 trillion in government debt and mortgage-backed securities in recent years.

The Federal Reserve, through its power to change interest rates and purchase vast amounts of financial assets, has exercised more influence over economic growth and the level of employment than any other part of Washington.

Internal divisions limit the Fed’s ability to pursue some measures. Three of the board’s seven members, who regard inflation as a more serious threat to the economy than unemployment, voted against holding rates down. The bank also has faced pressure from Republican leaders in Congress and Republican presidential candidates, who argue that further steps to stimulate the economy could weaken the dollar or increase inflation.

The Fed’s success in reducing rates through its rounds of asset purchases has not brought predicted benefits. Mortgages and small-business loans may be cheap, but because lenders are so cautious about the unpredictable Obama administration, the loans aren’t easy to get. (On a personal note: I was lucky enough to refinance recently with a 4 percent rate, despite the bank’s having to jump through multiple regulatory hoops caused by the hideous Dodd-Frank law.)

Since the financial crisis began in 2007, the Fed has been moving into unexplored waters, “aggressively intervening in deals to prop up or sell of failing institutions, making loans available to banks in new ways and buying vast amounts of assets to help keep the global economy afloat,” according to The New York Times.

As the financial system was on the brink of collapse in late 2008 and early 2009, the Fed made up a whole new rule book, not only slashing interest rates virtually to zero, but pumping well over a trillion dollars into the economy through purchases of securities and the creation of new lending. Some economists credit those actions, known as quantitative easing, along with the federal bank bailout, with preventing a global depression. But they also made the Fed the focus of unusual criticism.

The day after last November’s elections, the Fed announced that it would buy $600 billion in government debt, calling the recovery “disappointingly slow.” The effort, nicknamed QEII, drew fire from conservatives worried about inflation and from countries around the world. They saw it driving up their export prices by weakening the dollar.

Mortgage loans have seldom been available at such low interest rates. But companies aren’t hiring new workers, and people aren’t buying homes. Almost 25 million Americans can’t find full-time work, a number that is rising again after declining slightly.

More than 25 million people are unable to find full-time jobs. Concerns about Europe’s economic health and the political sickness in Washington have depressed consumer confidence to the lowest levels since the 2008 crisis.

When rate cuts lose their impact, central banks turn to “quantitative easing” — unorthodox methods of pumping money into an economy and working to lower interest rates that central bankers don’t usually control. Their effect is the same as printing money in vast quantities.

The Federal Reserve has used a variety of lending programs in trying to revive corporate and consumer lending. Since 2008, the Fed’s balance sheet has swollen from about $900 billion to more than $2 trillion as the central bank has created new money and lent it out through all its new programs. If the Fed completes its plans to buy up mortgage-backed debt and consumer debt, the balance sheet will peak to $3 trillion.

Since the American economy plunged into its worst financial crisis since the Great Depression. Bernanke and the Fed have been bailing out financial institutions, printing money in unheard-of volumes and stepping in to fill the lending gap left by crippled capital markets.

Republican lawmakers now portray the Fed as the symbol of heavy-handed big government. But liberal Democrats have accused the Federal Reserve of caving in to demands by banks for huge bailouts and for failing to protect consumers against dangerous financial products.

The ire at the central bank is sure to figure into the continuing debate over how to reform financial regulations. The Obama administration has proposed consolidating regulatory powers under the Fed, while some in Congress want to rip away its oversight.

The Fed has invested more than $2 trillion in a range of unprecedented programs. Critics, however, describe the results as lackluster and warn that added policies could make it more difficult for the Fed to control inflation.

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