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Wednesday, January 28, 2009 3:46 PM

Fed Adopts "Throw The Kitchen Sink" Policy

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The Fed is using all the tools it has available including a threat to buy long dated treasuries to break the downward spiral of the economy.

The Federal Open Market Committee kept its interest rate target in a range of zero to 0.25%, as expected. Rates will need to stay close to zero for "some time," the statement said.

The lack of action on interest rates was expected, as was the FOMC's statement that rates were likely to stay low for a considerable length of time.
All of the action in the statement was related to the Fed's continuing efforts to flood the financial system with money.

The Fed has adopted a "throw the kitchen sink" approach to combating the downturn, which is being fueled in part by weak banks.

"The Fed stands ready to buy anything that anyone suggests might help. The sky is the limit," said Mike Englund, chief economist at Action Economics.
Buying longer-term Treasurys would be a new tool in the Fed's arsenal to repair financial markets. Some economists worry that buying Treasurys would cause foreign investors to lose their appetite for the securities.

"If the Fed commits itself to a policy of artificially depressing the returns on Treasury securities for an extended period, it will force investment committees around the world to reconsider their portfolio allocations to the U.S. Treasury market as an asset class," wrote Lou Crandall, chief economist at Wrightson ICAP in a note to clients.

The Fed said was "prepared" to buy Treasurys "if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."
Full Text of FOMC Statement

Interested parties may wish to read the Full FOMC Statement as listed below.
The Federal Open Market Committee decided today to keep its target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Dennis P. Lockhart; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.
Flooding The Market With Words

The more unconventional the Federal Reserve's policy becomes, the more it feels the need to explain itself. So the Fed flooding the market with words.
In its statement on Wednesday, the Federal Open Market Committee didn't change policy at all. It kept its interest rate target with a whisker of zero percent; it said rates would be low "for some time"; it vowed to continue buying mortgage-backed and asset-backed securities; and it said once again that it was prepared to buy longer-term Treasurys if warranted. Nothing new.

What was new in the statement was the explanation the FOMC gave for these unconventional moves. The Fed can't lower interest rates any further, but it can do a lot to grease the wheels of commerce. Most of the statement was an explanation for why the Fed thinks the grease is necessary, and a few details on what brand of grease they intend to employ.

The result was the longest and most detailed FOMC statement on record. The typical FOMC statement covers about 300 words; this one weighed in at 474.

The FOMC repeated its commitment to use "all available tools" to bring the economy back to life. They went into great length about the tools they've got in the box, including a promise to buy longer-term Treasurys if they think that would help.
All that detail could be counterproductive. It may look like the Fed is doing some fancy footwork, but all they are doing really is bailing as fast as they can.
FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets

Bloomberg is reporting FDIC May Run ‘Bad Bank’ in Plan to Purge Toxic Assets.
The Obama administration is moving closer to setting up a so-called bad bank in its effort to break the back of the credit crisis and may use the Federal Deposit Insurance Corp. to manage it, two people familiar with the matter said.

FDIC Chairman Sheila Bair is pushing to run the operation, which would buy the toxic assets clogging banks’ balance sheets, one of the people said. Bair is arguing that her agency has expertise and could help finance the effort by issuing bonds guaranteed by the FDIC, a second person said. President Barack Obama’s team may announce the outlines of its financial-rescue plan as early as next week, an administration official said.

“It doesn’t make sense to give the authority to anybody else but the FDIC,” said John Douglas, a former general counsel at the agency who now is a partner in Atlanta at the law firm Paul, Hastings, Janofsky & Walker. “That’s what the FDIC does, it takes bad assets out of banks and manages and sells them.”

Bank seizures are “going to happen,” Senator Bob Corker, a Tennessee Republican, said in an interview after a meeting between Obama and Republican lawmakers in Washington yesterday. “I know it. They know it. The banks know it.”
Everyone knows a tsunami of bank failures is coming. Flooding the market with words and throwing the kitchen sink at the problem will not stop the impending wave of failures. In cases of tools vs. tsunamis, the tsunami will win every time.

Mike "Mish" Shedlock
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