The Fed's Thaw
The Federal Reserve Board's clout isn't what it was during Alan Greenspan's glory days. Back then, the Fed looked and acted all-powerful (even though it wasn't). Now it's visibly failing to unfreeze key debt markets in which giant institutions lend to each other. Those markets have frozen out of fear: No one knows what hidden time bombs are on other firms' balance sheets, or even on their own. The Fed hasn't been able to thaw the markets with interest rate cuts or by using its discount window, through which it lends directly to institutions, and it has been reduced to trying to bribe and cajole big players into borrowing its money as a substitute for borrowing from each other.</br></br>It's not clear whether its recently created "term auction facility," designed to induce institutions to borrow from the Fed, will unfreeze things. The first two auctions were a blowout success. The Fed said it got about $3 in bids for each $1 offered, but I suspect that's because the auctions were for a relatively small $20 billion each and because the Fed and its allies jawboned institutions to bid.</br></br>Am I really saying that the Fed, which to many people still seems omniscient and omnipotent, has lost much of its mojo? I am. Why should you care? Because if the Fed continues to lose clout, it will be even harder than it is now to rescue the world's financial system when the next disaster strikes the markets. And there's always a next disaster.</br></br>The mojo minimization isn't all the Fed's fault, of course. The United States has become less dominant financially, thus reducing the Fed's global influence. Meanwhile, markets have become enormous and transnational and, thus, harder to influence.</br></br>Part of the problem is of the Fed's own making. Its power has always depended more on its reputation than on its actual resources. The Fed lost credibility for not trying to pop the stock bubble of the 1990s or the recent housing bubble; it obsessed about nonexistent deflation; it even (unintentionally) exacerbated the housing bubble by not stopping institutions it regulates from offering dangerous products, such as "liar's loans" and the teaser-rate mortgages that now plague the financial system. Finally, it keeps bailing out the enablers of financial excess while penalizing prudent Americans by reducing the rates that their savings earn and accelerating the dollar's decline relative to commodities and foreign currencies.