U.S. Fed addressing the crisis: where is the way out?

Numerous strategies were considered, proposed and implemented so far to boost the economy of the U.S. Yet the recession is deepening. On Wednesday the Federal Reserve will issue a policy statement that may clarify what should be done to make a path towards recovery while Obama’s team is preparing their program to address the U.S. foreclosure and bank crisis which will likely be presented within the following several weeks. Meantime all are discussing the Fed’s possible purchase of governments in order to reduce long-term borrowing costs while short-term interest rates cannot be lowered any further because they are practically at zero. In addition the central bank is also considering another bailout program known as the Term Asset-Backed Securities Loan Facility, or TALF. The program is intended to spur auto, student and credit card loans as well as loans to small businesses.

In January 13 speech in London Fed Chairman Ben Bernake noted that in ‘determining whether to proceed with such purchases, the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets’. Among the main concerns entailed by the Federal Reserve’s purchase of long-term Treasury securities are these: ever-more taxpayers dollars could be put at risk, the country will feel an adverse effect of inflation in the future, and the companies may indulge in a kind of moral decay feeling more comfortable at making high-stakes gambles because the government will rescue them.

By the moment the central bank has introduced a number of projects and solutions since the crisis burst out in 2007. At the beginning of this year only the Federal Reserve started buying mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae in order to revive the moribund housing market. Such projects and programs resulted for the Fed in a $2.05 trillion balance, up from just under $900 billion in September. And while the Treasury is managing the TARP program of $700 billion bailout the new administration along with the congress are reconsidering it to enact an $825 billion package of increased government spending and tax cuts to revive the economy.

Millions. billions and trillions of dollars are spent by the U.S. to resuscitate itself. But the economy seems to have turned into the cask of Danaides when the money is constantly pumped into the system and no signs of life are seen so far. And the move to buy long-term Treasury debt as an option for helping the economy is not guaranteed to bring the fruits wanted. As Bloomberg notes ‘The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices.’ The result may prove inverse with the prices and long-term interest rates abnormally fluctuating because investors react to what they say and do.

The talks about Fed’s plans to buy longer-dated securities have been led since 2002. Bernake advocated the idea as a way to fight deflation. Under the influence of this speeches along with the remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a “firewall” against deflation many investors concluded that the Federal Reserve has distinct plans to acquire bonds. The result was that the yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year. Later the course was quickly reversed by the traders as it became known that the central bank has no such intentions and the 10-year Treasury yield jumped to 4.6 percent just three months later.

Apart from inflation, moral risk, and prices wild volatility there is another risk ensuing from the treasuries purchase. Former Fed Governor Laurence Meyer notes that foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high. Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, also adds that foreign investors might in addition get spooked if they conclude that the Fed is monetizing the government’s debt -- in effect, printing money -- by buying Treasuries.

As for the TALF, a $200 billion program, the Treasury pitched in $20 billion to underwrite the Fed's investment. Through this program the Federal Reserve intends to support auto, student, credit- card and small-business loans while the officials also say that the program could be expanded to cover securities tied to commercial mortgages and an array of home loans.

Meanwhile the prices keep on falling which is certainly a good news for consumers but it will not be the case when they spread to wages and already stricken prices for homes, stocks and other things for a long time as long as it would further deal a crippling blow to the economy.