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Thursday, March 19, 2009

FED WATCH: Democratic, Or Just Dazed And Confused?

The Federal Reserve's dramatic decision Wednesday to
commit an additional $1 trillion-plus to steadying the economy and financial
markets gave equity and fixed-income markets a much-needed jolt.

But the one-day fix may come at the expense of the Fed's reputation for
clarity and predictability.

It might be something investors and the public just have to live with under
the Ben Bernanke era, where an apparently more democratic and consensus-driven
approach means meeting outcomes aren't always going to be foregone conclusions.

Whatever the rationale, the Fed's $300 billion Treasury purchase shocker
caught Fed watchers off guard.

The announcement came less than two weeks after the Fed's main ambassador to
Wall Street, New York Fed President William Dudley, appeared to close the door
to the idea. "At this point in time the Fed has judged buying long-term
Treasurys is not the most efficient means of easing financial market
conditions," Dudley said.

Of course, that's a bit of a noncommittal committal. With the benefit of
hindsight, Dudley seemed to be referring to what the Fed's thinking was to that
point, and it wasn't a promise of future action (or inaction). But at the time,
it appeared to be a clear signal that buying Treasurys wasn't on the immediate

Another head-scratcher from Wednesday's statement was Richmond Fed President
Jeffrey Lacker's shift from the "nay" to "yea" camp. He had dissented at the
January FOMC meeting because he wanted the Fed to increase the monetary base
via Treasury purchases and not targeted credit programs.

The Fed took a baby step toward Lacker with the Treasury purchase plan. But
it took a giant leap away by supersizing the agency debt and agency-backed
mortgage backed securities purchase plans by a combined $850 billion to $1.45
trillion. Those programs, and others like the $1 trillion Term Asset-Backed
Securities Loan Facility, are precisely the kind of market-specific facilities
that Lacker had opposed.

One interpretation may simply be that the outcome of a meeting can't, or
shouldn't, be predetermined. The Fed now meets for two-day stretches, giving
lengthy time for discussion, and even perhaps for minds to be changed.

"What we're seeing is if there's a more democratic monetary policy,
individual participants talk about it...and small shifts in the median voter is
enough to move a program," said Vincent Reinhart, an American Enterprise
Institute economist who headed the Fed's monetary affairs division under former
Chairman Alan Greenspan and in the early months of Bernanke's term.

And there may be a good economic rationale for being so aggressive now.
Although gross domestic product likely fell again in the first quarter after
plunging 6.2%, at an annual rate, in the fourth quarter, there are some signs
of stability.

Consumer spending was fairly solid in the first two months of the year, and
housing starts appear to have stabilized, albeit at very low levels. If the
economy has indeed hit bottom, then the Fed's actions might add some wind to
the sails. At least there's less of a risk they'll be overwhelmed by a
deepening recession.

It's harder to have a charitable view about how the Fed is arriving at these
mind-boggling figures. It's unclear why the Fed decided that $750 billion, and
not $100 billion or $400 billion, was the right amount to increase the MBS
facility, or why they doubled the separate agency debt program instead of, say,
quadrupling it.

"The sizes do puzzle me," said Reinhart, as do the changes that occurred in
the intermeeting period to prompt the actions. "Why are circumstances so much
different this time?"

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