The Fed Was Blindsided
Peripheral vision is an attribute that is missing in our current crop of financial leaders. They don’t see obstacles out of the corner of their eye. If you’ve noticed, this Federal Reserve focuses on how raising interest rates will curb inflation. But doesn’t seem to notice the impact of these higher interest rates on the overall financial system.
That’s especially puzzling, given that we are transitioning from the most accommodative monetary policy in history to a much more restrictive approach. And under Chairman Jerome Powell, we’re doing it in record time, all to fight inflation.
It’s been a year since the Fed began this transition from essentially zero interest rates to nearly 5%short-term rates. Because of this very hot inflation, the Fed feels they need to make as rapid a transition as possible to higher rates. Congress has given the Fed the twin mandate of stable prices and full employment. Unfortunately, those have become the only two factors this myopic Fed has focused on.
However, as I have argued in other columns, it is more likely that the high cost of energy, especially oil, and gas, ignited today’s high inflation. And that we should be looking to lower energy costs to reduce inflation. As a side note, this may be why President Biden approved additional drilling in Alaska. He may finally realize the connection between escalating energy costs and inflation.
Also, in a recent column, we discussed the correlation between the spike in the number of disabled following the Pandemic and the increase in the JOLTS Job openings. It appears that we have reached the Fed’s mandate of full employment when there has merely been a reduction in the number of able workers.
My point is that by focusing merely on these two criteria, full employment, and stable prices, the Fed has missed all that its march to higher interest rates has caused. And incidentally, the Fed is not just tightening monetary conditions by raising rates. They are also reducing the Fed Balance Sheet, which draws liquidity from the financial system.
So, in 16 years, we’ve come full circle; as Ben Bernanke reported in a speech entitled “ Monetary Policy Since the Onset of the Crisis,” he outlines how this all began. In 2007 the Fed’s target interest rate was 5 1/4%, which is about where we are today. That’s when the Fed, under Bernanke, recognized an impending Recession. The Great Financial Crisis of 2008, the most significant Recession of the 21st Century, turned out to be less than a year away.
The Fed then recognized the financial crisis was brewing because they closely monitored their member banks. Stress was increasing at most of the money-centered banks. And before the 2008 Recession was over, at least one of the nation’s big four banks, Citigroup, would have been insolvent, except for the fast action of the Bernanke Fed.
In the face of the growing crisis, the Bernanke Fed began to lower interest rates and provide the financial stimuli we’re now familiar with, Quantitative Easing, balance sheet expansion, and so on. Although the Fed could not mitigate the full effects of the Recession, they recognized the impending catastrophe and saved one of the nation’s largest banks, CitiBank.
Why? Let me take an educated guess. I’ve been around enough banks to understand how much happens in a bank. Communication is the key. Talking to the different divisions. What we used to call our meeting around the “water cooler” or, more informally, “bull sessions.” It’s when people from different departments in the bank casually chat about how things are going. They may gripe about their troubles or explain some confusing policies. But by talking to each other, we get the “big picture” of the bank’s performance.
It was those lines of communication that Bernanke had with their member banks that are missing today. No doubt, some of the bankers in Bernanke’s day were telling the Fed that they needed relief. “Do something, or we’re going to be in trouble.” And the Bernanke Fed reacted, reducing interest rates to zero.
It doesn’t appear that’s happening today. Today’s Fed was blindsided by the news that Silicon Valley and Signature Banks were going out. That’s why we saw the reaction on a Sunday, not a weekday.
It must have been a four-alarm fire that weekend, which caused the Fed to bail out (my word) all, not just the FDIC insured, but all the accounts. These people appeared to be in complete panic. Probably because these failures, and the indication that there could be more on the way, totally blindsided them.
Believe me, when the Chief Financial Officer is as near insolvent as the CFOs at Silicon Valley Bank and Signature Bank were last weekend, they’ll tell you all about it. What they need to survive, and if you’re the Fed, how you can help them. Likely, they could have averted last weekend’s troubles with a phone call. But it looks like that call never took place. Or if they did take place, they went unanswered.
One gets the impression that today’s Fed doesn’t talk to people. It consults computers. In their well-used phrase, they are “data dependent.” Currently raising interest rates because that’s where the data leads them. In fact, at his last address before Congress just a couple of weeks ago, Chairman Powell indicated they would raise rates even faster if needed.
“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” said Powell.
Those are not the words of someone who would pick up the phone and talk to one of his member bankers. No, this is a “numbers guy” who would prefer to follow what the computer models tell him rather than talk to the Fed Member Banks.
It’s also why, in the end, this fed may win its battle with inflation but lose some banks along the way.
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