The Federal Reserve used up almost all of its remaining conventional ammo today as it desperately tries to prevent the second Great Depression. The statement is below, along with the previous statement, and with my commentary interspersed.

“The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.”  

“The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.”

Hard to believe that just six weeks ago the fed funds rate was at 1.50%. Now we are near zero. The use of a range is unusual and perhaps unprecedented. Then again, the fed funds rate has never been this low before, and at the low end of the range I can safely say that it is a record that will never be broken.

That’s it folks — the Fed is officially out of its normal ammunition, although by using a range perhaps it has retained a BB. On the other hand, the effective fed funds rate has been in this area for several weeks, so the Fed is really just catching up to the market, not leading it.

“Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.”

“The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.”

No disagreement here. The economy is a mess and getting messier by the day.  Pick your indicator and it is either at a record or a multi-decade low or high, depending on which indicates a soft economy.

“Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.”

“In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.”

In the short run, the problem is deflation, not inflation. The CPI [Consumer Price Index] came out today down 1.7% for the month, with the core unchanged. On the headline numbers, that is far from price stability. If this continues, it will slow spending much more, since people will not want to buy today if they think they will be able to get a much better price next week.

Deflation also raises real interest rates, and the Fed is powerless to help out. However, the Fed is turning on the printing presses and is going to run them day and night. Eventually they will cure the deflation problem. There is a huge danger that they will overshoot and we will have very high inflation (more than Ford/Carter, less than Zimbabwe) as a result, in a year or two.

“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.  

“The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will 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 its purchases of agency debt and mortgage-backed securities as conditions warrant.

“The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.”

“Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.”

Extraordinary times, indeed.  The Fed is promising to keep fed funds low for a long time. This should help bring long-term rates down. I’m not sure that really is the problem though, since the 30-year bond is flirting with 3.0% — levels not seen since the Great Depression.

The talk of buying the longer-term Treasuries and mortgage securities, that is Fed speak for “Turn on the printing presses and run them full speed night and day.” The use of the Fed balance sheet to support credit to households and small businesses could be helpful, but moves the Fed in the direction of being a commercial bank, not a central bank.

We have to give the Fed high marks for creativity and trying hard. Generally, though, creativity is not a highly cherished trait in either accountants or central bankers. The potential unintended consequences are huge. The most likely of these is potential hyperinflation in 2010 or 2011. The dollar could also end up losing its status as the world’s reserve currency.

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.”

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.”

Everyone on board with the plan.  Geithner has removed himself from the committee pending his move over to Treasury.

“In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco.  The Board also established interest rates on required and excess reserve balances of 1/4 percent.”

“In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.”

The discount window is not a window anymore, it is a gaping hole in the side of the building. Come and get it, bank boys — free cash! Use of the discount window is supposed to be at a penalty rate, but somehow even in this environment 0.25% does not seem like a very tough penalty.

While these actions are friendly to the banks, I would still avoid names like Bank of America (BAC), Wells Fargo (WFC) and Citigroup (C). There are still way too many bad debt shoes left to fall before it is safe to get back into the banks.

Read the full analyst report on WFC

“C” Free Stock Analysis: Buy? Sell? Hold?
“BAC” Free Stock Analysis: Buy? Sell? Hold?
“WFC” Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

Last 5 posts by Dirk Van Dijk

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