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The Bush administration shifted into "shock and awe" mode last week in its attack on the credit crisis, abandoning the gradualist approach of the first 10 months of the year in favor of blasting the frozen nexus of lenders, borrowers and buyers with a new set of 10,000-degree heat rays.
Make no mistake: This is the War to Save Credit. No more quarter-point cuts in interest rates or measly $25 billion injections of bank capital for this crew, now that its power is ebbing and the incoming executive-branch team is stealing its thunder. The Treasury Department and Federal Reserve have opened a gun rack full of trillion-dollar programs aimed at forcing loss-ridden banks such as Citigroup (C, news, msgs) to lend like mad.
Yet money isn't everything, even in the debt markets, and it will likely take a lot more than near-zero interest rates and massive boosts in the monetary base to ward off the painful effects of global deleveraging and a prolonged recession.
The main beef: Few of the government's weapons in the crisis have been tried on this scale, if at all, so they amount to the most speculative experiment in modern financial history. And no matter what the suits at the podium say, they have no idea -- no idea -- whether their plans will work.
The $7 trillion fire hose
If you liked the way the government spent tens of billions of dollars improvising to bring peace to Iraq and to hunt for Osama bin Laden, in short, you're going to love the way they spend a few trillion slapping together a battle of the bonds.Think about it: About $7 trillion has been put at risk by a Federal Reserve team that has admitted it failed to understand the credit crisis for years, has no direct expertise in lending money to anyone but the highest-quality banks and has no staff expertise in insurance, credit unions, consumer lending or the other financial institutions that are standing in line for its new largesse. Plus the Fed's computer models that suggest the dollar flood will work magic were built by the same type of folks whose financial models got investment banks into trouble in the first place -- and the money will have even less oversight by risk managers, if that's possible.
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The speed of the spending alone is enough to make you gasp. In just the past two weeks, Treasury boss Hank Paulson and Fed chief Ben Bernanke snapped their fingers to come up with $100 billion to buy new debt from Fannie Mae (FNM, news, msgs), Freddie Mac (FRE, news, msgs) and the Federal Home Loan Banks; $500 billion to buy the agencies' worst mortgage bonds; $200 billion to guarantee securities backed by student, auto, small business and credit card loans; $20 billion in capital for Citigroup; $306 billion in guarantees for Citigroup's worst assets; and $30 billion more for American International Group (AIG, news, msgs). This doesn't even count the $700 billion bank bailout, the first $85 billion for AIG or $25 billion for automakers.
I hate to moralize, as surely something must be done. Yet I don't think the sheer audacity of the Fed's and Treasury's extralegislative efforts has been grasped by the public, nor has its cynical whimsy.
In economics circles, this battle has another name and a set of theories. It's called quantitative easing, or QE, and the only place it has been tried is Japan, starting in 2001. The fact that it has failed there doesn't discourage U.S. policymakers, because they think they can get it right.
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Are bonds in trouble?Investors are starting to worry about where all the money will come from for bonds. Governments need to sell $2 trillion in bonds in 2009 to pay for bailouts and stimulus packages. MSN Money's Jim Jubak wants to know who will be buying.
Quick primer: Central banks pursue their mission to stabilize a nation's money supply and promote economic growth in two ways: changing the price of money via interest-rate cuts or changing the quantity of money by printing or destroying it. Ninety-eight percent of the time they pull the interest-rate lever, which is why we care about the rate-setting meetings of the Federal Open Market Committee. Yet in the rare cases when rates approach zero amid a collapse in inflation, central banks turn to quantitative channels to deliver economic stimulus.
This is the classic playbook from seminal 1930s-era British economist John Maynard Keynes, who proposed that governments should run big deficits to intervene directly into markets and maintain a zero-interest-rate policy, or ZIRP, when under extreme stress.
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