Guy Monson and Subitha Subramaniam on how the US Federal Reserve is facing up to recession
US policymakers are at war against recession. Since January, the Federal Reserve under Ben Bernanke has cut interest rates by 1.25 per cent; markets expect another cut of as much as 1 per cent this week. Such dramatic reductions are a far cry from the studied gradualism of the Greenspan years. In addition, Treasury secretary Hank Paulson has deployed fiscal policy to offset the housing squeeze with an aggressive package of $152 billion in tax rebates.
At its core, this ‘war’ aims to shore up US house prices, the essential collateral for the US financial system. The Fed is moving into unchartered territory with policies such as its Term Securities Lending Facility which allows banks and securities dealers to swap risky mortgage securities for Treasury bills. This week’s fire sale of Bear Stearns to JP Morgan is underwritten by a $30 billion Fed guarantee. Meanwhile the Treasury’s ‘Hope Now’ alliance aims to provide targeted debt relief through voluntary loan work-outs, while Bernanke is encouraging bankers to write down problem mortgages. Taken together, liquidity infusions, debt forgiveness, tax rebates and aggressive rate reductions demonstrate a gritty response against a recession that has not even officially started.
The role of Bernanke in this war is pivotal. As a Princeton academic, he authored the seminal Essays on the Great Depression. His research found the Great Depression to be the tragic consequence of an erroneous contraction in money supply that was amplified by banks. In an essay on the impact of banking problems in 1930–33 he wrote, ‘the effects of this credit squeeze on aggregate demand helped convert the severe but not unprecedented downturn of 1929–30 into a protracted depression’.
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