The Hindu Business Line : Fed wants to arrest asset price fall

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Fed wants to arrest asset price fall

S. Balakrishnan

The Fed Chairman, Mr Ben Bernanke, may or may not like it but his predecessor Alan Greenspan’s spirit is alive and well at the Fed.

It is all to do with asset price inflation. Mr Greenspan thought central banks had no way to figure out if it was right to raise interest rates purely in response to a sharp rise in asset (property, stocks) prices. But he was sure that the right thing to do if asset prices crashed was to cut rates quickly and a lot — which he did quite a few times in his 18-year tenure at the Fed.

On Tuesday, Mr Bernanke followed Mr Greenspan’s previous class acts in slashing 75 bps off the Fed’s benchmark just days ahead of the Federal Open Market Committee’s (FOMC’s) scheduled meeting next week. So dire was the market situation that policymakers couldn’t afford to wait even that long.

Mr Bernanke and his FOMC colleagues may have concluded that the first (and only) thing to do is to staunch the haemorrhage of asset prices. (In the current US context, it means mainly house prices). That necessitates cutting interest rates till the Fed’s will is done. The rest will take care of itself is probably the calculation.

Worry line

It is easy to see why. More than the havoc created in consumers’ balance sheets and spending and the not inconsiderable loss of jobs as new construction slows on weakening demand and to work off unsold inventories, it is the collective impact of foreclosures, delinquencies, erosion in collateral values, and credit downgrades which worry the Fed.

The consequent bank write-offs and provisioning arising from mark-to-market obligations and the fear of what and how much more of the same there is to come and from which institutions brought credit markets to a grinding halt, striking at the very heart of the financial system.

The Fed was prompt in providing liquidity to market players in distress, but this is far from enough. The final solution lies in stabilising asset prices and their rebound. That will put an end to collateral bleeding and hasten the pace of restoring banks’ balance sheets without vast new capital infusions (and ownership?).