Fed Rate Hike: Mysterious Political Theater

Feb. 22, 2010 - PRLog -- By David Caploe PhD, Chief Political Economist, EconomyWatch.com

During Alan Greenspan’s long tenure as head of the Federal Reserve, people were used to not understanding his arcanely-worded, mystically Delphic, pronouncements on interest-rate policy –

even though he has been refreshingly clear in publicly recanting his nonsensical life-long libertarian Ayn Rand world-view in light of the eruption of the global financial / economic crisis in Black September 2008.

But the Benjamin Bernanke-led Fed’s latest move, the first hike since Black September in any of the Federal Reserve’s array of interest rate policy instruments, in this case the not-very-often used discount rate – the rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank’s lending facility, or discount window, as well as the shortening of the re-payment period from the unusual 28-days to the more standard overnight – was notable in two ways:

First, it was not previously telegraphed, either directly or indirectly, as is “normally” the case with interest rate moves, either up or down; second, and perhaps even more surprising, was its timing - coming between, rather than immediately after, a regularly scheduled policy meeting.

Given these unconventional “atmospherics”, it seems obvious to investors / speculators / media “pundits” / and Fed-watchers everywhere that the Fed meant to say something with this move.

The problem is no one can quite figure out exactly WHAT the Fed was trying to say, a confusion reflected in the uncertain and contradictory movements in money / stock / and bond markets globally in its immediate aftermath.

To be sure, there has been the usual array of totally un-convincing conventional explanations: technical / economy “bouncing back” / a key symbolic move in the fight against – now non-existent – inflation

·        “Many economists said banks were no longer borrowing in large amounts from the Fed using the discount rate, and so the move on Thursday was, in a sense, purely technical” … that is, we don’t know what’s going on, and so are “discounting” the discount rate move …

·        “This is a victory lap by the Fed,’ Zach Pandl, economist at Nomura Securities, said. ‘It is a signal that the Fed is very confident in the health of the banking system. Fundamentally, these actions are a sign of policy success.”’ … Of course, we have made absolutely clear that this position is completely absurd, and, as Michael Corleone said to the Senate in Godfather II, “that is a complete falsehood” …

·        “t was the symbolic value of the step that mattered. Ulrich Leuchtmann, of Commerzbank, said the normalisation of Fed policy meant the central bank would be able to raise the Fed funds rate, its main lending rate, eventually. ‘It no longer matters whether the Fed funds rate will be raised in August, September or November,’ he said. ‘What matters is that the Fed is the only large central bank able to raise rates in the foreseeable future.’



But it’s by no means self-evident the ability of the Fed to raise the – admittedly more important – funds rate is all that significant anyway, since that is a move specifically designed to fight inflation.

And, as others, more in tune with existing reality, such as Karen Dynan, long-time economist at the Fed and now co-director of Economic Studies at the Brookings Institution, have noted, there is no inflation anywhere on the American or European horizon: Indeed, “given that unemployment is nearly 10 percent, she said, it is unusual that inflation expectations have not declined.

So if the “eye-catching” Fed move is not technical, nor a reflection of an economy on the rebound – 4th quarter figures aside – nor a move to fight inflation no one can see, especially given record post-WWII US unemployment figures, with millions facing years of sustained joblessness, as the New York Times noted in a prominent lead article – what the heck WAS the purpose of this move ???

In our view, the move basically represents a capitulation to three powerful forces in the post-Black September 2008 American political economic landscape:

Most importantly – despite the fact that it MAY result in decreased profits for some of the smaller banks – it represents a victory for the “lending freeze” blackmail in which the Too-Big-To-Fail [TBTF] banks have been holding the entire financial system hostage since the post-Black September bail-outs, when they realized they could get the government to cover their losses, while they hold onto their massive – at least for the moment – profits.

Basically, the Obama team has continued the “give the TBTF banks whatever they want” policy initiated by Cheney / Bush / Paulson / Geithner, an approach we have pointed out was immediately signaled when the President named Geithner as Treasury Secretary – despite his “asleep at the wheel” presiding over the New York Fed as the crisis was developing and then exploded – and his former boss at Treasury during the Clinton years, Larry Summers, as head of the National Economic Council –

both acolytes of destructive Democratic economic policy guru, Robert Rubin, under whose guidance the two played a key role in the “under cover of night” de-regulation of the DERIVATIVES that have played such a destructive role in both the US and now, it is becoming clear, European financial / economic / political disasters.

The hope was that, if you did indeed give the TBTF banks a huge amount of basically free money to play with – thus insuring the massive profits several of them did enjoy in 2009, while the rest of the “real economy” was reeling – that, eventually, they would relent on their extortion scheme, and start lending to individuals and companies who desperately needed it, either to start innovative new ventures or simply to keep going.

But as 2009 dribbled desperately into 2010, and the banks continued to show no interest in lending despite all the free cash the Fed was throwing at them, Obama and the Fed apparently realized their gambit had failed,

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