E Timid Fed And Jeremy Stein And Potholes

The Timid Fed, trying to muster the fortitude to raise interest rates by a measly .25 percent, does not listen to Harvard Professor Jeremy Stein. Before getting into Jeffrey P. Snider's examination of Professor Stein and shortages of collateral, it would be good to see some of the things Dr. Stein was proposing as a help to the real economy, through his research at the Federal Reserve.

Stein retired from the Fed, and he gave this assessment upon his exit from the institution:

If your only real concern is monetary policy implementation and controlling rates, I think then there’s lots of ways you can do it.

For example, suppose the RRP rate is 5 basis points and it’s creating a pretty tight floor at five. Meanwhile the interest on reserves is 25 basis points, so the federal funds rate is going to be between 5 and 25.

Now, suppose you wanted to raise rates a lot. One thing that would work perfectly well is to raise both of these things by 200 basis points. The fed funds rate would still be somewhere in the middle.

Professor Stein first appears heroic in his desire to see rates raised by 200 basis points. His focus of research reflects his concern about the real economy more than about the derivatives economy. Prof Stein acknowledged what Kevin Erdmann has been saying, that during the Great Recession, there were not enough treasury bills in the Fed's war chest. Kevin goes on to say that this forced the Fed to terminate subprime, even the good subprime.

Stein said this:

If you think of financial stability policy, and some of the problems that we had leading up to the crisis, it was the search for safe assets. There weren’t enough T-bills so money funds went around searching for things that look like T-bills. If the government won’t make safe assets, then the private sector will make things that resemble safe assets, such as broker dealer repo, hedge fund repo, asset-backed commercial paper. [Emphasis mine]

My argument was that the Fed should have bought commercial paper way earlier than it did, as that market, which funded subprime, cratered in August 2007. Certainly, one would hope that if more paper of any kind is created, and considered safe assets, that the Fed would act as the lender of last resort, not waiting for the middle class to lose their assets while the Fed fiddles around. Many subprime loans were soundly underwritten.

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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