What the Fed is doing to help end the economic crisis

The Fed's Balance Sheet. WaPo Editorial
What the agency is doing to help end the economic crisis
WaPo, Monday, April 13, 2009; A14

IN NOVEMBER 2005, BusinessWeek published a story that began, "Welcome to the era of the diminished Fed." It predicted that incoming Federal Reserve Chairman Ben S. Bernanke would avoid the activist models of his predecessors and turn to a more predictable rules-based system that he called "constrained discretion." Now, a few years later, the Fed is in uncharted territory in an effort to save the economy, and "quantitative easing" has handily trumped constrained discretion. The central bank has massively expanded its balance sheet by more than a trillion dollars, with more to come, and simultaneously increased the types of activities in which it engages, making the notion of a central bank that focuses merely on adjusting interest rates seem positively quaint.

The new activities focus on providing credit to help financial institutions, making direct loans and, recently, purchasing long-term assets, such as Fannie Mae debt. As a result, the U.S. central bank is now the proud overseer of the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), which helps money market mutual funds meet their obligations; the Commercial Paper Funding Facility (CPFF), which lends directly to market participants; and the Term Asset-Backed Securities Loan Facility (TALF), which makes direct loans in an effort to fix the securitization markets and provides liquidity swap lines to a host of central banks around the world -- not to mention TAF, TSLF, PDCF, and MMIFF. It's enough to make even the most avid Fed watcher's head spin. While Mr. Bernanke has made efforts to increase transparency -- ranging from the helpful expansion of Fed Web sites to granting an unusual interview on "60 Minutes" that was downright folksy -- the effectiveness of these policies is virtually impossible to assess.

That the Fed has entered into so many new areas is in part a reflection of Congress's unwillingness to do so. Reeling from the political sting of the Troubled Assets Relief Program bank bailout and bonuses, politicians have been thus far unwilling to provide more funds to help stabilize the financial sector. This has pushed the Fed to shift from broad, macroeconomic manipulation to specific intervention in targeted areas and institutions. These activities may well turn out to be the winch that pulls the economy out of the credit and financial market meltdown, though no one can say for sure, and the midst of a crisis is not the time for handing out final grades. We do know that traditional Fed rate reductions, which left the federal funds rate hovering near zero, were not enough to jump-start the economy and that something else had to be done.

The real challenge will be "unwinding" all of these activities. If the Fed fails to turn off these new policies quickly enough, they could be highly inflationary, but shedding the assets it has purchased could tangle up markets tremendously. The president of the Federal Reserve Bank of Philadelphia has warned that there could be significant political pressure to keep many of the programs in place, particularly since the economy may still feel weak when it is time to start contracting the Fed's bloated balance sheet. Creating all these new programs was a heavy lift; getting rid of them may be even harder.