Bernanke Swarms In

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Well, we now know what the true meaning of "Helicopter Ben" is.

Ben Bernanke and the Federal Reserve incited a stock market rally after announcing that they'll buy $300 billion of long-term Treasuries as well as $750 billion more of mortgage-backed securities in an effort to flood the economy with liquidity and keep interest rates low.

I have a few thoughts on this grand adventure.

First, money velocity is practically zero right now. That being the case, the Fed can keep pumping as much cash into the economy as it wants to; it's not going to make much of an impact in terms of staving off the deflationary bugaboo in the short run.  

Second, and more importantly, is what impact this will have on long-term yields, and hence mortgage rates. That's really what this is about -- doing everything possible to keep mortgage rates low to help spur demand. Thing is, mortgage rates are already incredibly, and historically, low. By and large, the cost of money isn't what's hampering real estate. A decade of massive oversupply, a consumer wracked with fear over future losses, and a market where prices were exorbitantly high to begin with is the crux of the problem. Bringing interest rates down does indeed help, but it's an artificial help that doesn't let the root problem work itself out. Let's not forget, artificially low interest rates are partially what got us here in the first place. Just sayin'.

Third, I know I'm not the only one wondering how large the Fed's balance sheet can be before it reaches a tipping point of no return. The plan du jour is that all these expansionary projects will be unwound once the economy picks up steam, but there comes a point where the Fed's balance sheet will be so large that unwinding it in a meaningful way -- in a way where time is of the essence -- won't be feasible. To see what I mean, go ask AIG (NYSE: AIG  ) or Citigroup (NYSE: C  ) how easy it is to unwind a massive balance sheet when the forces of finance aren't working in your favor.

Outside of long-term implications, this is indeed good news for a few wounded members of the economy. Banks like Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , and JPMorgan Chase (NYSE: JPM  ) exploded this afternoon, and well they should; with the Fed and Treasury doing everything humanly possible to keep banks' cost of capital at or near zero, banks have a tremendous tailwind in rebuilding their capital positions going forward.

What do you think about these huge moves? Stocks got some much-needed relief on the news, but I'm always drawn back to what long-term implications these programs will have. Care to chime in? Share your thoughts, concerns, and suggestions for ol' Benny B. in the comment section below.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. JPMorgan Chase is a former Motley Fool Income Investor recommendation. The Motley Fool is investors writing for investors.

Read/Post Comments (8) | Recommend This Article (30)

Comments from our Foolish Readers

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  • Report this Comment On March 18, 2009, at 5:01 PM, whereaminow wrote:

    Thanks TMFHousel. You and TMFLomax and TMFSinchiruna get it. I hope others will eventually.

    Here's a video for those interested in how the Federal Reserve works:

    David in Qatar

  • Report this Comment On March 18, 2009, at 8:24 PM, jerryguru69 wrote:

    I had similar thoughts about “liquidity”. There was a newswire story that financial institutions had so much liquidity, that they were pumping $100B’s of cold, hard cash into the treasury as a safety net in case they needed it. They were in no way ever going to lend it out to another financial institution. Same story with BOE and ECB.

    As you said, the velocity of money is near zero, so a $gazillion in more liquidity will add nothing to business activity, since all the liquidity goes into a black hole. Question: how is confidence restored, so that financial institutions will shovel $10B’s every night, like the old days?

    I still maintain that changing “mark-to-market” (FAS157 or “fair value” or whatever it is called these days) has the best chance of instantly unlocking institutional lending markets. Yeah, I know, “toxic” assets would no longer be toxic, because we have changed the rules. Still…

    Unlike you, however, I am not concerned about unwinding. True, this is difficult in current conditions. But, in a couple years when both unemployment and GDP gain are about 5%, Uncle Sam will be able to unload all of these accumulated securities to a boatload of willing investors.

  • Report this Comment On March 18, 2009, at 8:34 PM, babypoop wrote:

    buy gold?

  • Report this Comment On March 18, 2009, at 11:00 PM, texjammer wrote:

    The handling of this has been a fiasco since TARP. 'OMG!! You have to pass this in 24 hours or the world as we know it will explode!' What a load of BS!

    If they had let Freddie, Fannie, AIG, all the banks and the brokerage houses pretending to be banks fail, the S&P would probably already be rebounding from about 400, interest rates would be above 20% and everyone would be shaking their heads and asking "What do we do to keep that from happening again?" And in another 40 years or so, all the laws that were passed to stop another banking catastrophe will be repealed and there will be another crisis shortly thereafter.

    Human nature is to get everything you can, as fast as you can, before someone else gets it first. We as a species are greedy. There will always be someone out there trying to find a new, fast, easy way to make money by bending the rules as far as they will go without breaking. It's obvious that most of the lessons from the Great Depression were lost or forgotten.

    "Those who don't learn from history are doomed to repeat it."

  • Report this Comment On March 19, 2009, at 1:56 AM, Justapoorolddoc wrote:

    Something similar to this was tried during the great depression. It was called operation twist. I don't know anything about this. I just heard it on a news cast. They said that operation twist did not work during the great depression and this is only the second time in 40 years the fed has tried something like this. Whether or not this is a different world and it will work in this situation needs to be seen.

    How many more rabbits can the fed pull out of its hat?

  • Report this Comment On March 19, 2009, at 9:45 AM, Knifecatcher1 wrote:

    Hats off to Mr B for taking a bold step to reduce mortgage rates (indirectly) and provide a support for both home prices and disposable income.

    In the coming years we'll read about the hidden economic realities that have spurred such a move.

  • Report this Comment On March 19, 2009, at 1:15 PM, MissAmericaRichH wrote:


    Rich Hartmann - Miss America | Mar 18, 2009

    Today I will argue that the standard measures by which we assess our economic health no longer apply to our current situation. The most common terms "Inflation" & "Deflation" are based on the general price level of goods and services. Inflation is the increase in price, thus limiting the purchase power of your money. Deflation is the decrease in price, and increase in purchasing power. My argument is that the general price level of goods and services is temporarily not price-able, and the purchasing power of all currencies is unknown due to due to the lack of transparency of overall credit and debt at all levels of the economy (from Countries and Governments through companies and households) due to known and unknown variables and their known and unknown ripple effects. The broad systemic risk of commingled good/toxic assets in the globally interconnected financial world has now limited the ability to accurately measure factual and fictional wealth based on fusion of such infinite variables of destruction. In addition, the unknown levels of wealth creation, extraction and destruction, coupled with actual consumption leave us with a decreasing denominator in relation to the increasing nominator of debt.

    As we teeter on the edge of an economic abyss, pricing goods like an automobile becomes impossible. The factory says it cost $18,000 to produce. The retailer said it costs $25,000 to move. The buyer, based on the current status of the market, their employment, and the availability of credit will be willing to pay between $0 - $25,000 for the automobile. This is obvious and has always been the case, but unlike past situations, when the person walked out without buying the car, there was the assumption that someone else will walk in and buy it. That pricing mechanism is based on the fact that there will be a buyer to finance the cars production, and their purchase would fall somewhere between that $18,000 - $25,000 range. Depending on the strength or severity of the economy, that price level (inflation/deflation) would be found. That is not the case anymore! In the current environment, there are many more cases where there is no bid at all. The new price model needs to include $0 - $25,000

    For that same reason, hedge commodities are sitting on a plateau where they could either fall off the cliff, or shoot to the sky. Oil sits at $40-45 with the risk of dropping to the $20's and the risk of rocketing to $200 a barrel. Gold sits at $900, with a $2,000+ ceiling and a sub $500 basement. Milk and Orange Juice may be $4, or they may be $20? At the same time, the purchasers of all goods and services are sitting on the brink of having an income, house and various other assets or having nothing at all except existing debt obligations.

    With that said, how do you price a CDO? How do you price GM? How do you price the USD? How do you price a house? How do you price a car? How do you price eggs?

    At the moment, we have economic history pricing goods and services since there is no transparency, confidence or consistency to attain current supply/demand price. Without these factors secured, all you have is a risky wager that borders on being an extremely explosive or implosive bet that could play itself out in a couple of days time. That kind of volatility leaves us stabbing at prices that are nothing better then guesses based on dogmatic review rather then the actual consumer's current reality. Those kinds of shocks don’t bring about the price discovery that supply and demand in a capitalist market would accurately set.

    Evaporflation, Vaporflation and Condenflation occur when natural economic factors like inflation and deflation meet with such an immense artificial force, that direction of price and purchase power become temporarily unattainable. They can be immeasurable due to the ambiguity of the calculating factor of: time of creation, synthetic composition, velocity and size.

    Evaporflation - is the disappearance of debt, or increase of credit to bring about a net debt reduction. (Disappearing debt also brings about the destruction of credit creation) It occurs as there is an increase in the difference between overall credit/cash/liquidity in relation to the overall debt obligations at a rate where the difference grows at a perpetual rate of motion. Through debt reductions and credit infusions, the pressure on the economic system can be vented in a manipulated fashion. If obstructed or without a large enough release valve, Evaporflation will lead to Vaporflation.

    Vaporflation - is the rapid disappearance of debt, or increase of credit to bring about a net debt reduction. It is hyper inflationary and hyper deflationary. It can easily lead to combustion during the venting process and if not contained would lead to a complete meltdown / collapse.

    The difference between Evaporflation and Vaporflation is the level at which the debt outpaces the credit. If debt outpaces credit beyond the sustainable levels of vaporflation, we will reach combustion (collapse). We have seen some of the early bailout packages (venting) combust. Bear Stearns, Lehman, and the first $350billion from Bush/Paulson bailout are samples of combustion during the venting process. Recapitalization, cannibalism, and self preservation absorbed all available liquidity, thus vaporizing institutions or programs that had nowhere to sit when the music stopped.

    Whenever there is a large decrease in overall wealth being met with less then needed reduction of overall debt obligations, no reduction of debt obligations, or an increase in debt obligations in relation to the overall credit/cash/liquidity it would lead to either evaporflation or vaporflation rather inflation or deflation. This is why we have not seen any favorable direction in inflation or deflation. The reason for this anomaly is due to the fact that the lead up to the crisis was also misdiagnosed. What preceded this was a phenomenon called: Condenflation.

    Condenflation – Is the self propulsion or positive feedback loop of credit creation through debt, where un-vented credit does not accurately reflect the actual inflation/hyperinflation of the credit cycle, due to the offsetting (real) long term debt. This can be and was attained through fractional reserve banking, leverage and unregulated markets meeting with the giant pools of liquidity and the circular loop of alchemy that led to more credit creation without yet another venting of inflation. The recycling of fractional reserves and leverage went well beyond their intended safe levels as the ratio of risk became immeasurable, and small shocks could lead to systemic risk due to cross pollinating and counterparty risk.

    Ill transparent markets acted like a pressure cooker. Liquidity/credit became trapped (unable to inflate) in a system that was not letting the vapor escape. The gradual release of this pressure would've deflated overheated markets (that were severely understating the short term credit/gain, and long term loss/debt) where an equilibrium of loss and gain could have been attained (and thus contained.) ...but instead, a collusive cycle between Financial, Political, and Media outlets was born for short tem profit. The short term upside became so easily attainable for the malfeasant, that the downside risks falsely appeared to be non existent. The trap itself, became self propelling through manipulation, greed, and misguided confidence. The false sense of confidence permeated every country, market, and home where the expectation of gains bordered on entitlement, and created a temporary self fulfilling loop.

    On the upswing, the liquidity in the markets pressure cooker had gone well beyond the boiling point. Real inflation was being severely understated as it did not weigh the short term credit versus long term debt properly. Redemptions, consumption, poor investment decisions, excess and larceny started to finally extract the credit (liquidity/liquid) from the pressure cooker. (The release of pressure was never properly reflected in the inflationary upswing so disinflation did not occur in the release.) When the markets pressure cooker reached what appeared to be a saturation point, (equilibrium) it was too late to realize that this was not the actual case. The unrealized exit of liquidity, coupled with the growing wave of debt obligations led to the immediate downside pressure of evaporflation (which was happening on the surface) and vaporflation (which was occurred beneath the surface). This pressure needed a release valve. Subprime became that escape!

    Within the “pressure cooker” analogy, the size of the pressure cooker has grown (debt), and there is less liquid (credit) in the pot. The pressure (the actual “pressure” is “the market” i.e. supply/demand, inflation/deflation, etc…) continues to build at an accelerating rate as there was less “liquid” in the pressure cooker, and the pressure cooker’s surface area continued to grow (which lead to a point beyond boiling) The stimulus plans, rate cuts, TARP, etc have added little bits of liquid to the pot, keeping us from vaporflation, but leave us in the current unique phase of evaporflation. The attempt to saturate the market, and reach equilibrium will be better achieved when a larger batch of liquid is poured in, and the size of the pot is reduced.

    With that said, the size and scale of artificial economic forces that we have created, was overlooked and underestimated which has left the price discovery mechanism flawed. …thus technically (and in reality), leaving the natural forces of inflation and deflation directionless as their driving forces (the price of goods and services, and purchase power) are inaccurate.

    The rest is present history.

    All the best,

    Miss America

  • Report this Comment On March 25, 2009, at 6:17 PM, snjeep wrote:

    "buy gold"

    actually: buy brass... with copper... and lead...

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