Bernanke's Out of Bullets

No surprises from Ben Bernanke today, although the end result is pretty overwhelming. The Federal Reserve lowered the target on the Fed funds rate to a range of zero to 0.25% … call it free money.

What's it mean for the economy? Two things: One, the Fed is making money about as easy to come by as it ever has, and two, it can't make it any easier going forward. Bernanke's spent the past year and a half firing as many bullets as possible to prop up the economy, and he's finally out of ammunition. With a fed funds rate at effectively zero, there're few traditional tools he can use to get things moving again.

I say "traditional" because Bernanke seems to want to pull a few more tricks out of his sleeve. One tool is the direct purchase of Freddie Mac (NYSE: FRE  ) and Fannie Mae (NYSE: FNM  ) securities in an attempt to lower borrowing costs for home owners; another is the Federal Reserve floating its own debt to inject more money into the economy. Both are ad hoc, untested, unparalleled, and should probably scare you silly.

There are a few conflicting arguments surrounding these moves.

One is that with the economy as weak as it is today, the Fed should do everything it can to get money in consumers' pockets to get them spending again. In a vacuum, that probably makes sense, but when you consider that too much spending and too much easy credit is partially what got us into this mess, it seems pretty paradoxical.

The other argument against cutting rates to zero is the danger that we'll enter a "liquidity trap," which is essentially what happens when consumers come to expect deflation and hoard money rather than spend it. When this happens, deflation feeds on itself, but since the Fed has already cut rates as far as possible, there's nothing it can do … there are no more tools to get the economy moving again. Again, Bernanke's out of bullets.

The flip side of the liquidity trap is what happens when the economy inevitably begins to reinflate on its own. One factor that could spawn this is the weakening of the dollar, which we saw firsthand today as soon as news from the Fed came out. The Fed can, in theory, pull liquidity out of the economy before inflation begins to spiral skyward, but come on -- its history of being Johnny-on-the-spot isn't too impressive.        

Winners of this free-money giveaway are obviously banks. Not surprisingly, Citigroup (NYSE: C  ) , Wells Fargo (NYSE: WFC  ) , and Morgan Stanley (NYSE: MS  ) were all up double-digit percentages on the news.

Well, another day, another history-making event. How do you feel about the Fed essentially lending money for nothing? Fire your thoughts away in the comment section below.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Motley Fool is investors writing for investors.


Read/Post Comments (15) | Recommend This Article (20)

Comments from our Foolish Readers

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  • Report this Comment On December 16, 2008, at 4:36 PM, TMFTheDoctor wrote:

    He's not out of bullets...he can still slash it to 0.00%. Or maybe the Fed should go negative and start paying people to take and use its money.

  • Report this Comment On December 16, 2008, at 5:03 PM, flyonthewall45 wrote:

    I think we are already in a liquidity trap. The cost of living is dropping rapidly and no one is in a hurry to buy anything. What the Fed did today was shoot a dart gun with a slow-acting medicine at the elephant in the room. The market may have gone up today, but that is just a knee jerk reaction. We won't see the real effects for almost two years, just like we didn't see the mortgage bubble collapse until 2 years after interest rates started being hiked by the Fed.

  • Report this Comment On December 16, 2008, at 5:23 PM, Pantodon wrote:

    If the banks get money for nothing, do they also get their chicks for free?

  • Report this Comment On December 16, 2008, at 6:38 PM, wooties wrote:

    So, what about us that are potentially in the market for a home? I'm prepared, no debt decent job. Is it time to start hunting for the house deals of a lifetime? Does the consumer win in any of this crap?

    Is news like this something that means I can look forward to having a superduperly low interest rate on a Mortgage or does it get lost to banks in the translation to us lowly tax payers?

    I want to wait until next winter to score a house, should i contemplate looking for one now or ..see just how low we can go?

    ^ methinks this would be a great subject for a Fool article.

  • Report this Comment On December 16, 2008, at 8:45 PM, jbowser12 wrote:

    Wooties,

    Mortgage rates are not directly tied to the fed funds rate. Rather, the mortgage rates you see from the various lending institutions are tied to the 10 year t-bill, which as we know, is sitting at historic lows (back to about 1950 or so). So when the fed makes this type of move, there is really no direct correlation with a drop in mortgage rates. Alternatively, as more and more people pull money out of equties and put their money into t-bills (as the price is inverse to its yield) the 10 year t-bill yield falls, and so do mortgage rates. make sense?

  • Report this Comment On December 16, 2008, at 11:10 PM, kamuirei wrote:

    Although in addition to rate you should consider the relative price of housing. TDRH pointed out awhile back that median price for a home is still historically high in comparison to median salary.

  • Report this Comment On December 16, 2008, at 11:11 PM, kamuirei wrote:

    (at least I think it was him... correct me if I attributed it wrongly)

  • Report this Comment On December 17, 2008, at 1:13 AM, wooties wrote:

    @jbowser12 and Kamuirei

    Thanks!.. and sad.

    Again, none of this directly translates to the consumer. I do understand the macro portion to this all, .. I just wish the micro would benefit some of us who have been patiently responsible.

  • Report this Comment On December 17, 2008, at 2:10 AM, Sinfest wrote:

    You know what's another neat little trick?

    Fiscal stimulus. Granted, that won't be the Fed's job, but hopefully an Obama administration will save the day.

  • Report this Comment On December 17, 2008, at 8:28 AM, DaretothREdux wrote:

    Sinfest

    Yea...fiscal stimulus worked so great during the last depression...kept it going for a good tens years!

    But the great one can save us...all hail the Great Obama!

    Sorry, I just don't buy that the government is helping when the markets are not allowed to correct themselves...

  • Report this Comment On December 17, 2008, at 8:48 AM, joelmusicman wrote:

    Wag the dog... many don't believe this but the Fed doesn't even control its own rate!

    The Federal Funds rate trails the prevailing 3-month T-bill interest rates as that reflects their costs.

    If you buy a 3-month T-bill right now, you'll earn a whopping 0.01% (annualized) on your money.

  • Report this Comment On December 17, 2008, at 8:52 AM, joelmusicman wrote:

    In response to Wooties: I've never owned a home, and today I'm glad about it!

    That said, this credit bubble is NOT done imploding.

    Keep renting, save up cash (keep some physical cash on hand too in case your bank fails!), and you'll probably be able to buy a home with cash in about 5 years...

  • Report this Comment On December 17, 2008, at 11:58 AM, jfielhauer wrote:

    Sinfest,

    Even Bernanke admitted that the NRA was detrimental to the economy. If that's what he thinks, hopefully he'll voice that opinion when Obammers tries to socialize more of the work that private industry should be doing.

    The only bullet Bernanke has left is for Paulson to keep cranking out money. Sure, it's a horrible idea but it makes the economic numbers look better, because homes (and everything else) can sell for the same numbers they sell for now, they're just not worth as much. Again, I don't advocate inflationary policy but as a homeowner with all my spare cash invested in precious metals, I'm positioned correctly for it. When inflation hits, my gold and silver will maintain value and the amount I owe on my house will be easier to pay off when inflation pushes up my salary. I'm locked in for 30 years so I can coast right through the Volcker-style interest rates we'll endure to get inflation under control.

    Get a good deal on a house, lock in on a 30 year mortgage and transfer your money to precious metals, agricultural commodities and commodity stocks. You should be able to weather the storm OK.

  • Report this Comment On December 17, 2008, at 12:02 PM, cohiba123 wrote:

    Bernanke's out of bullets?

    I have not seen anyone mention, open market operations? Purchases and sales of U.S. Treasury and federal agency securities—the Federal Reserve's principal tool for implementing monetary policy. The Federal Reserve's objective for open market operations has varied over the years. During the 1980s, the focus gradually shifted toward attaining a specified level of the federal funds rate (the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed), a process that was largely complete by the end of the decade.[53]

    Or

    Reserve requirements: the amount of funds that a depository institution must hold in reserve against specified deposit liabilities.[55]

    http://en.wikipedia.org/wiki/Federal_Reserve_System

    Joe

  • Report this Comment On December 17, 2008, at 12:55 PM, pointsplat wrote:

    I don't understand why there are all these complications in this system and why the government is essentially giving billions upon billions of dollars away with little to no stipulations and without some of those stipulations involving things such as forcing banks to lend at lower rates.

    Some may argue you dont want the government dictating how businesses should be run, im sorry but if we are infusing your broke business with a few billion your damn right we better have the right to tell you what to do or not. Your options are die out like any small business would be forced to do if they acted stupidly as you did or we can give you money but we're going to make you clean the ship up while your at it and start to help float the economy.

    The fact that banks can essentially borrow money for nothing and are not passing these savings onto consumers is absurd and if they wish to not do this they should not receive any money nor the rate cut. Want to keep business as usual and not change your business good keep borrowing at the current rate, want to help fix the mess you created and clean up your act ok we'll give you a temporary shot to get you back in place but only if you agree to our stipulations.

    I am happy Citigroup was scrutanized and many stipulations have been attached to their infusion of cash though I dont think they are enough its a start. Look at the auto industry yea there are a ton of issues with the auto industry and most of it is due to their own stupdity but the bills that eventually didnt pass had requirements out the wazoo and many wanted even more then that, there has not been any debate or discussion or anything like that with the financial sector, it seems all you have to do is drive a ferrari and have a tin cup and the government is more then happy to fill it for you.

    As a final cap to it all I agree with all the others if you don't allow a free market to operate as it should you completely screw up the fundamental workings of it. We are in the process of destroying ours.

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