Wednesday, December 12, 2007

Steve Randy Waldman on the new Fed plan

I'm a bit more blase than that, but I did think it worth a blog post. The core innovation is that the Fed announces a quantity of funds to be auctioned, and the market sets the price. That is in contrast to the Fed targeting the Federal Funds rate; price-quantity equivalence results do not hold when credit rationing is present. It's like forcing a certain amount of discount window borrowing. This means that new funds will get to banks, and to banks with credit problems, it will be interesting to see at what price.

The skeptical Jim Lowe, over at Mark Thoma's, says:

The primary problem facing credit markets is not lack of liquidity but rather a combination of capital inadequacy and fears of credit/counterparty risk. I don't see how another liquidity injection addresses these problems.

In response, the Fed seems to be promising to "hold the bag" on the collateral offered by the soon-to-be borrowing banks. Could this be a collateral pledge disguised as a liquidity injection? Or is the main goal simply to reroute liquidity injections away from the main banks and toward the troubled cases?