Wednesday, January 16, 2008

Anna Schwartz Joins the Fed Bashers

No sooner had I pushed the "publish" button on my previous post, that the illustrious Anna Schwartz joins the Fed-bashing fray, according to this article at the London Telegraph, quoted by Ambrose Evans-Pritchard.

AnnaSchwartz
[Thanks to nber.org for the photo.]

Anna Schwartz, still fully active and coherent at 92, is one of my favorite economists and a co-author with Milton Friedman of a classic text called "A Monetary History of the United States." She issues what EP calls a "scathing indictment," of Fed policy under Greenspan. She says:

"They [the Fed governors] need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence.... There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for.... It is clear that monetary policy was too accommodative [in 2003 and 2004]. Rates of 1 per cent were bound to encourage all kinds of risky behaviour.... This attempt [by Greenspan] to exculpate himself [by blaming an Asian savings glut] is not convincing. The Fed failed to confront something that was evident. It can't be blamed on global events.... Liquidity doesn't do anything in this situation. It cannot deal with the underlying fear that lots of firms are going bankrupt...."

Goldman Sachs wants the Fed to loosen rates to combat the problem, but as one of the commentators after the article notes: "[Goldman Sachs economist Jan Hatzius] is proposing reducing interest rates further? What about inflation? It is getting scary when oil hits $100 a barrel and we are lowering interest rates. I want to be paid in gold next year!" (Posted by James)

Note that Anna Schwartz is not credited with having recommended Fed loosening, but rather with stating that "liquidity doesn't do anything in this situation." She also states that our present quandary is nothing like 1929. "This is nothing like the Depression. I don't really believe the economy as a whole is going to fall apart. Northern Rock has been the only episode of a bank failure so far." (Well, she doesn't mention the big Wall Street firms' poor balance sheets; mortgage company bankruptcies; German, French and Spanish banks' troubles; Countrywide's near-miss; WaMu's coming buy-out; and NetBank's demise, this last probably only a coincidental incident.)

We are in a very sticky situation. It is true that stifling credit right at this moment would be devastating, but I would agree with Professor Schwartz that gobs of credit will not necessarily cure the disease. We may just have to plug through this.

The Fed is experimenting with ways to handle the blips as they occur. They will certainly lower rates on or before January 30. Meantime, they are lending billions of credit through another "banking" window, purportedly on a temporary basis, to sidestep inter-bank stoppages that risk throwing the economy into unnecessary turmoil.

Foreign money is also cooperating, furnishing needed capital to shore up our big Wall Street firms. I much prefer that to seeing them declare bankruptcy and using up the little FDIC cash we have on hand. As I said earlier, this foreign investment is the ignominious savings glut the Fed was trying to implicate in our previous credit problems. It will surely come in handy now, won't it?

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