Federal Reserver Policy in the Subprime Crisis

The Wall Street Journal‘s Greg Ip has a great article today, "Bernanke, in First Crisis, Rewrites Fed Playbook."  (Subscription required, and well worth the price.)  The story is written in a narrative that reads almost like a thriller.  Almost, because it is Federal Reserve policy, after all.  Ip explains Bernanke’s economic views, and how he relied on a number of savvy advisers for up-to-date market information.

My own fear about Bernanke, when he was first appointed, was that he lacked the gut feel for economic fluctuations that one gets from being an economist at a bank, Wall Street firm, or macroeconomic consulting firm.  However, Bernanke isn’t showing any weakness in that dimension.

We still have to worry about his use of "The Greenspan Put."   This is the idea that if big institutions make stupid mistakes, the Fed will cut interest rates to prevent a crisis, effectively bailing the institutions out of their problems.  (A put is an option to sell an asset.  The Greenspan put, as commonly discussed, is not a true option, just a sense that the Fed won’t let the big guys fail.)  However, Merrill Lynch’s eight billion dollar loss on mortgage-related securities suggests that if there’s support for bad decisions from the Fed, it’s not total, complete support.  Or else eight billion is not what it used to be.

Business planning conclusions:  The Fed is on top of things, with an eye to ensuring that businesses and consumers with good credit standing continue to have access to loans.  That means no recession, probably.