Money Sage (archive)

Without question the great surprise of 2007 was the eruption of the Sub-Prime Crisis.

The second greatest surprise was the mind-boggling incompetence demonstrated by the FEDERAL RESERVE. The Bernanke FED was apparently absent when the crisis materialized. Judging from their non-response and their reiterated assertions that all was well, and that the main issue was how to manage growth and contain inflation in 2008, we presume that they were reposing comfortably on CLOUD NINE when the crisis hit. It took a totally "unexpected" worsening of the crisis, benchmarked by the freezing up of key credit markets and a sudden and acute distress in the banking system to jolt the FED from its trancelike state. Then it took many weeks for the OVERLY WELL-INSULATED FED to move from its foggy state to some semblance of awareness that something serious was afoot.

The mind-boggling analytical ineptitude of the FED was matched only by the pusillanimity of its actions. The painfully slow grasping of reality was matched in the "policy" realm by an equally lackadaisacal response. Indeed, with the inflation-adjusted monetary base having actually CONTRACTED in the face of the massive DEFLATIONARY WAVE of the subprime tsunami and its hits to the banking system, inter-bank lending, the depreciation of bank assets and lendable capital, the commercial paper market, money market funds, municipal bond markets,and, most recently, global equity markets. Indeed, the persisting lack of a real liquidity-producing response by the FED continues, raising questions both about the FED's consciousness level and its basic intellectual competence.

We do not expect a miracle-working FED. What we do expect is a central bank which:

--gets the main direction of price movements right, not dead wrong;

--bases policy on forward-looking indicators, rather than THE MOST LAGGING OF INDICATORS;

--can draw obvious inferences between the underlying trend and the likely DIRECTION OF
IMPACT on the economy.

Clearly, the FED has failed on all fronts. In sum, the biggest surprise of 2007 is a FED which manifests numerous signs of an intellectual regression toward the mindset of the Federal Reserve of the early 1930s.