To Ease or Not to Ease

When the economy turns south, what should the politicians do? Sometimes they do too much. Sometimes they do too little.

In his first term, Bruce Fein relates, President Nixon vowed he would not resort to the expedient of wage and price controls. Until he did.

Nixon soon renounced his declamation in August 1971 as a presidential election year approached: "The time has come for decisive action. Action that will break the vicious circle of spiraling prices and costs. I am today ordering a freeze on all prices and wages throughout the United States for a period of 90 days."

On the other hand, the Great Depression was made immeasurably worse because the Federal Reserve Board failed to act as the lender of last resort in the four long years from 1929 to 1933. Banks failed in the thousands. Then the government ran around trying to bail everyone out in the New Deal, and that was just as bad.

So what should the government do?

Right now the Federal Reserve is doing all it can to ease the “credit crunch” of the last few months. On the other hand it is clear that the residential mortgage market was way overblown and house prices need to come down.

A recession is the natural cleanup process, the liquidation of the malinvestments of the previous boom. But a huge depression threatens the very fabric of the nation as people get desperate and flock to leaders who promise a way out of the wilderness.

Today the Federal Reserve Board, in conjunction with other major central banks, injected liquidity into the financial system, as reported by Jeannine Aversa.

The Fed announced the creation of a new tool, called the Term Securities Lending Facility (TSLF), geared to provide primary dealers — big Wall Street investment firms and banks that trade directly with the Fed — with 28-day loans of Treasury securities, rather than overnight loans. They would pledge other securities — including federal agency residential-mortgage-backed securities, such as those of mortgage giants Fannnie Mae and Freddie Mac — as collateral for the loans of Treasury securities.

Always remember. The one thing that really matters to the government is the market in US Treasury securities. And that means looking after “the big Wall Street investment firms and banks that trade directly with the Fed.” Before the voters, before widows and orphans, before even the majestic AARP, the government cares about the Treasury markets. Right now, of course, it looks pretty good, with short-term Treasuries yielding 1.5 percent and 30 year bonds yielding 4.5 percent.

That is fine, but the rest of the financial market is tanking. And if the rest of the market goes south then it affects the big ivestment firms and banks that do business with the Fed. So you can never be too careful, so that’s why the Fed intervened today to shore up the financial markets.