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December 14, 2007
The Fed’s not-so-magic wand
Banks aren’t lending to each other or to us, but this isn’t the result of an “irrational panic,” says Paul Krugman in The New York Times. “It’s a wholly rational panic,” and one that the Fed can’t calm with the wave of “its magic wand.” Unlike the financial crises of 1987 and 1998, the problem today isn’t just a lack of liquidity, which the Fed can fix. With banks and other financial institutions holding very real, “very, very bad” debt, “there’s also a fundamental problem of solvency” this time. The markets “won’t start functioning normally” until housing prices hit bottom and “financial institutions have come clean about all their losses.” So don’t hold your breath.
Sure, if you’re hoping “the Fed can turn around and twirl a magic wand to make everything OK, you’re apt to be disappointed,” says Randall Forsyth in Barron’s Online. But “give Professor Bernanke a B-plus for substance.” His new scheme to improve liquidity through auctioning off loans—an anonymous “eBay for credit for banks” rather than the old “pawn shop” Fed discount window—may not be a “magic bullet,” but “it’s a far sight better than the blunderbuss approach taken in recent years” by Alan Greenspan. Whether these “new, innovative weapons” will work is “an open question.” But at least it’s a promising idea.
of The Week magazine.