Bernanke's 16 Gun Salute

MarketWatch is reporting Fed ready to act further, Dodd says.

Federal Reserve Chairman Ben Bernanke said he's "absolutely" prepared to use all the tools at his disposal to address the credit crisis in the U.S. financial system, Sen. Chris Dodd, D-Conn., said Tuesday following a closed-door meeting with Bernanke and Treasury Secretary Henry Paulson.

Dodd, chairman of the Senate Banking Committee, told reporters after the meeting that he put no political pressure on Bernanke to lower the federal funds rate.

The Fed and the Treasury should do more to encourage banks to take advantage of the discount window for short-term funds and to open up their lending windows to customers, Dodd said. "A little more moral suasion would be helpful."

"The Fed gets it and understands it," Dodd said, but "the Treasury doesn't." Dodd said the important thing is to keep people in their homes.

Dodd urged the Treasury to lift a cap on the amount of mortgages that Fannie Mae and Freddie Mac can hold, saying the administration clearly has the authority to act.

In one of the few things the Bush Administration has gotten half right is the refusal to lift the cap on the amount of mortgages that Fannie Mae and Freddie Mac can hold. The reason I say half right is that Fannie Mae and Freddie Mac should be eliminated entirely. They are a big part of the reason we are in this mess in the first place. Heck, the derivatives mess at Fannie Mae is still not straightened out and Dodd foolishly wants them to assume still more risk.

And I am openly laughing at this statement by Dodd: "The Fed and the Treasury should do more to encourage banks to take advantage of the discount window for short-term funds and to open up their lending windows to customers. A little more moral suasion would be helpful."

This you see is where the rubber meets the road. The Fed can encourage banks to lend and it can encourage consumers and businesses to borrow. But it cannot force either. Even dropping money out of helicopters does not force consumers to spend. It's too bad Bernanke did not mention helicopters specifically when he said he's "absolutely" prepared to use all the tools at his disposal to address the credit crisis in the U.S. financial system.

Bernanke's Tools

• Jawboning with Dodd.
• Jawboning with Bush.
• Jawboning with the ECB.
• Essentially meaningless cuts of the Discount Rate (see The Fed's Tight Monetary Policy for a lengthy discussion of this idea).
• Cutting interest rates.
  

What about the Helicopter Drop?

Once consumer attitudes toward spending change, additional money (even dropped from helicopters) would be used to pay down debt. This is one of the reasons the helicopter drop theory is essentially an idle threat. Banks simply will not want to be paid back with worthless dollars.

Willingness to spend and willingness to lend is at the heart of the problem. From the banking side, once banks finally understand the risks, willingness to lend halts as well. That is the process that is underway right now and all this jawboning by Dodd and Bernanke will not change a thing. For more on this idea please see Will Rate Cuts Save The Economy?

The following comment by "GotAWatch" in response to this news summed things up rather nicely: 'LOL@oleBEN - He sure pulled out all the verbal heavy weapons, didn't he? Fired the 16" naval guns, too bad they were blanks.'

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/