– By the end of the day on Friday, the Fed threw $38 billion in “temporary funds” at flailing U.S. banks. The market responded. The Dow recovered to a loss of 31 points.
– Market watchers and history buffs will recognize this move for what it really is: moral hazard writ large.
In his 1978 classic, Manias, Panics and Crashes, Charles Kindleberger suggested that in a world where the U.S. dollar is the universally accepted currency, the Fed has a duty to serve as “the lender of last resort.” But the Fed shouldn’t appear to do it willingly, lest it encourage “moral hazard” – the idea that no matter what dunderheaded lending mistakes bankers make, the Fed will always step in with a “free lunch” program of easy terms and free cash.
Last Tuesday, Bernanke and company stuck to the script. They announced they wouldn’t change rates in response to market volatility caused by subprime revelations. But by Friday, the temptation was too great… and the liquidity spigots were opened wide. Friday’s record $38 billion injection was second only to the $81 billion the Fed gave away following the Sept. 11 attacks.
Our question now: What happens if we face a real crisis? Another terrorist attack? During this era, when the U.S. is supposedly at the highest economic apogee in its history, why does it take so much credit to keep the dog afloat?
In his 1978 classic, Manias, Panics and Crashes, Charles Kindleberger suggested that in a world where the U.S. dollar is the universally accepted currency, the Fed has a duty to serve as “the lender of last resort.” But the Fed shouldn’t appear to do it willingly, lest it encourage “moral hazard” – the idea that no matter what dunderheaded lending mistakes bankers make, the Fed will always step in with a “free lunch” program of easy terms and free cash.
Last Tuesday, Bernanke and company stuck to the script. They announced they wouldn’t change rates in response to market volatility caused by subprime revelations. But by Friday, the temptation was too great… and the liquidity spigots were opened wide. Friday’s record $38 billion injection was second only to the $81 billion the Fed gave away following the Sept. 11 attacks.
Our question now: What happens if we face a real crisis? Another terrorist attack? During this era, when the U.S. is supposedly at the highest economic apogee in its history, why does it take so much credit to keep the dog afloat?
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