The Fed has implemented an alphabet soup of market interventions (TALF, TARP, CPFF, TAF, etc) in the last few months. Many of these programs are exploratory and the results are unknown. I am still trying to digest these programs myself, but I do think one thing is clear – supporting the banking system is hugely important. The reason this crisis has morphed from a recession to a potential depression is because a housing crisis has turned into a banking crisis. And the banking crisis is influencing parts of the economy that should have never been impacted. The Fed is responding as Lender of Last Resort here.
But these programs are going even one step further. The latest intervention, TALF, involves a direct public purchase of the bad assets many of these banks own. That’s a tricky proposition because the Fed could end up holding trillions in assets that are potentially worthless. Now, I doubt these assets are worthless, but that doesn’t mean the Fed won’t run into significant political hurdles as they expand their balance sheet.
We’re entering a new world for monetary policy. And while I think the Fed’s interventions in the banking system are necessary and helpful I don’t think they’ll be enough on their own to turn the economy around.