Food, fuel, and $/import prices present a triple negative supply shock.

Now gold pushing $900 as LIBOR falls, commercial paper issuance increases, and ‘market function risk’ subsides.

Downside risks to GDP are still not trivial.

Consumer income and desire to spend it may be problematic, and banks and other lenders may further tighten borrowing requirements.

And weaker overseas demand may cool US exports.

Yes, the Fed knows and fears demand MAY weaken, and forecasts lower inflation as a consequence.

But inflation is the clear and present danger, vs an economy that may weaken further

And mainstream economic theory says the cost of bringing down inflation once the inflation cat is out of the bag is far higher than
any near term loss of output incurred in keeping inflation low in the first place.

And the Fed addresses its dual mandate of low inflation and low unemployment with mainstream theory that concludes low inflation is a necessary condition for optimal employment and growth over the long term.


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4 Responses

  1. What if Countrywide almost did declare bankruptcy?

    Currently Bernanke’s mission to keep the financial sector sound overrides his need to control inflation.

    How would the bankruptcy come about?

    1) Perhaps a large bond issue came due which is unrollable? Next I see is 5/21/2008.
    2) Perhaps a surprise Fed audit? Wouldn’t that just scare other banks from the TAF?

    I don’t think solvency issues will reveal themselves until after the TAF’s end. The Fed will know before they end. When they end, ouch!

  2. Bankruptcy would likely result in a loss of value for the shareholders and new ownership of the assets by someone who wanted to stay in the business. The outstanding debt would most likely be honored, and, even if liquidated, trade reasonably close to current values.

    There notion of ‘scare other banks from the taf’ isn’t applicable as the taf is banks borrowing from the fed independently.

    Unless countrywide’s bank is dependent on the taf for its own funding the end of the taf wouldn’t matter. they would still have the discount rate.

    insolvency for a bank happens when the fed decides its capital ratio is insufficient.

  3. “There notion of ’scare other banks from the taf’ isn’t applicable as the taf is banks borrowing from the fed independently.”

    …and the borrowers identity is hidden from the public. Yet there might be information for the Fed to determine who should be audited, if it was so inclined, in the list of TAF bidders, no?

    “Will the Federal Reserve release information about individual Bids or Participants?

    The data on Bids of individual Participants or of Participants will not be made public,
    except as required by law”

    ……also sounds like Bush/Paulson/Bernanke meeting was productive after all.

    “Noncompetitive Bids
    Noncompetitive Bids may be accepted beginning with the third TAF Auction as
    determined by the Chairman of the Board of Governors. In the event noncompetitive
    Bids are permitted, information and procedures for noncompetitive bidding will be
    announced prior to the date noncompetitive Bids may be submitted in an Auction.”

    http://www.federalreserve.gov/monetarypolicy/files/TAFfaqs.pdf

  4. “. The outstanding debt would most likely be honored, and, even if liquidated, trade reasonably close to current values.”

    Well that bet paid off quite nicely.

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