May 14 2008 - Fed Speak Overload

When the roster of Fed speakers in a single day stretches past five, you know you are in for a real treat of undecided commentary.  That was the case Tuesday when eight members of the Federal Reserve Board took to podiums around the country to speak in an official capacity. 

The Lineup

Two members - Fed Governor Warsh and Philadelphia Fed President Plosser - served as moderators of panel discussions while five other members - Fed Chairman Bernanke, Cleveland Fed President Pianalto, San Francisco Fed President Yellen, Kansas City Fed President Hoenig and Dallas Fed President Fisher - delivered actual speeches that touched on the topics of liquidity measures, monetary policy and the economic outlook (Chicago Fed President Evans was due to speak Tuesday night).

A Familiar Tune

By and large, most of the remarks in these speeches weren't seen as breaking any new ground.  There was the requisite concern about inflation pressures, the reminder that the housing market remained a key risk in terms of the growth outlook, the thinking that the stimulus plan should help boost growth in the second half, and an acknowledgment that conditions in the financial markets are still far from normal.

The latter was heard in Fed Chairman Bernanke's speech, which focused on liquidity measures. 

Anyone who works in the financial markets would tell you that Bernanke's observation wasn't a mind-blowing one.  Credit spreads, while improved, still reflect conditions that are less than ideal. 

Spreading the News

One such measure known as the TED spread, which is the difference between the 3-month Treasury bill and 3-month LIBOR, stood at 85 basis points.  In a more normal environment that spread is in the neighborhood of 10 to 50 basis points.  However, it would be remiss not to add that the 85 basis point spread is a marked improvement from the 204 basis point spread seen shortly after the Bear Stearns bailout in March.

The understanding that the spread has contracted in the way that it has speaks to the calming influence of the Fed's efforts to boost liquidity through a series of innovative policy actions that include the Term Auction Facility, the Term Securities Lending Facility and the Primary Dealer Credit Facility.

In his speech Bernanke noted that the Fed stands ready to boost the size of its auctions if warranted by financial developments.  Based on the Fed's actions thus far, there was no surprise in that admission.

Remembering the Past

Bernanke's remarks provided a sobering reminder that it would be a mistake to grow complacent on the credit market situation due simply to recent improvements in credit spreads. 

Remember, we are in an environment where the worst of the market's fears have been tempered, yet as seen in the TED spread, we're not back to normal.

Bernanke wanted to make this point clear, as well as the point that it will most likely take more supervision and regulation of financial institutions to tackle the problem of moral hazard that always arises when the Fed is acting outside the scope of normal operations.

The stepped up supervision and regulation would presumably reduce the likelihood of the Fed being in the position of having to implement emergency measures to guard against a systemic risk.  It is a virtuous idea, but come to think of it, wasn't that supposed to be the ideal in the wake of Long-Term Capital Management?

There will undoubtedly be more supervision and regulation of financial institutions following the credit mess of 2007 and 2008.  However, when conditions return to normal, and eventually tip to better than normal, you can bet there will be increased calls for reduced regulation in an effort to maximize profit potential. 

Those calls will likely be heeded, and just as we'll see a thriving subprime mortgage business again some day, we'll also see the Fed wrangling again with a systemic risk. History and human nature all but assure it.

--Patrick J. O'Hare, Briefing.com