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Wall Street Gives Bernacke a Vote of No Confidence

The big news this week is that Federal Reserve interest rate cuts have failed to calm equity markets. The stock market is sending Ben Bernanke a vote of no confidence.

This is really no surprise. The Fed can cut the federal funds rate to zero, and it won’t solve the problems besetting the U.S. economy. As long as Bernanke clings to the idea that interest policies alone will increase consumer and business spending, investor confidence will not be restored.

The Federal Reserve lowers interest rates to create more liquidity and increase spending by making it easier for banks to make loans. However, this requires sound financial institutions and working credit markets.

In the wake of the losses suffered on mortgage-backed securities and other “engineered products” pushed on investors by the large Wall Street banks, bond market investors are no longer willing to purchases securities underwritten by those banks. Wall Street bankers are no longer viewed with the same trust as more soundly run regional banks.

Investors are correct to be cautious. The Wall Street banks and bond rating companies have shown little serious intention to change their business models and create transparent, easily evaluated mortgage-backed and other loan-backed securities, or to change the self dealing inherent in bond underwriters paying rating agencies to evaluate their securities.

With a lower federal funds rate, regional banks can write additional Fannie Mae conforming mortgages but many of the new mortgages are really refinancing existing loans. They can also reset existing adjustable-rate mortgages at more reasonable terms. Neither of the activities appreciably increases liquidity-it’s a holding pattern.

Banks are limited to writing non-conforming mortgages they may finance through deposits, and the Federal Reserve by cutting interest rates may actually erode the deposit base of banks.

Without a fix for the non-conforming loan market, reducing the federal funds rate does not increase liquidity. Monetary policy becomes impotent and cutting interest rates an exercise of limited utility.

Ben Bernanke must confront the Wall Street banks about their business practices and encourage systematic reform. He has shown no serious intention in that direction.

Without bank reforms, equity markets lack confidence in Ben Bernanke’s ability to do his job effectively.

PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.

 

 

 

 

 

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PETER MORICI is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.

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