In Fed We Trust, Sometimes

By Gross, Daniel | Newsweek, December 20, 2010 | Go to article overview

In Fed We Trust, Sometimes


Gross, Daniel, Newsweek


Byline: Daniel Gross

Bad decisions leave little room for faith.

There's an old saw in the investing world: don't fight the Fed. Just as politicians shouldn't square off with people who buy ink by the barrel, investors shouldn't buck the folks who can print endless amounts of dollars. If the Fed says it wants rates to go down, and is prepared to buy bonds to make that happen, the market usually complies.

But not this time. Ever since Federal Reserve chairman Ben Bernanke's announcement in November that the central bank would purchase $600 billion in government bonds in an effort to lower interest rates, politicians, monetary officials, and investors seem to be spoiling for a fight. German Finance Minister Wolfgang Schauble dubbed the policy "clueless." A gaggle of right-wing economists and policy wonks penned an angry letter accusing Bernanke of economic malpractice. The bond markets threw a collective fit, pushing up interest rates in defiance. Some of these attacks are motivated by crass politics. But it's clear now that the Fed no longer possesses the imperium it had in the 1990s because, too frequently, it has been behind the curve.

In the 1990s then-chairman Alan Greenspan was way ahead of economic trends. His reputation was cemented by a critical insight and gamble: advances in globalization, the advent of China into the world trading system, and the telecommunications revolution meant the U.S. could grow at a higher rate without risking inflation. But that was last century. Since then, the Fed's record under Greenspan and Bernanke has been one of overshooting, furious rushes to catch up, and frequent displays of bewilderment.

After several months of a jobless recovery, Greenspan took the federal-funds rate down to 1 percent in 2003 and left it there for 13 months, even as the economy was powering ahead. His lethargy in raising rates allowed the housing bubble to inflate. The Fed similarly dozed through the subprime mess. In May 2007 Bernanke said, "We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system." In November 2007, when a congressman asked if subprime losses could reach $150 billion, Bernanke responded: "That's in the ballpark.

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