Credit Tightening? Please!

Another useless article about potential Fed Credit tightening.

http://online.wsj.com/article/SB20001424052748703427704575051442884515742.html

I sure hope the Fed doesn't raise the interest rate on excess reserves.

"Federal Reserve Chairman Ben Bernanke will begin this week to lay out a blueprint for a credit tightening, to be followed once the Fed decides the economy has recovered sufficiently."

Recovered sufficiently? When is that? Some time in 2020?

"When the Fed is ready to tap the brakes, it plans to raise the rate paid on excess reserves, according to Fed officials in interviews and recent speeches. The higher rate would entice banks to tie up money they otherwise might lend to customers or other banks."

Do these guys actually live in the real world? There is no lending happening currently, because there is no loan demand. Many Americans are in a secular deleveraging cycle. Small Business hiring is very weak so even though the demand for small business loans is somewhat strong, banks don't want to lend to them because employment trends continue to be weak. All this would accomplish nothing except to further pad the coffers of the banks where the excess reserves are being held. Don't these smart guys at the Fed know or realize this? Don't they get monthly or quarterly updates on the state of lending?

This would raise the cost of credit as other short rates will also move higher.

"In response to the worst financial crisis in decades, the Fed took extraordinary action to prevent an even deeper recession -- pushing short-term interest rates to zero and printing trillions of dollars to lower long-term rates. Extricating itself from these actions will require both skill and luck: If the Fed moves too fast, it could provoke a new economic downturn; if it waits too long, it could unleash inflation, and if it moves clumsily it could unsettle markets in ways that disrupt the nascent economic recovery. Mr. Bernanke and his colleagues are attempting to explain -- both to markets and the public -- that the Fed has an exit strategy in the works in order to bolster confidence in its ability to steer the economy."

Pot to Kettle: There is no exit strategy. Every exit strategy that the Fed has done so far has not succeeded. Reverse Repo's failed because Banks and Primary Dealers couldn't complete deals. This is because the collateral the banks were using or trying to peddle back to other counterparties were of weak quality.

The only reasons why the credit system has not completely keeled over is because:

1-The Fed printed money to monetize bad debt in the credit system
2-Mark To Market Rules were relaxed and in some cases suspended.
3-The Fed has printed trillions so that banks can just refinance there bad loans.

There is over a trillion dollars in excess reserves in the banking system. These reserves are basically holding the economy afloat.

The Fed is looking for inflation in all of the wrong places. There is artificial inflation in current asset prices, But real inflation everywhere else.

"In the past, it simply raised its target for the federal-funds rate on banks' overnight borrowing. That rippled through to other rates. The Fed steers the fed-funds rate, which has been near zero since late 2008, by buying and selling securities to influence the supply of money in this market. Because it has put so much money in the banking system, the Fed expects to find it hard to control the fed-funds rate with traditional approaches. Hence the search for alternatives."

This is wrong. The Fed knows they cant raise the Fed Funds or Discount Rate in the near future,this would automatically cause major dislocations as many of the same knuckle heads that ruined the system or heavily leveraged to ZIRP this time around.

So they are looking at other areas. The excess reserve solution is an exercise in futility. It will only make the banks richer and screw up the lending environment far worse then it is now.

We have not even spoken about how the Fed is going to extricate themselves from the US Housing Market. They are right at the $1.25T limit ceiling at the moment, but every MBS they buy are older/higher coupon MBS, which tend to pay back faster over time, this phenomena is called negative convexity, so as these securities pay down principle faster, the Fed is left with smaller pieces of MBS on their balance sheet. This inherently is deflationary is it not? Why do need more QE, when the Fed can just pump the prepays back into the economy?

Its a total cluster*$%* at the moment.