21 Dec A Zero Economy

President and CEO of the Philadelphia FRB Charles Plosser hits the nail on the head in his column in Mortgage Orb when he points out that Fed policy is weakening the U.S. economy. He runs through the litany of measures, “liquidity” provision, quantitative easing, asset purchase and maturity extension programs, and finds they all come up short.

In reality, these were nothing but workouts for the Fed’s client institutions and their key counter-parties, who were bankrupt. They do nothing for our zero economy. The Fed has no understanding of or responsibility for credit, no levers to grow the economy.

The crisis and follow-on recession have “tested our resolve, our patience and our economic theories,” Plosser says. Especially our theories. It is time to admit our theories are wrong and accept that financial permissiveness does nothing but undermine the credit benchmarking function,which is broken. Big firms can borrow at 0% (or negative real interest rates) and growing firms cannot borrow at all. There is little in-between. Without reliable credit benchmarks, we can’t price loan assets.

Until we have a well-functioning, modern rating system that levels the information asymmetries and encourages credit granters to price for business and operational risk–not sucker risk–our credit markets will remain in shambles and our recovery prospects anemic.