Saturday, November 29, 2008
The Fed has engaged on a path of “quantitative easing” (defined in Part II of this report), which has only been tried by Japan, where it was met with limited success. Success rests on the hopeful, but possibly flawed, assumption that cheap money will lead to renewed borrowing.
Understanding the mechanism and implications of this requires an appreciation of the credit markets, what they are, and how they operate. In Part I we discuss the credit markets and the extent to which the government is now a credit market participant. In Part II we examine the Fed’s chosen strategy of fighting the collapse in lending activity with the tool of quantitative easing, and what this could mean for you.
Often, the present financial crisis is misrepresented in the media as being one of bad loans dragging down the balance sheets of unlucky banks. Justification (or political rationalization) for the extravagant loans and outright gifts to the major banks rests on the false implication that if their past losses were covered, then “normal” bank lending would resume, and all would be well again. Insofar as this is a regretfully incomplete view, it is false.