Fall of the Stock Markets: Mr. Bernanke Is Disenchanted

The Fed braces the budget with half a trillion dollars — and rates take a tumble anyway. The reaction of the markets attest that confidence in the once most powerful bank in the world is sinking, and only one thing can contain the crisis: politics.

Impartial observers may have been puzzled on Thursday morning: The American Federal Reserve attempts to brace the budget with a further $400 billion and prevent a fall into recession. However, the investors in the world markets are not pleased about the gift; to the contrary: They flee from anything that appears to be a risk — the stock prices take a tumble. How can that be explained?

The severe reaction has two discernible causes. First, the Fed has visibly darkened its economic outlook. For the first time there is talk of “significant” risks for a further worsening of the situation in the explanation of the open market committee. These risks lay outside of the grasp of the Fed, namely in Athens, Brussels and Berlin. The fear that the debt crisis in Europe will also infect America and the rest of the world is meanwhile large, and the Fed made this manifest on Wednesday, without having to have mentioned the word “Europe.”

The second cause lies in the small print of “Operation Twist.” This operation — the core of the most recent Fed decision — entails the Federal Reserve’s purchase of $400 billion in long-term bonds by June 2012 and the sale of the same amount of short-term bonds. The desired effect is that the difference in interest rate between the one-year and thirty-year bonds will shrink. Thereby credit will be cheaper for home-buyers and businessmen, but it will be more difficult for banks to earn money on these credits. Pension funds and wholesale investors will find it difficult to keep promises to their customers. Therefore financiers were hardest hit by the selling wave in the stock markets.

Still one further point is important. The Fed decided to invest future yields that they obtain from their mortgage bonds in new mortgages again. They are thereby massively bracing the American housing market and thus admitting that the market — four years after the bursting of the real estate bubble — is still in a desolate condition. The action helps homeowners, but hurts the banks that can earn less money with mortgages.

All in all, the Fed has followed the course of its chairman, Ben Bernanke: Facing danger, it is still better to do something than sit around idle, even if this something only promises modest successes. It has become clear that the monetary policy has come to its limits, even then, when it resorts to unconventional and controversial means. Interest rates cannot sink below zero percent and the closer they come to the zero point, the less the effect of a further marginal decrease.

The Fed is Disenchanted

One consequence is that the Fed is disenchanted, and confidence in the most important Federal Reserve in the world is sinking. Not to be underestimated is that it is increasingly pulled into political turf wars. The entire top leadership of the Republican Party asked Bernanke in an open letter to not further relax monetary policy. An unprecedented occurrence that not only shows how controversial the course of the matter is, but also how much respect the Fed as an independent institution has lost with the American right.

The crisis remains highly dangerous, as the IMF wrote in its economic outlook. It cannot be defused by means of monetary policy, but rather only there where it originated: in politics. Three years ago, in the fall of 2008, the finance ministers and Federal Reserve chairmen of the seven big industrialized nations succeeded in containing the crisis at that time on the sidelines of the IMF meeting in Washington. This weekend the IMF meets again — and the expectations are accordingly high that the politicians will succeed once again.