1. Monetary Policy: Contemporary Issues - I
ECO Dr. Dennis Foster
W.A. Franke College of Business

2. Monetary Policy: Contemporary Issues
Heading into crisis II
The bank failures
III
Fed inaction & action IV
What has the Fed accomplished? V
The problem with policy VI
The Austrians & rethinking policy

3. What does the Fed Want?
A healthy & strong economy with low unemployment and low inflation.
I. Heading into crisis
Policy? Stimulate spending by reducing interest rates.
Why? They are Keynesians.
Effect? Creates housing boom.

4. Federal Funds rate of interest, 1995 to 2004

5. Median home prices, 1999 to 2006

6. Home sales, 1999 to 2006
Sept. 2005

7. The Bear Stearns Story $133.20 - 52 week high prior to collapse.
Lost billions in collapsing subprime market; slowly recovering.
March Assets/equity = 35
Lots of assets in MBS.
Spring Clients pulling out funds.
3/10/08 - Turned down for $2 b. loan
Continued loss of confidence in Bear all week.
3/13/08 – Cash  from $10 b. to $2 b.
II. The bank failures
$400 b.
Assets

8. The Bear Stearns Story Tried to get LOC w/JPM for $25 b.
3/14/08 – Fed lends $13 b. for 3 days.
JP Morgan deal - $2 per share!
Fed creates Maiden Lane LLC
Fed loans ML $30 b.
JPM “sells” bad assets to ML.
3/24/08 - New stock deal - $10/share.
Cost to the Fed?
Was Bear TBTF? Yes!
What about Lehman?

9. The Three Failures: IndyMac WaMu Lehman
Spun off from Countrywide.
Not a “mac”
Overleveraged on “Alt A” loans.
WaMu
Shut down 100’s of offices
Sub-prime victim.
Final 10 days lost $17 b. in cash w/d
Lehman Brothers
Losses = $7 b. in Q2 & Q3
Final day: $1 b. in cash
$32 b.
Assets
$300 b.
Assets
$640 b.
Assets

10. Stock prices collapse for IndyMac WaMu Lehman Bros.
18 months

11. Stock prices collapse for IndyMac WaMu Lehman Bros.
12 months

12. Stock prices collapse for IndyMac WaMu Lehman Bros.
8 months

13. Did the Fed see this coming?
"At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."
-March 2007
"It is not the responsibility of the Federal Reserve – nor would it be appropriate – to protect lenders and investors from the consequences of their financial decisions."
-October 2007
"House prices have risen by nearly 25 percent over the past two years… [T]hese price increases largely reflect strong economic fundamentals."
-October 2005
"We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize…”
-July 2005
"The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."
-June 2008
"The Federal Reserve is not currently forecasting a recession."
-January 2008
III. Fed inaction & action

14. What did the Fed do? Quantitative Easing. Raise the money supply
Buy Treasuries.
Buy MBS.
Boost short term lending.
Raise the money supply
Lower interest rates.
"One myth that’s out there is that what we’re doing is printing money. We’re not printing money."
-December 2010

15. Monetary Policy: Contemporary Issues
ECO Dr. Dennis Foster
W.A. Franke College of Business