Financial 'Meltdown Moment': Thomas Palley Suggests a Solution

Everyone paying attention to our current financial mess seems to be scratching their head, wondering just what might get us out. Paul Krugman threw up his hands earlier today. Thomas Palley to the rescue! Palley suggests simply that the Federal Reserve "open its term auction facility to all publicly traded financial intermediaries rather than just deposit taking institutions." Sounds reasonable to me, but I only watch from the sidelines.

I suspect that such a move would have some banks trembling in their boots, since they would have to play on a more level playing field than they are used to. I'm sure that some libertarians will scream, perchance for good reasons, that this is getting us one step closer to dreaded big-brother land. It will be interesting to see if Palley's suggestion garners favorable response, and from whom. To Palley:

Meltdown Moment: What Must be Done: … In today's crisis environment the problem in financial markets is not the level of interest rates, or even the size of the Fed's term auction facility. The problem is getting liquidity to those links in the financial chain that are most stressed. Reliance on the normal channels of distribution does not work when confidence has evaporated and markets have seized-up.

There is a very simple and fair solution to this problem. That solution is for the Federal Reserve to open its term auction facility to all publicly traded financial intermediaries rather than just deposit taking institutions. That means giving access to insurance companies, mortgage investment trusts, mutual funds, and hedge funds. These firms would be subject to the same borrowing terms as banks, and would have to post collateral of identical quality.

Such a change would level the playing field in financial markets and remove the unfair subsidy to banks. Most importantly, it would tackle the problem of credit market seizure that is afflicting all financial institutions. In a world where distinctions between financial intermediaries have become increasingly blurred, broadening access to the term auction facility is the logical and correct policy.

The Federal Reserve's current policy is failing because it is structured for the world of the past in which depository institutions dominated lending. Thus, current policy restricts access to emergency liquidity to deposit taking institutions, ignoring how lending has become detached from deposit taking. The challenge of the day is preventing a meltdown that destroys sound lenders and sound assets. That calls for widening access to temporary emergency liquidity. Afterward, there will be time to visit the question of regulatory reform and more permanent policy change.

Comments

[Cal]

The only solution, as Nouriel Roubini pointed out earlier this week (before Carlyse Capital and Bear Sterns) is for the US Government to take over or essentially nationalize all of the bad debt in the economy (subprime mortgages, commericial paper, auto loans, students loans etc) and perhaps a couple of investment houses too. I know this is the antithesis of free market capitalism....but free market capitalism has created one gigantic mess. Do I hear a flushing toilet????

[man with all the answers]

It is getting very serious out there...but will get worse

the property bubble pops the same time as teh credit bubble oh dear...i think you will find things will slowly crumble.

have a look at this vid for more. http://www.youtube.com/watch?v=8Ze0qjjGA-8