Economic Dreams - Economic Nightmares

Fed to Consider Preventative Medicine re: Asset Bubbles

I have never understood the unwavering reluctance by the Fed to lean against emerging asset bubbles. Now — in the wake of the worst financial mess since the Great Depression— it looks like that reluctance is disappearing:

Bernanke Weighs Limiting Consolidation, Asset Bubbles, Craig Torres: Oct. 15 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the central bank will consider discarding its long- standing aversion to interfering with asset-price bubbles and warned that the banking business may be concentrated in too few companies.

Officials should review how supervision and interest rates can minimize the "dangerous phenomenon" of bubbles in housing, stocks and other assets that risk bringing the financial system and economy down with them when they burst, Bernanke said.

"There is no doubt that as we emerge from the current crisis that we are all going to look very hard at that issue and what can be done about it," he told the Economic Club of New York in his broadest remarks on future regulatory changes since the credit crisis deepened last month.

The comments signal that the 54-year-old chairman, while trying to quell the worst market turmoil since the 1930s, is crafting an agenda for greater oversight. Policy makers will toughen their response to "excessive leverage," give more weight to financial stability in economic analysis and examine ways to strengthen the system of trading and settlement behind complex derivative securities, he said.

The U.S. faces "a very serious too-big-to-fail problem," in which the insolvency of a large financial company could threaten a market collapse, Bernanke said in reply to an audience question. "There are too many firms that are in some sense systemically critical." …

James Galbraith on the 'Collapse of Monetarism'

Hyman Minsky, John Kenneth Galbraith and John Maynard Keynes take center stage as James Galbraith throws down the gauntlet to contemporary mainstream economists. Speaking at the 25th Annual Milton Friedman Distinguished Lecture at Marietta College, Marietta, Ohio, Jamie Galbraith asks Fed Chair Ben Bernanke and a host of others to embrace the " intellectual victory of John Maynard Keynes, of John Kenneth Galbraith, of Hyman Minsky." — else to explain "why not". We will search and update on any "why nots" if and when they surface. To Galbraith:

The Collapse of Monetarism and the Irrelevance of the New Monetary Consensus [PDF], by James K. Galbraith, March 31, 2008 : … I come to bury Milton [Friedman], not to praise him. But I would like to do so on the terrain that he favored, where he was strong, and over which he ruled for many decades. This is monetary policy, monetarism, the natural rate of unemployment and the priority of fighting inflation over fighting unemployment. It is here that Friedman had his largest practical impact and also his greatest intellectual success. It was on this battleground that he beat out the entire Keynesian establishment of the 1960s, stuck as they were on a stable Phillips Curve. It was here that he set the stage for the counter-revolution that has dominated academic macroeconomics for a generation, and that – far more important — also dominated and continues to influence the way in which most people think about monetary policy and the fight against inflation.

What was monetarism? Friedman famously defined it as the proposition that "inflation is everywhere and always a monetary phenomenon." This meant that money and prices were tied together. But more than that, Friedman believed that money was a policy variable — a quantity that the Central Bank could create or destroy at will. Create too much, there would be inflation. Create too little, and the economy might collapse. There followed from this that the right amount would generate the right result: stable prices at what Friedman came to call the natural rate of unemployment.

The intent and effect of this line of reasoning was to defend a core proposition about capitalism: that free and unfettered markets are intrinsically stable. In Friedman's gospels government is the lone serpent in Eden, while the task of policy is to stay out of the way. Just as this was the vulgar lesson of "Free to Choose" so it turns out it was also the deep lesson of the larger structure of Friedman's thought. Friedman and Schwartz's Monetary History for all its facts and statistics carried a simple message: the market did not fail; the government did.

Friedman succeeded because his work was complex enough to lend an aspect of scientific achievement to his ideas, and because the ideas played to the preconceptions of a particular circle. As Keynes wrote of Ricardo:"The completeness of [his] victory is something of a curiosity and a mystery. It must have been due to a complex of suitabilities in the doctrine to the environment into which it was projected. That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, I suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain much social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely…to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority."

Friedman's success was similar to Ricardo's but not in all respects. Yes he also explained away injustice and supported authority. But the logical superstructure was not vast and consistent. Rather Friedman's argument was maddeningly simple, yet slippery. He would appeal to short run for some effects and to the long run for others, shifting between them as it suited him. … His money growth rules promised stable employment without inflation. Their promise was not austere, but happy. Ricardo was Scrooge. Friedman was more like the Pied Piper.

Short take on MuCulley at the Hyman Minsky Conference

I've been meaning to post up a cut-down version Paul McCulley's recent assessment of our current plight: "Reverse Minsky Moment" interview with Kathryn M. Welling, but haven't yet. So yesterday I was glad to see Floyd Norris do a spot on McCulley's talk at the Hyman Minsky Conference for the NY times, titled Ponzi Squared:

… Minsky argued there were three levels of investment as the cycle progresses. First comes hedging, in which investments are made to reduce risk. Then comes the speculative phase, and finally the Ponzi phase, in which the investment can be justified only by the assumption that prices will keep rising, not by the expected income.

Paul McCulley of Pimco, the big bond manager, gave an interesting speech in which he said the recent subprime mortgage fiasco proceeded to a fourth level — one that he called "Ponzi-squared" — before it collapsed.

At the end, he said, the marginal subprime loan was:

No money down
No documentation of income
Initial below-market teaser interest rate
Negative amortization

That is not a loan, he said. Instead, it amounted to giving the home buyer a call option to buy the house at the current market price, coupled with a put option to sell the house back at that price.

If house prices kept rising, the "buyer" could make the small interest payments to keep the option open, and eventually sell the house. That happened for a time, and led to the conclusion by rating agencies that such borrowers were good risks.

But when prices went down, the "buyer" would suffer no loss if he exercised the put and gave the house to the lender. That is just what happened.

As Paul Simon wrote in 1975, said Mr. McCulley, the strategy became:

Drop off the key, Lee,
And set yourself free.

Here is the written version of McCulley's April 17 talk at the Minsky Conference. Oddly, the "Drop off the Key" remarks are not included, although they are in the longer, Welling-McCulley rendition above. Some tidbits:

… [I]n what I call a "Reverse Minsky Journey" … Ponzi Units evaporate. Then many Speculative Units morph into Ponzi Units and are shot. Surviving Speculative Units are only those with explicit liquidity support from banks, who have explicit liquidity support from the Federal Reserve. Hedge Units, of course, remain standing tall, fundamentally sound, though cheaper in price, providing an excellent long-term buying opportunity.

This has been precisely the process in place since almost a year ago, and particularly since last August, when the shadow banking system — defined as any levered lender who does not have access to (1) deposit insurance and/or (2) the Fed’s discount window — experienced a modern-day run, with asset-backed commercial paper holders refusing to roll over their paper. It has not been fun. It has not been pretty. And it is not over.

Along the way, policy makers have slowly recognized the Minsky Moment followed by the unfolding Reverse Minsky Journey. But I want to emphasize "slowly," as policy makers, collectively, still suffer from more than a thermos full of denial. Part of the reason is human nature: to acknowledge a Reverse Minsky Journey, it is first necessary to acknowledge a preceding Forward Minsky Journey — a bubble in asset and debt prices — as the marginal unit of debt creation morphed from Hedge to Speculative to Ponzi.

That is difficult for policy makers to do, especially ones who claim an inability to recognize bubbles while they are forming and, therefore, don’t believe that prophylactic action against them is appropriate. Nobody likes to admit they were blind, dumb, or asleep at the switch. Or all three. …

That's not to say that Minsky had confidence that regulators could stay out in front of short-term profit-driven innovation in financial arrangements. Indeed, he believed precisely the opposite:

"In a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always outpace regulators; the authorities cannot prevent changes in the structure of portfolios from occurring. What they can do is keep the asset-equity ratio of banks within bounds by setting equity-absorption ratios for various types of assets. If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy."

Minsky wrote those words in 1986! Twenty-two years later, we can only bemoan that his sensible counsel was ignored. …

Minsky's insight that financial capitalism is inherently and endogenously given to bubbles and busts is not just right, but spectacularly right. And when the financial regulators are not only asleep but actively cheerleading financial innovation outside their direct purview, a disaster is in the making, as the last year has taught us. We have much to learn and relearn from the great man as we collectively restore prudential common sense to bank regulation — both for conventional banks and shadow banks.

Cecchetti on Recent Fed Policy Changes

(Via David Beckworth at Macro and Other Market Musings, April 11:

Previously I discussed how much of what you learned in your money and banking class is now outdated given the many policy innovations by the Federal Reserve since last summer. Stephen Cecchetti now has a nice summary of these innovations that can be found here (shorter version) or here (longer version). Read these updates and you will be current on the workings of the Federal Reserve.

I too find Cecchetti to be a good go-to source on where things stand and where we may be heading—barring bad politics, too-intense lobby pressures, and host of other interferences that seem to get in the way of "Economics Dreams".

Speaking of Money and Banking "learning" being outdated, consider this from Kevin Quinn at Econospeak, April 9

It is scandalous that nowhere in what passes for mainstream macroeconomics will you find anything that helps you understand what Hyman Minsky called "financial fragility" - the inherent instability of the credit system - and the implications for the real economy. No models - nothing!! - Nothing in a macroeconomics textbook that would aid in understanding the current crisis, and countless previous cises in the history of capitalism….

Butier Responds to Greenspan's Latest Attempt to Rewrite History

{Updated, April 9}
At maverecon Willem Butier counters Alan Greenspan's latest claim the he and the US Fed not be held responsible, in large part, for our current mess. Butier's eight policy "tragedies":

1. The Greenspan Fed (August 1987 - January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
2. The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
3. The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
4. The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
5. The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
6. The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
7. The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
8. During his years as Chairman of the Federal Reserve Board, Mr. Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan's theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08.

Butier elaborates on each. We will bring forward only one, dealing with possibilities for moral hazard. But before we do, I just found Martin Wolf's counter-balancing position, Ft.com, April 8, still praising Greenspan, while fearing that over-zealous regulatory reform spaned by a Greenspan "blame game" will kill the "good" that free-er (my word, Wolf uses "free) market mechanisms bring. Whereas Butier lists eight "tragedies" of Fed policy/practice, Wolf highlights two: (1) regulators should have been "tougher", in subprime and elsewhere, and (2) monetary policy should have been tigher, not looser — to lean against prevailing winds of excess instead of leaning with them.

David Beckworth, via Macro and Other Musings, adds insight into why Butier's critique is on target:

… [T]he Federal Reserve is a monetary hegemon. It holds the world's main reserve currency and many emerging markets are pegged to dollar. Thus, it's monetary policy is exported across the globe. This means that the ECB, even though the Euro officially floats, has to be mindful of U.S. monetary policy lest its currency becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. The Fed's loosening, therefore, of monetary policy in the early-to-mid 2000s triggered a global liquidity glut that set the stage the subsequent housing boom-bust cycle. This is not to say the 'saving glut' and financial innovation had no role, but rather that loose monetary policy was a key factor behind the boom. …

Back To Butier:

The Greenspan Fed: a tragedy of errors, Willem Butier, maverecon:Financial Times, April 8: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince. …

Everyone Hates Treasury Secretary Paulson's Reform Proposal

{Updated April 1, 2}

Ok. Some are cheering, if softly. But not among folks I read regularly. Clearly Robert Reich hates Secretary Paulson's self-proclaimed reform proposal, concluding: "Hank Paulson's discussion paper – it's not even meant to be enacted under the Bush Administration – is not broad, it's not an overhaul, and heaven forbid, if we're facing another Great Depression, it will do absolutely zilch to head it off."

More dissent:
Not "Calculated Risk" or Paul Krugman.
Not Clive Crook
Not Willem Buiter
Not Barry Ritholtz or Michael Mandel

Last but not least:

Stephen Cecchetti, soon to be Economic Advisor to the Bank of International Settlements, in a 19 min. Bloomberg audio podcast with Tom Keene says "Paulson Proposal isn't right first move". Included are good insights into much-needed regulatory reform, particularly w/r/t leverage and the troubling phenomenon of investment banks, hedge funds etc. moving where-ever around the world to avoid any specific country's regulatory requirements.

A few tidbits from Crook:

The new Treasury blueprint for reforming financial regulation is not really a blueprint at all. (The full document is here; or see a Treasury summary of it here.) It says some sensible things and has some good ideas, but for the most part it is an agenda for discussion rather than a detailed plan. Given that the Treasury has been working on this thing at least since March 2007, it is surprisingly thin.

Moreover, it is concerned exclusively with the structure of the regulatory system. I think that getting this right is more important than Paul Krugman does—he calls this the Dilbert strategy—but Paul is surely right to complain that a better structure will get you only so far. It is a question of form and content. What the rules say matters more than which regulators are responsible for enforcing them, and the so-called blueprint does not go into that. …

At least there is some agreement that "Something should be done." Duh! AND: It's about time. But 'not yet', of course it's an election year! Next year the excuse will be something else.

Here is CNNMoney Good plan, bad plan - Reaction to Paulson, demonstrating that mainstream media will always find opposing views, no matter how far and wide the search.

Still, I'm a wee bit hopeful, as is Paul McCulley, that we may at least avoid a Depression and get some needed financial regulatory reform as well—but it will take time and much deliberation, and perchance more pain felt by stock and bond fund holders as well as by taxpapers in general. Here's Paul McCulley's latest perspective [PDF] on the general financial/economic landscape—not specifically on Paulson's proposal. I think McCulley nails it! What do others think?

Fed's 'Historic Steps' into Uncharted Waters

Unless I'm mistaken, the Fed just took a first step toward Thomas Palley's suggested solution to our current mess:

Central Bank Offers Loans To Brokers … Historic Steps, Greg IP, WSJ, March 17: … It took a unanimous vote by the Fed's five governors yesterday to invoke a Depression-era clause in the Federal Reserve Act to waive the usual prohibition on Fed loans to nonbanks. A Fed official told reporters today's circumstances couldn't have been envisioned when the Fed was created, and noted newer central banks like Europe's have many of these powers. But these steps also take the central bank into uncharted territory with new and potentially troublesome risks.

Those risks include the possibility that with the credit crunch showing no sign of lifting, the Fed will be called on to lend to other troubled firms and end up a major creditor of Wall Street, even if at present the risk of any substantial loss appears small. Another risk is that while the Fed used a loophole yesterday in the Federal Reserve Act to expand its lending to nonbanks in "unusual and exigent" circumstances, it has in effect expanded the federal safety net with no political debate. However, the Fed sought and received agreement over the $30 billion loan from Treasury Secretary Henry Paulson, who informed President Bush.

Bigger Test

For now, though, the bigger test will be how the markets greet the initiatives today: with relief at the bold steps taken to shore up the financial system, or with alarm at how unstable the financial system had to be to invite such action.

Officials appear to hope the initiatives will restore enough confidence to markets to allow a smaller rather than larger rate cut tomorrow, but they acknowledge it will depend partly on how markets evolve over coming days.

On Wall Street, there is likely to be some relief that the Fed has finally opened the discount window to securities dealers, something they have long clamored for. The Fed has been reluctant because the move was outside its explicit mandate. "This is a five-vodka event," said a senior executive at one big brokerage firm that previously didn't have access to this funding source. "Liquidity is no longer an issue."

Federal Reserve Bank of New York President Timothy Geithner told reporters: "This is designed to help get liquidity to where it can help play an appropriate role in helping address the range of challenges" in the markets, especially in the mortgage-backed securities market.

Mr. Paulson said in a statement, "I appreciate the additional actions taken this evening by the Federal Reserve to enhance the stability, liquidity and orderliness of our markets."

For all their creativity, the Fed moves are also an acknowledgment that its previous steps have failed to stem the collapse in investor confidence, forcing it to abandon many of its original principles, such as not favoring particular firms or market sectors and sticking within its explicit statutory authority.

Last Tuesday, it announced what Wall Street called its most creative initiative yet: It lent up to $200 billion of its much-sought Treasurys to investment banks starting March 27 in return for a like amount of now-shunned mortgage backed securities for up to 28 days. The announcement led to a huge rally in stocks. But within days dealers were telling the Fed it didn't go far enough. They wanted longer term, more immediate funding against a broader range of collateral.

It also came too late to save Bear Stearns. On Thursday evening, Bear Stearns informed the Securities and Exchange Commission and Fed that it had experienced a dramatic loss of cash reserves and now saw no option other than to file for bankruptcy protection Friday morning. Fed officials at that point saw just two options. They could try to wall off the rest of the financial system. If the environment had been less tumultuous they might have chosen that option.

But in the current period they feared that a failure by Bear to make good on billions of dollars of contracts could severely dislocate critical markets, especially garden-variety repo loans -- overnight loans secured by various collateral that are the grease of the credit markets.

Too Interconnected

Officials grimly concluded that while Bear Stearns wasn't too big to fail, it was too interconnected to be allowed to fail in just one day. They spent Thursday night going over Bear's books and huddling with the SEC and Treasury. By Friday morning it had settled on its second option: a 28-day secured loan via J.P. Morgan to give time for a sale or wind up of the firm.…

Krugman: Fed Lacks Tools to Deal with Crisis

Paul Krugman says Nouriel Roubini was right: We are in the worst financial crisis since the Great Depression. AND, The Fed probably lacks the tools to deal with it. Then Krugman muses, "Who ya gonna call?", The White House? Greenspan? To Krugman:

Who ya gonna call? Paul Krugman, March 17:

Um, on second thought

Nouriel is right: this is the worst financial crisis since the Great Depression, and the Fed, with the best will in the world, probably lacks the tools to deal with it. Broader action is necessary.

But then comes the question: who ya gonna call?

The Gang That Couldn't think Straight still holds the White House; no good ideas will come from that quarter. Worse, Incurious George would probably veto any sensible plan from Congress, even if said plan could get past a filibuster.

Hey, here's an idea! Let's create a nonpartisan expert commission, headed by Alan Gr …. oh, wait. He's part of the problem. In fact, is there any way we can repossess his book royalties?

Seriously, it's very hard to see who can take charge.

Things fall apart, and the center doesn't exist.

PS. Most of what I dig up and find "most interesting to share", I now distribute via Google Reader on my Econ Dreams - Nightmares sidebar.

US Fed Caught Between Rock and Hard Place

At Economist's View, Tim Duy tries to sort out Bernanke and Co.'s next moves. In short the Fed risks a dollar collapse on one horn of its dilemma and a systemic banking crisis on the other. Which path will they choose? Or is there some way to steer clear of a near-term-future in which the ever-vocal, times-past market cheerleader Alan Greenspan says we will see many banks failing (Financial Times, March 17). Here's Duy:

Fed Watch: Anything and Everything is On The Table, Tim Duy, March 17: … [P]olicy may soon be dangerously close to the having to choose between a collapse of the Dollar and a more generalized banking crisis. Another description of this tradeoff comes from Fed Chairman Ben Bernanke in a 1995 paper, The Macroeconomics of the Great Depression: A Comparative Approach:

A particularly destabilizing aspect of this process was the tendency of fears about the soundness of banks and expectations of exchange-rate devaluation to reinforce each other (Bernanke and James 1991; Temin 1993). An element that the two types of crises had in common was the so-called "hot money," short-term deposits held by foreigners in domestic banks. On one hand, expectations of devaluation induced outflows of the hot-money deposits (as well as flight by domestic depositors), which threatened to trigger general bank runs. On the other hand, a fall in confidence in a domestic banking system (arising, for example, from the failure of a major bank) often led to a flight of short-term capital from the country, draining international reserves and threatening convertibility. Other than abandoning the parity altogether, central banks could do little in the face of combined banking and exchange-rate crises, as the former seemed to demand easy money policies while the latter required monetary tightening.

To be sure, Bernanke is describing the Fed's tradeoff during the Great Depression, when it was constrained by gold standard. Still, the basic problem remains. Tight policy would accelerate and intensify the pain in the banking system, but loose policy could destabilize the Dollar, causing capital to flee the US and also undermining the banking system. And, to make matters worse, a collapse in the banking system due to tight money could then trigger a currency collapse.

I think it is safe to describe this as a no-win situation, which means an ugly choice has to be made. And, with this in mind, perhaps the Fed only offered 25bp on the discount rate in hopes they could avoid a greater than 25bp cut in the Fed Funds rates. At this point, that does not look like an acceptable domestic policy choice, and if they ultimate cut 50bp or more, they have accepted the risk of destabilizing the Dollar.

I have to imagine that global central banks are ready to intervene at the drop of a hat, and would not be surprised by some action when New York opens Monday. If there is an intervention, it will be interesting to see if the Fed participates. Could the Fed credibly buy the Dollar one day while cutting rates 75bp or more the next? And what are the odds of a successful intervention if the monetization option looks increasingly viable in the weeks ahead?

[N]othing but tough policy questions at this juncture. …

Bottom Line: An aggressive cut in the Fed Funds rate seems likely, with 100bp certainly on the table. Still, one has to ponder why this was not part of the Sunday policy package. Could it really be as simple as not being able to contact enough FOMC members to have a teleconference? Or was it hope that a bigger than 25bp Fed Funds rate cut might not actually be necessary? Or has the Fed come to believe that their policy actions might trigger a destabilizing fall in the Dollar? At this point, I anticipate a cut larger than 50bp, with even odds on 75 and 100. The greater the cut, the more the Fed is willing to risk a Dollar collapse.

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.