Thursday, March 20, 2008

5 Reasons Why the Federal Reserve is a Failure!

Posted in Investing by

March 15, 2008 07:14 AM - 5 Comments

federal-reserve.gif No single quasi-private institution has as much influence on the worldwide economy as the Fed, and as a leader can head this institution for an indefinite term, no one man is as influential on the markets as the Fed Chair.

The Dollar has plummeted in the currency markets and shows few signs of recovery or even stabilization. The new style and policies that accompanied Bernanke into office have made the Forex markets more volatile than ever and even more difficult to predict. An examination of what has gone awry can help Forex traders understand this new era at the Fed.

1. The Fed ignored the signs
The Fed has stated that it will never act as a regulator in any financial market, but it has the duty to use its influence for reform when it sees signs of consumer exploitation. Since as early as 2001, at least two senior officials inside the Fed urged its board to call for tighter regulations in the housing markets, especially in abuses that were clearly evident in the handling subprime mortgages. At the time, the White House was singing the praises of America’s new society of ownership, so the Fed took this cue and did nothing.

These deceptive loans were making possible the dream of home ownership to millions of Americans, even to those who could not come close to affording it. Now these same Americans are living through a nightmare of foreclosure and debt, much in thanks to the Fed’s willingness to ignore long-term repercussions and revel in immediate accomplishments, no matter how hollow and transitory they might be.

2. The Fed did too little too late
Other than advocating for reform, the Fed should have fully committed to a strategy of lowering target interest rates. Instead, Bernanke procrastinated, and when he did finally announce a cut, it was insufficient and ineffectual, at best. On December 11th, the Fed dropped its benchmark rate by a quarter of a percent rather than the half of a percent that had been called for by analysts and investors. Wall Street promptly responded, as the Dow plummeted nearly 300 points in one day.

The Fed might argue that this cut was prudent and that a more drastic cut would have unnecessarily fueled a rise in inflation. However, many view the Fed’s temerity in this matter as merely an extension of its inertial proclivity towards inaction.

3. The Fed kept interest rates too low for too long
Though this may seem to contradict the statements above, one of the reasons that the Fed might have hesitated in cutting rates is that they were already too low to begin with. Greenspan’s long tenure at the Fed was defined by a tendency to aggressively cut interest rates, which he began to do frequently in 1987 after the drastic correction in the stock market.

This initial move helped stave off disaster, but the further rate cuts of the late 1990s eventually led to the dot-com bubble. Rates should have been raised again in the early 2000s; if this had been done, the US might have avoided the furious borrowing that has led to the current credit crunch.

4. The Fed’s view of inflation is flawed
The Fed seems rather befuddled by this important economic indicator. The soaring costs of food and energy are a phenomenon is the US and worldwide, but the Fed does not take these developments into account.

The Fed’s analysis focuses on “core inflation,” which excludes a number of indices that it views as transitory, including energy and food costs. “Headline inflation,” which does take these costs into account, is favored by European economists, who view high energy prices as a long-term trend. By choosing to disregard the rising costs of a barrel of crude oil and a bottle of olive oil, the Fed is ignoring reality.

5. The Fed gives gold stars to those deserving detentions
Fed policy following the recent economic slowdown has done nothing but reward those who helped caused it. The majority of financial stocks have suffered of late, and justifiably so. However, the Fed seems dedicated to bailing out even the worst of the perpetrators with the recent set of economic interventions that it has enacted.

While working to eliminate any downturn in the market might seem feasible for short-term success, it is a purely shortsighted endeavor that will hurt the economy in the long run. In order for a free market to truly exist, bear markets must coexist peacefully with bull markets. Unfortunately, the Fed has its bright orange vest on and is going bear hunting. This is a doomed outing, and one that is going to get us all hurt in the end.

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