Explaining the Fed's Dramatic Moves Over the past week, the Federal Reserve has made a serious of unprecedented moves to shore up confidence in the shaken investment community. Former Fed Vice Chairman Alan Blinder explains what the moves mean for taxpayers and the rest of the economy.
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Explaining the Fed's Dramatic Moves

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Explaining the Fed's Dramatic Moves

SUSAN STAMBERG, host:

This is WEEKEND EDITION from NPR News. Coming up, is Kenya ready to get back to business?

But first, when the Federal Reserve acted to help save the investment giant Bear Stearns and lowered a key interest rate, it put cash and its reputation on the line. The Fed may lend hundreds of billions of dollars to investment firms trying to prevent a credit crisis on Wall Street from spreading throughout the country.

Alan Blinder was vice chairman of the Federal Reserve from 1994 to '96. Now he's a professor of economics at Princeton. He joins us from his office. Hello, professor.

Professor ALAN BLINDER (Former Vice Chairman, Federal Reserve; Economics, Princeton University): Hello.

STAMBERG: What's so different about the Fed's actions this week? Can you tell us that compared to things they've done earlier to sort of shore up the market?

Prof. BLINDER: The differences exceed the similarities. This is extraordinary. First of all, the Fed got itself involved in - I don't want to call it a bailout, but let's say the radical restructuring of a specific company, Bear Stearns, as you mentioned. The Fed is not in that business. It's essentially never in that business.

Secondly, it has opened what's called the discount window, which is the code phrase for lending to banks to firms that are not banks. The Fed has been lending to banks since it opened for business in 1914, but it has almost never lent to an institution that's not a bank. And now it has simply opened the door and said, please come in and borrow.

STAMBERG: But also another criticism has been that maybe the Fed is simply encouraging moral hazard, more risk taking on Wall Street with steps like this. Because people wonder why shouldn't Bear Stearns go through the terrible consequences of the actions and decisions that it's taken?

Prof. BLINDER: Yeah. I don't think that argument is right in this particular case because it more or less has gone through the terrible consequences. If you were a shareholder of Bear Stearns, you've been virtually wiped out almost as much as you would've been if Bear Stearns had been allowed to go to bankruptcy.

On the other hand, if you were a creditor of Bear Stearns, you've been pretty much made whole, at least presumably. We'll see how it plays out. I could assure you that there isn't a firm on Wall Street that wants to go through what Bear Stearns just went through.

STAMBERG: Well, how big a risk is the Fed taking when it commits such a huge chunk of its cash reserves? Because there's all this concern that they're going to run out of funds, and guess who's going to end up having to pay for everything? Us.

Prof. BLINDER: Well, first of all, the Fed won't run out of funds because unlike you or I or a bank, should it find itself short, it can create the funds out of thin air - or more accurately with a keyboard and electrons.

STAMBERG: Print more money, right?

Prof. BLINDER: Yeah, print more money, as they say. But what is a worry for the Fed, and believe me, they're worried about it 'cause it's not something they ever do, basically, is they have essentially by this arrangement with JPMorgan and Bear Stearns put taxpayer money at risk in the following sense:

The Fed is hugely profitable. It makes tens of billions of dollars every year, and it turns that money over to the Treasury. Should it suffer a loss, it will turn less money over to the Treasury. So in precisely that sense, the taxpayers will lose out if the Fed loses out.

STAMBERG: What about the risk of inflation? Does that not become sort of inevitability once you start cranking out more paper and putting more money out into the economy?

Prof. BLINDER: Yeah. Well, as I said, as a last resort of the Fed's running out of funds, it can print it up. It does not want to do that for the reason you just said. Lowering interest rates, which it's been doing, and printing more money come about to the same thing. They're almost two ways of phrasing the same sort of Federal Reserve operation. So to some extent, the Fed wants to do that in order to prevent a recession.

STAMBERG: Is a recession inevitable, do you think?

Prof. BLINDER: You know, I may surprise you. I think I'm one of the few holdouts that says no. Don't get me wrong, I don't rule out a recession. We could have a recession; we could even have a big recession. We haven't yet had one negative quarter of growth. The popular definition of a recession is two in a row.

We do have a fiscal stimulus coming on-stream in May. We've had all these rate cuts from the Fed. So if we can get the financial markets in a less panicky state and functioning better, I think we might slip through this episode avoiding a recession by the skin of our teeth.

STAMBERG: Alan Blinder was vice chairman of the Fed from 1994 to '96. He is vice chairman of the Promontory Interfinancial Network. Thank you so much.

Prof. BLINDER: My pleasure.

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