Have you ever played Three Card Monte?
It’s a classic street con here in New York. All you have to do to win is guess which of three cards is the Queen. The dealer and his accomplices set up the mark with a fast shuffle, often on a cardboard box so that nothing expensive is left behind if the police break up the game, and even faster talk. The key to a successful con is distracting the bettor with talk so that he or she can’t follow the motion of the cards.
And if somehow the mark does guess correctly, the dealer and his crew always find an excuse not to pay off.
Right now the U.S. Federal Reserve is running its own version of the game. The talk by Ben Bernanke and Co. is all about how rates will stay near the current 0% to 0.25% range for “an extended period.” That’s kept asset prices rising.
Which is critical to the Fed’s plan to restoring the health of the financial system. If banks need to raise more capital, and they do, it sure helps if they’ve got a relatively liquid and climbing stock market to sell their offerings into.
In Three Card Monte you have to watch what the dealer does and not listen to the patter.
In the Fed’s case while its chairman, vice-chairman, and every governor who can command a podium somewhere are talking up the “extended period” promise, the bank is acting to reduce liquidity now.
The goal is to get the financial system back to something like normal.
So, for example, on November 17, the Federal Reserve announced that it will reduce the maturity of the loans it makes to banks through its discount window to 28 days effective January 14. During the crisis, when banks couldn’t meet their short-term funding needs through the commercial paper market, since that market had frozen solid, the Fed had extended these loans to 90 days. Now the Fed is moving to get out of the commercial paper business by reducing the term of its short-term loans.
There’s still quite a way to go. Before the crisis, loans from the discount window were overnight only.
This move follows other recent efforts to get the Fed out of the capital markets. For example, the Federal Reserve let the Money Market Investor Funding Facility, designed to help hard-pressed money market funds raise the money they needed to meet redemptions, expire in October. The Fed had setup this program in October 2008 when the financial markets were so locked up that money market funds couldn’t raise the funds they needed, raising the prospect of some money market investors being unable to withdraw their money. That, the Fed rightly concluded, could have set off a run on all money market funds as panicked investors all rushed to get their money while they could.
Yes, the Fed keeps talking about low interest rates for an extended period. But its actions show that the Federal Reserve is getting ready for the day when the economy and the financial system are ready to return to normal.
My best guess sometime in the second half of 2010.
The bank’s definition of “normal,” investors should remember, doesn’t include interest rates at 0%.