If the Fed truly believes that they can absorb over a trillion dollar damage by inflating, they will have to keep printing much more than their current balance sheet since they are not only trying to save the mortgages anymore. There is complacency building in the bond market and this bubble will not pop before the Treasuries collapse eventually since this bubble is bigger than the Fed, only then a deflation will likely follow. However, it won't happen gradually, it will come very fast when it comes, after all it will be a bond sell off like in Jul-Aug 2007...
Are we there yet? HELL NO! Will the Fed allow a recession eventually instead before it reaches to that point? I am afraid we passed that point since Fed is only part of the bigger credit bubble fueling its last stage. See, taking the liability from the private banks and puting it on the back of the public doesn't fix the bubble since the reason of the bubble was the public and private borrowing in the first place. The other central banks, mainly China and Japan, could come to the rescue one more time and share the burden, but the inflation is roaring all over the world. It will be hard to swallow the pill for any of them without pushing the yields significantly higher or compensation for the risk they will be taking...
I could tell when the risk was mispriced in the bond markets and I was able to do so in January 2007 ahead of the first "dip" in March 2007, when the junk yields were still going lower even after what appeared to be a growing problem in the credit markets. Many participants told on TV that the danger was not showing up in the risk premiums at the time. I believe this could be one of those false moments of relief again by looking at the news articles this Sat night, I will watch the junk yields over the next 2-3 weeks more carefully...
Anyhow, here are quotes from the Warren's link below (thanks!)
April 28 - Bloomberg (Craig Torres): "Vincent Reinhart, a former senior policy adviser to Alan Greenspan and current Federal Reserve Chairman Ben S. Bernanke, said the central bank's rescue of Bear Stearns Cos. was the 'worst policy decision in a generation... The panicked decision jumped over other possibilities' and may prove as damaging as Fed policy errors that caused the 'great contraction' of the 1930s and the 'great inflation' of the 1970s, Reinhart said..."
May 2 - Bloomberg (Craig Torres): "A month after the Federal Reserve rescued Bear Stearns Cos. from bankruptcy, Chairman Ben S. Bernanke got an S.O.S. from Congress. There is 'a potential crisis in the student-loan market' requiring ``similar bold action,' Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans. In a separate letter, Pennsylvania Democratic Representative Paul Kanjorski and 31 House members said they want Bernanke to channel money directly to education-finance firms. Student loans are just the start. Former Fed officials and other Fed-watchers say that Bernanke's actions in saving Bear Stearns will expose the central bank to continuing pressure to use its $889 billion balance sheet to prop up companies or entire industries deemed important by politicians. 'It is appalling where we are right now,' former St. Louis Fed President William Poole...said... The Fed has introduced 'a backstop for the entire financial system.' ... 'There is no way to put the genie back in the bottle,' Minneapolis Fed President Gary Stern said... 'What worries me most about where we wind up is that we will have an expansion of the safety net without adequate incentives to contain it.' ... 'If there is a public purpose in lending to investment banks, and taking dodgy mortgage securities as collateral, then it is a question of degree about other potential lending,' Vincent Reinhart, former director of the Fed board's Division of Monetary Affairs, said... 'That's the consequence of crossing a line that had been well established for three- quarters of a century.'"
April 29 - Financial Times (Gillian Tett and Krishna Guha): "The Federal Reserve could use proposed new regulatory powers to try to stop credit and asset market excesses from reaching the point where they threaten economic stability, the US Treasury said... Nason, assistant secretary for financial institutions, said the Fed could even use its proposed 'macro-prudential' authority to order banks, hedge funds and other entities to curtail strategies that put financial stability at risk. By 'leaning against the wind' in this way, the US central bank could 'attempt to prevent broad economic dislocations caused by potential excesses', he said. His comments come amid debate inside the Fed as to whether it should try to do more to contain asset price bubbles, following the housing and dotcom busts. Some see enhanced regulatory powers as a better tool for this than interest rates."
April 28 - Bloomberg (Simone Meier and Simon Kennedy): "European Central Bank President Jean- Claude Trichet said the bank must set interest rates with the sole goal of maintaining price stability... 'It's crucial that the Governing Council sets the appropriate monetary policy stance on the basis of no other considerations than the delivery of price stability in the medium term,' Trichet said..."
