x Abu Dhabi, UAEWednesday 26 July 2017

Night of the living dead

There are probably few people who have not seen the movie The Night of the Living Dead

There are probably few people who have not seen the movie The Night of the Living Dead. But for those of you who missed it, a handful of people are trapped in a farm besieged by flesh-eating ghouls brought back to life by a mysterious radiation. Our trapped protagonists keep killing the ghouls through one very long night. But each time they begin to think the worst is over, the ghouls "won't stay dead" and keep coming back at them. At one point, the leader of the survivors - Ben - finds a rifle and some ammunition. And after fiddling with the antenna of an old television set, he learns from a news bulletin that to really stop the ghouls he has to shoot them in the head. "Kill the head, you kill the ghoul," a local sheriff tells the viewers. But by now Ben is running out of bullets. The Ben in the movie reminds me of the Fed chairman, Ben Bernanke. Like those flesh-eating ghouls, the crises in the housing and the financial markets have just kept coming back at him. The Fed chairman has had to scramble to find temporary, quick fixes just to keep the financial system from breaking down - just as Ben boarded up the doors and windows to the farmhouse to stop the ghouls from breaking in. For the Fed Ben, things were not all that scary at first. About this time a year ago, he declared a problem with rising delinquencies in the subprime mortgage market "contained". Things, of course, did not quite work out that way, but instead got progressively scarier. There were the travails of Structured Investment Vehicles, or SIVs, and the asset backed commercial paper market, in which the banks discovered their hundreds of billions of dollar worth of blatant regulatory arbitrage would come careening right back on to to their balance sheets when the game was up. The Fed cut the discount rate, extended the term for any discount loans, cut fees here and there, and was soon cutting Fed funds to soften the blows of the demand shock to the real economy. But the zombies came back. The Fed's Ben tried introducing new term lending facilities to foster more liquidity, and hopefully, some trading in the interbank and funding markets. And of course, this was all before "Bear weekend", which gave central bankers a few sleepless nights to ensure that a US$2 (Dh7.35) a share sale of a major investment bank was completed by Sunday night. Another liquidity facility was tossed into the mix. And then just when Fed Ben had barely begun to message a "we really mean it this time!" on inflation risk, the financial ghouls again just wouldn't stay dead, with two really big and scary ghouls - Fannie Mae and Freddie Mac of mortgage guarantee fame - bursting right through the shuttered doors. The ghouls finally broke into the farm house, as it were, and the Fed was falling back to the basement and barricading the door, even offering another access to its discount window as a rearguard measure. But where should the Fed's Ben aim his one shot to the brain of his zombies that won't stay dead? Of course, the advantage of living your night of the living dead through in a movie is that it ends and you can go home or turn off the DVD player. And perhaps this crisis will soon end, but before it does, there will be a reckoning just as there was in the movie. For one, the viability and credibility of the deregulated, highly leveraged US style financial system will be sorely challenged. In the new financial system that will emerge from the debris, many of the financial players will be crushed or folded into stronger institutions, and transformed by the imperatives of new regulatory restraints and by conditions that could end up being dictated by the Chinese and Arabic-speaking owners of the world's surplus capital. And there is perhaps no institution that will undergo a more dramatic transformation than the Fed itself. There are those who argue the Fed's twin mandates are pulling in opposite directions and stretching its credibility. But the fact is, the Fed's real problem is the three, not two, mandates it is contending with, since maintaining financial stability is now so central to the policy calculation. After all, there is not much point in debating the trade-off between inflation and unemployment if your transmission mechanism is not transmitting. In the movie things did not work out so well for the other Ben. Let's hope there is a happier ending for the Fed's Ben. Dr Mohamed Ramady is a former banker and Visiting Associate Professor, King Fahd University of Petroleum and Minerals.