I don't *think* I agree with what you are saying, but I don't know, because I'm having a really hard time understanding what it is you are trying to say. Um.... I *think* you don't understand how open market operations work. When it needs to drain the reserve, it will sell bonds (at a very nice, very high interest rate). Bank or their clients will buy, thereby swapping their reserve for securities. The 'massive reserve' is drained. So again, what's the problem??
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ahWhEldj8090 http://blogs.wsj.com/economics/2009/08/07/should-the-fed-be-buying-fannie-debt/ http://en.wikipedia.org/wiki/PPIP http://www.fanniemae.com/resources/file/aboutus/media/q32011_release.pdf
Thank you for sensible responses from both denner and Hopeless. Actually the Fed is on steroids now compared to the Greenspan years. So why should we not expect a new bubble leading to more trouble? To that I would answer that the Current Fed is operating against a vastly different economic backdrop than was the Greenspan Fed. This is the right policy now, it was the wrong policy during much of Greenspan's tenure. If the Fed fails to contract and tighten in time we will indeed see another runaway bubble. I have faith, however, that the Fed has learned the lesson of the past, and this time will be different. What makes me think that? It is this. I believe Bernanke does not believe, as did Greenspan, that markets left alone will harmlessly seek equilibrium. Nor can Bernanke possibly believe in the efficient market hypothesis. In other words, I believe Bernanke, is a much better economist than Greenspan. If Soros is right. and I am convinced he is, markets almost always distort prices, they are not efficient, and they spontaneously move away from equilibrium, not towards it. I think Bernanke understands this, Greenspan did not; consequently major bubbles are preventable. Actually they have always been preventable, but Greenspan's belief in market equilibrium theory kept him from acting. It is obvious that Bernanke is trying to re-inflate real estate prices to bring them into better balance with the amount of existing housing credit, cool down the foreclosure rate, inject value into pre-existing MBS, and eventually ameliorate damage to the building sector. He'll stop short of the kind of crazy bubble we just experienced. Mortgage underwriting standards have already been tightened way up. We are still a long ways away from the situation that prevailed in early 2007. The Fed detractors could be right; I think they will be proven wrong. There is no guarantee however.
I'm not sure if there is any way of ever knowing the truth. There are so many different rumors. http://abcnews.go.com/blogs/business/2011/11/fed-gave-banks-trillions-in-bailout-bloomberg-reports/
Have you forgotten that the Fed sets the reserve requirement? They can raise it at any time they see fit.
Think of the Fed as trying to "facilitate liquidity" by taking the loans that are clogging up the system.. buying them and selling them to investors. That is what they are trying to do. Selling them will be tricky.. because when they begin to unwind.. it will create a rise in interest rates.. the same way that buying them lowered rates. So.. they will hope that the economy picks up. When or if it does.. will come some inflation.. at that time they can begin to sell to raise rates and put a damper on inflation. Inflation in itself is not the problem here. They could raise interest rates easily by unwinding the reserves. The problem is if inflation comes.. and they need to sell reserves to lower inflation.. they will at the same time be slowing the economy down.
They are paying banks for excess reserves. "risk free" for the bank http://washingtonoutside.blogspot.com/2011/08/why-does-federal-reserve-pay-interest.html
Yup, so far there is none of that problem Mr. Tao was concerned about. It's the opposite. How to get banks to lend.
It is the Fed's job to keep the Genie at least partway in the bottle. The U.S. will not become Argentina, nor Greece, nor Spain, nor Italy, not Portugal, nor Ireland -- not for the foreseeable future anyway. So sleep well, and don't bother yourself with extremely low probability events. If you are going to worry about something, let it be something with a finite probability, such as the probability that you'll be struck and killed by a box of lawn furniture falling from the top shelf at Costco.