The People's National Bank?

The Federal Reserve is running out of conventional monetary policy and bond market options. Thus, the time for unconventional policies may be at hand.

The Fed has cut the federal funds rate and its short-term lending rate to banks to near zero, but those moves have done little to unlock credit markets. Traditional mortgage money and business loans remain too scarce because regional banks - the arteries and capillaries of our credit system - remain short of loanable funds.


Near-zero short-term lending rates for banks do little to help, because the regional banks do not lack for short-term access to funds; the Fed is providing all the near-term liquidity they want. Rather, banks lack longer-term sources of funds to back up mortgages and commitments for medium-term lines of credit to businesses.

Since the savings and loan crisis of the late 1980s, regional banks have relied on both deposits and the sale of mortgages and other loans to big Wall Street banks to finance home and business loans. Loans sold to these big money center banks, for many years, were securitized - that is, bundled into bonds for sale to insurance companies, pension funds and other fixed-income investors.


In recent years, many of those fixed-income investors were burned by the sharp practices of New York bankers and investment houses - schemes that were central to the subprime crisis, housing bubble and collapse, and the crisis of confidence on Wall Street that has poisoned credit markets globally.

Now, fixed-income investors have lots of cash to invest but are reluctant to buy bonds backed by mortgages and other loans. The large Wall Street banks are not much interested in creating bonds from mortgages and other loans made by regional banks, because securitizing high-quality loans into bonds doesn't create the opportunities to write fancy derivatives that pay bankers huge bonuses.

Instead, the big Wall Street banks have used their massive injections of capital from the Federal Reserve and Treasury to go hunting for new, high-profit businesses and acquisitions. The presence of federal regulators in their offices keeps them from getting involved in dangerous new schemes - but it does not address the shortage of funds regional banks have to lend.

The Fed has other options, but they won't help much either. It can buy 10-year Treasuries to pull down long rates, such as conventional mortgage rates. That would lower the rates banks pay for deposits but would not increase their deposits; hence, it would not increase the amount of money they have to make loans. It also can continue to buy mortgage-backed Fannie Mae and Freddie Mac bonds, pulling down their rates - but again, lowering rates on those securities does not make them more attractive to investors.

Ultimately, Fed Chairman Ben S. Bernanke should gather the CEOs of the big Wall Street banks, which have received direct infusions of capital from the Treasury and huge loans from the Fed, together with the biggest fixed-income investors to define the parameters of acceptable mortgage-backed securities. Then, the Fed should require its wards on Wall Street to buy loans from regional banks and bundle those loans into bonds for sale to fixed-income investors. Regional banks would finally have the funds to provide home loans once again.

The Fed could also buy bonds backed by conventional mortgages, just as it has Fannie and Freddie securities. In the end, though, the Fed may have to start making direct loans to the regional banks by accepting as collateral solid, prime conventional mortgages. Also, it could purchase those mortgages and bundle them into securities for sale to fixed-income investors directly or through large securities dealers. The latter are among the banks now receiving Treasury injections of capital and generous Fed loans.

This is all well outside the limits of what the Fed has done since World War II, but these are dangerous times.

In the end, if the New York banks won't do their job, the Fed may have to do it for them.


Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission. His e-mail is