What to do now with monetary policy –

Easing by many G-7 central banks has begun to lower economic risks. We have seen the coordinated short-term injection of funds by central banks to provide liquidity over the turn of the year to reduce liquidity needs. We have seen new regulation from the Fed to monitor mortgage bankers. The US Treasury secretary has changed jobs and become the housing and mortgage secretary. What more can be done at this time to solve the credit crisis?

Credit crises are very difficult to solve from both the monetary policy and regulatory perspective. If financial institutions do not want to supply credit, the government cannot force them. Lowering interest rates to provide liquidity is a start but it is a blunt tool and not one that can be easily targeted to a specific sector. Central banks have to worry about the fall-out to the general economy. Providing short-term liquidity is also good but we may not be in a situation yet where the central bank needs to be the lender of last resort; consequently, it is not clear that this is truly necessary. It may not be appropriate to add funds to solve the credit spread problem. The spread widening is a sign that there are risks with banks that need to be disclosed. Regulation is a help, but this policy change is forward looking and does not solve past credit problems. Past credit problems have to be priced in the market and any solution to stop this repricing from happening is not acceptable in the long-run.

Perhaps the best action now is to wait. The markets have increased volatility because it cannot determine what should be done or what is the impact of what has been done. The best Christmas gift may be to let investors reflect on the year and make appropriate adjustments based on the information available.