"The Fed Is Heading For Another Catastrophe... Central Banking Has Lost Its Way" Stephen Roach Warns

Tyler Durden's picture

Authored by Stephen Roach, originally posted At MarketWatch via Project Syndicate,

America’s Federal Reserve is headed down a familiar — and highly dangerous — path. Steeped in denial of its past mistakes, the Fed is pursuing the same incremental approach that helped set the stage for the financial crisis of 2008-2009. The consequences could be similarly catastrophic.

Consider the December meeting of the Federal Open Market Committee, where discussions of raising the benchmark federal funds rate were couched in adjectives, rather than explicit actions.

In line with prior forward guidance that the policy rate would be kept near zero for a “considerable” amount of time after the Fed stopped purchasing long-term assets in October, the FOMC declared that it can now afford to be “patient” in waiting for the right conditions to raise the rate. Add to that Fed Chair Janet Yellen’s declaration that at least a couple more FOMC meetings would need to take place before any such “lift-off” occurs, and the Fed seems to be telegraphing a protracted journey on the road to policy normalization.

This bears an eerie resemblance to the script of 2004-2006, when the Fed’s incremental approach led to the near-fatal mistake of condoning mounting excesses in financial markets and the real economy. After pushing the federal funds rate to a 45-year low of 1% following the collapse of the equity bubble of the early 2000s, the Fed delayed policy normalization for an inordinately long period. And when it finally began to raise the benchmark rate, it did so excruciatingly slowly.

In the 24 months from June 2004, the FOMC raised the federal funds rate from 1% to 5.25% in 17 increments of 25 basis points each. Meanwhile, housing and credit bubbles were rapidly expanding, fueling excessive household consumption, a sharp drop in personal savings, and a record current-account deficit — imbalances that set the stage for the meltdown that was soon to follow.

The Fed, of course, has absolved itself of any blame in setting up the U.S. and the global economy for the Great Crisis. It was not monetary policy’s fault, argued both former Fed Chairmen Alan Greenspan and Ben Bernanke; if anything, they insisted, a lack of regulatory oversight was the culprit.

This argument has proved convincing in policy and political circles, leading officials to focus on a new approach centered on so-called macro-prudential tools, including capital requirements and leverage ratios, to curb excessive risk-taking by banks. While this approach has some merit, it is incomplete, as it fails to address the egregious mispricing of risk brought about by an overly accommodative monetary policy and the historically low interest rates that it generated.

In this sense, the Fed’s incrementalism of 2004-2006 was a policy blunder of epic proportions.

The Fed seems poised to make a similar — and possibly even more serious — misstep in the current environment. For starters, given ongoing concerns about post-crisis vulnerabilities and deflation risk, today’s Fed seems likely to find any excuse to prolong its incremental normalization, taking a slower pace than it adopted a decade ago.

More important, the Fed’s $4.5 trillion balance sheet has since grown more than fivefold. Though the Fed has stopped purchasing new assets, it has shown no inclination to scale back its outsize holdings. Meanwhile it has passed the quantitative-easing baton to the Bank of Japan and the European Central Bank, both of which will create even more liquidity at a time of record-low interest rates.

In these days of froth, the persistence of extraordinary policy accommodation in a financial system flooded with liquidity poses a great danger. Indeed, that could well be the lesson of recent equity- and currency-market volatility and, of course, plummeting oil prices.

With so much dry kindling, it will not take much to spark the next conflagration.

Central banking has lost its way. Trapped in a post-crisis quagmire of zero interest rates and swollen balance sheets, the world’s major central banks do not have an effective strategy for regaining control over financial markets or the real economies that they are supposed to manage. Policy levers — both benchmark interest rates and central banks’ balance sheets — remain at their emergency settings, even though the emergency ended long ago.

While this approach has succeeded in boosting financial markets, it has failed to cure bruised and battered developed economies, which remain mired in subpar recoveries and plagued with deflationary risks. Moreover, the longer central banks promote financial-market froth, the more dependent their economies become on these precarious markets and the weaker the incentives for politicians and fiscal authorities to address the need for balance-sheet repair and structural reform.

A new approach is needed. Central banks should normalize crisis-induced policies as soon as possible. Financial markets will, of course, object loudly. But what do independent central banks stand for if they are not prepared to face up to the markets and make the tough and disciplined choices that responsible economic stewardship demands?

The unprecedented financial engineering by central banks over the last six years has been decisive in setting asset prices in major markets worldwide. But now it is time for the Fed and its counterparts elsewhere to abandon financial engineering and begin marshaling the tools they will need to cope with the inevitable next crisis. With zero interest rates and outsize balance sheets, that is exactly what they are lacking.

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TeamDepends's picture

Central banking has not lost its way, it is right on schedule. They will pull into the Neo-Feudalist station in the near future, according to plan.

GetZeeGold's picture



Serves the Fed right for not listening to the BIS.


I say....screw'em.


Hell.....maybe the EPA could do a better job. Let's give those guys a shot.

kliguy38's picture

He's a doomer. He's a conspiracy nut. He's a silver stacker. He's a goldbug. He's a prepper. He hates our freedom.

max2205's picture

Stop their strategy. ......yeah right....

General Decline's picture

Team Depends (first post above) is exactly correct. It knows exactly what it is doing. It's marching the world right into full-rippin' Zionism. Understand that, and the workings of this insane world becomes a lot more clear.

johngaltfla's picture

THIS time it is different. In other words we're totally fawked when it crashes. No Keynesian reindeer games to save the political elites. We will be going back to the dark ages and fast until the next technological leap causes a shift in economic struture in the failing aging Western economies.

General Decline's picture

The elites will be just fine. I'm guessing they've thought through every possible permutation of the out come and are preparred. Id like to think they have missed some important detail which will cause them great difficulty, but I'm thinking otherwise.

Merry Cristmas everyone!

Ahoy Polloi's picture

Looks like someone better chisel a working copy of the Mahabarata onto a Tycho Monolith before everything goes tits up [again]

MalteseFalcon's picture

FED policy went in the wrong direction when Greenspan gave his "irrational exuberance" speech in 1996.  All Greenspan had to do was reduce the margin available for stocks.  No need to adjust interest rates.  But he refused and when the tech bubble happened, he had to increase interest rates to pop it and the bubble crashed with  disastrous results.

Since then the FED has simply been doubling down on the same mistake.  The doubling down is completely counter to previous FED behavior and will ultimately lead to a historic catastrophe.

Completely foreseeable and unnecessary.

There are several villains, but Greenspan is #1.

livefreediefree's picture

Thanks for the perspicacious historical perspective. The longer view is good.

McCormick No. 9's picture

In this coming collapse, 450 nuclear power plants starved of vital spare parts means there will never be another "unitil".

Antifaschistische's picture

so....we're really worried about repeating 2009?   a catastrophie?   HARDLY!!   I'm not the least bit worried about a 2009 repeat.    I'm worried about 2009 x 10

....and i know it's coming, unfortunately...I'm too young and it will probably happen in my lifetime.

SAT 800's picture

I was gonna say; the bright side of this anouncement is that they had a way to begin with; it's news to me.

wmbz's picture

Ed Zackery!

The un-fed is right on target, they could not be happier! The banksters are where they want to be, above all laws and able to fleece all depositors at will.

Those mother fuckers are way beyound happy wth the ongonig events!

Merry Christmas! Now sit down shut up ad do as you are told!

scrappy's picture

Cops shot, kids shot, brinkmanship internationally.

Yes it is ALL Theatre, ALL the time.

The BRICS system will not save us, it is a setup.

We best get a hold of things here at home.

Do not worship the golden calf or their "system"

(The gold is mostly gone)


If we do not unite here in the US, we are toast.

Hence TPTB massive efforts to divide us, anyway they can.

(they know it's our only chance) - Make any sense now???

Wise up folks, quick.

Think Deeper.

angel_of_joy's picture

The BRICS "system" is not (and never was) intended to save our butts, but THEIRS ! They couldn't care less what happens to North America, and I suspect they won't suffer much to see us crashing and burning, especially if it's gonna be on our own doing... We are on our own, with a dumbed down population, and idiotic leaders detached from reality, in charge. Have a Merry Christmas !

ZenStick's picture

A new approach is needed. Central banks should...

Oh, this guy is serious. Thought he was joking.

Had to see who this Roach guy is: http://graphics8.nytimes.com/images/2012/02/17/business/dbpix-people-roach/dbpix-people-roach-articleInline-v2.jpg

He's got the zombie-in-a-suit thing going pretty well.

saveUSsavers's picture

cut the crap posting! He's one of the smartest around, despite YOU never heard of him.

HardlyZero's picture

Roach is one of the smartest (and most enjoyable) around, seriously.   He is not a friend or afraid of the banks.

His attitude and approach to Central Banks is similar to Jim Grant or Ron Paul.

Somehow he survived stints at major institutions and remains teaching now at Yale.




See here short snippets...on VPRO "The Day of the Dollar (Roel van Broekhoven, Backlight 2005)"


TruthTalker's picture

They will not change course because to do so will bring on the collapse that much sooner - they have painted themselves into a proverbial corner - stock up boys and girls

GeorgeHayduke's picture

Don't count on them taking responsibility for their stupid actions anytime soon. These folks serve the people who never have to take the hit for a bad decision. That is how they set this sytem up years ago. They will not take the their due downfall until they've thrown everything and everyone else into the raging fire first. Such is the nature of their thinking.

Motorhead's picture

And who's that chump-ass clown who said gold was going to $2,000 by the 31st of December 2014?

GetZeeGold's picture



Cat's got a week left......at least give him that.


Remember there's a holiday in there.


Although I think anyone trying to predict the price of gold right now is absolutely insane. Except for Jon Nadler....he could maybe do it.

aliki's picture

"lost its way" implies it was initially on the correct path. printing $$$ solves nothing. GDP at 5% in the U.S.? yeah, the obama-conomy is so awesome that he just lost the senate & repubs haven't had this tight a grip on the house in about 100 years. not that i expect much out of them either but just like the 3-card monti that goes on at the fed, the politicians just continue to get shuffled around & still nothing changes. just keep believing the steve liesmans of the world - no inflation created by the fed barring needing to eat, fill up your gas tank (price at the pump going from $1.00 to $5.00 & then back to $3.00 is still a 200% increase over a 15 year period), go to college, drive on a toll road, go to a movie, go to a ballgame, cross a bridge/tunnel, healthcare - outside of that, no inflation anywhere.

in other news, here in jersey, christie just bailed-out AC. more $$$ we are flushing down the drain. same clown who brought us the revel (which just went out of business about a year after openning). only time ill ever agree with larry summers is when he said "government shouldn't be in the VC business." i guess the next trade should be buy everything russia because the fed will just bail them out next. can't let anyone fail these days.

buzzsaw99's picture

Central banking has lost its way.

No, it hasn't. There are moar billionaires than ever.

Vincent Vega's picture

And 'moar' unsecured, unrepayable debt than ever.

NoDebt's picture

"Central banks should normalize crisis-induced policies as soon as possible. "

Yes, please.  I have a sandwich bet riding on this this and I'm losing big and losing fast.

In other news, there's a new PSA out encouracing children to steal their parents' guns and turn them in to their teachers.  And they said it could never happen here.


Ahoy Polloi's picture

Holy fucking shit!


A whole school full of kids walking around with guns in their backpacks [on a mission to turn them in to Saul Alinsky disciples]


What could POSSIBLY go wrong?

e_goldstein's picture

 the silicone chip inside her head gets switched to overload...

aliki's picture

speaking of the revel - it just shows how the public sector has NO BUSINESS openning a business. my girl and i walked in there when it first openned - we were on the escalator going up a level and i remember looking out the enormous, glass cylinder they had that ran up the front of the hotel (which is directly on the ocean). i said to my girl "did they even consider how much this place is gonna cost to heat in the winter & cool in the summer being that its basically a magnet for the elements?" during that year it was disclosed they had a sweet-heart deal with the utilities (shocker). guess the utilities could only subsidize them so much because there is no way on planet earth the revenues they were bringing in X 3 could = covering their bills in the winter & summer months. guess nobody decided to read the blueprints and put 2 & 2 together being their were building a monster on the ocean that swallowed up with windows.

Last of the Middle Class's picture

central banking did exactly what they wanted it to do. Anything else opens the door for plausible denial. They raped the country for the super rich period.

Last of the Middle Class's picture

fox is off of dish for whatever reason so watched chris matthews on msnbc last night for about 5 min. Didn't know whether to laugh or cry, haven't seen that BS in 5 years or so. His spittle flying performance was nothing short of legendary propaganda for the left. Every incident was twisted and distorted. there is no way any of that could be interpreted as anything but.

lester1's picture

Reaganomics is a failed economic policy. Trickle down is a failure..


The FED fuels Reaganomics to keep it going.


End the FED so Reaganomics can finally die!!

lordbyroniv's picture

The left hate Reaganomics but love Keynesian economics.


Which is funny....because near as I can tell...


they are practically the same thing.

Buckaroo Banzai's picture

"We are all Keynesians now." -- Richard Milhouse Nixon

alexmark2013's picture
Bill Holter's warning: “I suspect what is going to break are the derivatives, the $303 trillion in derivatives that the big banks have, and it will crash the world. " http://investmentwatchblog.com/bill-holters-warning-i-suspect-what-is-going-to-break-are-the-derivatives-the-303-trillion-in-derivatives-that-the-big-banks-have-and-it-will-crash-the-world/
Bearwagon's picture

You really think that those buttfuckers from ISDA will admit any form of a credit event, ever?! Oh, man, how I wish you were right ...

yogibear's picture

Now the taxpayer is on the hook for failed derivatives. This time 100's of trillions in bailouts.

And the housing schemes are back. No money down fog on a mirror.

Why worry when nobody is prosecuted?




saveUSsavers's picture


wrs1's picture

There is no bubble in housing or commodities so where is the bubble that is waiting to pop?  Guess we know the answer to that and where all the efforts of the Fed will go to keep that bubble floating.  I would imagine killing oil is more fed related than anything else, the Saudi's being the puppet of the fed.

SmallerGovNow2's picture

lack of demand is what is "killing oil"...

Latitude25's picture

$300 trillion in derivatives/ 170,000 tons of gold worldwide/32,000 ounces per ton = $55,000 per oz

Farmer Joe in Brooklyn's picture

I wish...!! 

I'd build a castle with a moat full of alligators to protect my stacks...!!!

lakecity55's picture

Wow, the last scam worked so well, let's do it again!

observer007's picture


Police say officer in Berkeley, Missouri, fired several times at suspect who aimed gun at him in gas station



The Count's picture

Pointing a gun at a police man...and then getting shot?! This is how nature takes idiots out of the gene pool.

The Count's picture

FED policy, immigration policy, political correctness policy...


These are all related even though it's not easy to connect the dots. But just like it usually is, follow the money to find out what is really going on. 

And it all can be traced to high finance. The strategically placed ex-Goldman hit men (think Drahgi) is a big tipp-off. To make it simple (so a caveman can get it)...the world has been made slaves by borrowing more than can be paid back. The banking 'Godfathers' want their money back, with interest, and without growth (even if totally bogus) that wont happen. So the numbskulls in politics think they can create that growth by more deficit spending and importing bodies (European Immigration is more out of control than ours). Get yer bug out bags in shape!

And Merry Christmas!