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How Bernanke Ruined the Stock Market's Week

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BEN BERNANKE
AP

Like a much-hyped movie that flops on its opening weekend, the Federal Reserve's latest attempt to revive the economy -- the so-called Operation Twist -- received a resoundingly negative reaction upon its announcement on September 21.

In just an hour and a half of trading after the announcement on Wednesday afternoon, the Dow Jones Industrial Average dropped by more than 200 points. It lost another 400 points by the end of trading on Thursday. In all, that's a market tumble of more than 5 percent in just over 24 hours.

With the decision to sell $400 billion in near-term Treasury bonds to purchase the same amount of longer-term bonds, the Fed said it hopes to hold down long-term interest rates and produce a more accommodating atmosphere for business. But the news didn't seem to
strike investors as they hoped.

So why did the Fed announcement bomb so completely?

The burden of high expectations

To a large extent, the Fed suffered from the burden of high expectations. It's hard to fathom what the market expected them to pull out of the hat when their options are so limited. Short-term interest rates are already near zero. Current mortgage rates -- a focus of Operation Twist's attempt to bring long-term rates down -- are already at record lows and have been well below historical norms for some time.

In other words, while the Fed can manipulate interest rates to some degree, two things were already clear before Operation Twist was announced:

  1. The Fed has essentially run out of room to push rates down any further.
  2. Lower rates have not stimulated spending.

Still, the market was clearly expecting something better than Operation Twist and expressed its
disappointment with a sharp sell-off.

Twisting the knife

The Fed may have added to the problem with the way it announced Operation Twist. Both in the wording of the announcement and in its increasingly gimmicky initiatives, the Fed has contributed to an atmosphere of rising panic. It is getting sucked into the short-term focus of the markets rather than reinforcing the ways that economic cycles tend to resolve themselves.

Ultimately, these style points didn't do the real damage, but they may have twisted the knife a little.

For those with savings in CDs, savings accounts, and money market accounts, Operation Twist is largely a non-event. It is, at least, an occasion to appreciate that even minuscule savings and money market rates are better than being in a sinking stock market. Operation Twist won't help those rates, but with its emphasis on bringing down longer-term interest rates, it shouldn't hurt short-term deposit rates any further.

As for the economy as a whole, in the long run Operation Twist might be like one of those movies that bombs upon its initial release, but later goes on to become a well-regarded classic. For now though, critics and the general public agree: Operation Twist is a flop.

The original article can be found atMoney-Rates.com:"How Bernanke ruined the stock market's week"

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