By Sheila Mullan

NEW YORK (MNI) – Blackrock’s Global Head of Fixed Income Peter
Fisher feels the Federal Reserve’s large scale asset purchases to aid
the U.S. financial system have been “vindicated — so far” but expressed
skepticism that further balance sheet expansion by the Fed would be
effective.

The situation that the Fed faced after its U.S. financial crisis is
mirrored now overseas in Europe as the eurozone struggles to overcome
its various economic woes, he said.

“It is quite rare in economic policy to have the chance to observe
the counterfactual” such as between the U.S. and European central banks’
reaction to the financial crisis, Fisher observed.

He contrasted the extraordinary balance sheet actions of the Fed
from 2008 onward, with the actions taken by the European Central Bank
and European governments. “Look at Europe” said Fisher, “and you can see
premature tightening of monetary policy two years ago combined with the
fiscal tightening by some governments, has almost blown up the banking
system and may well unravel the euro itself.”

“It’s not a perfect metaphor for the Fed” and its mid-crisis
actions, he added. “But if I was” at the Fed and “watching the market
overall the last several years, I’d feel pretty good” about the response
to the crisis.

Fisher also said the Fed’s actions reflected its unspoken “third
mandate to keep the banking system going” in addition to ensuring
maximum employment and stable prices. “One of the obstacles they face
(in Europe) and we face, is a shrinking banking system,” he said. “This
is the awkward policy issue that no one likes to talk about.”

Fisher spoke on quantitative easing and financial markets in front
of the New York University Money Marketeers group of economists and
bankers Thursday night. He also added some exclusive further detailed
comments for MNI since that time. BlackRock has $3.5 trillion in assets
under management as of Dec. 31, 2011.

Given the downside risks to U.S. growth, Fisher suggested the Fed
will need to consider whether and how to provide more stimulus. If they
do pursue further extraordinary balance sheet actions, “it would behoove
them to explain, why they think it’s going to work,” he added.

Fisher explained he could imagine four different rationales for
further U.S. policy easing but he was skeptical whether they would be
effective on their own terms.

The first rationale would be the “bank liquidity rationale” to
avoid a bank panic, he said. Given the high levels of excess reserves
that the Fed has already provided, he explained, “I just don’t think
that is credible.”

A second rationale would be the “asset price rationale,” to drive
asset prices higher to stimulate investor spirits in the hope of
creating corporate and household confidence, he said.

Fisher observed the Fed had some success driving asset prices
higher in the fall of 2010 but there had not been any followthrough to
growth in 2011. Moreover, “like No. 1, this is just a bridging
operation” and “it has to be a bridge to somewhere,” he said. So, by
itself, this rationale would not be likely to be an effective response
to slowing U.S. growth.

The third rationale Fisher saw would be to “hold down rates to
stimulate credit creation,” or the “credit channel rationale.” While he
observed that Fed’s Operation Twist had a greater impact on yields than
he had expected, Fisher told MNI that he did not think further purchases
of Treasury or Agency securities by the Fed, at this point would be
likely to stimulate greater private credit creation.

Fisher was concerned that for the Fed to keep pulling Treasury
securities out of the market might actually reduce credit creation due
to the Fed’s “hoarding” of the “best collateral” in the banking system
— the role government bonds play as the base asset for the banking
system.

The Federal Reserve currently holds 14% of the Treasuries and
Agencies supply (compared to 7% in 2005), he said, but the Fed combined
with foreign authorities hold 47% of Treasuries and Agencies.

“When the central banks of the world are holding 50%, if we suck up
more of them, there will be no actual stimulus of credit creation,”
Fisher said.

The fourth rationale that Fisher considered was for the Fed to
respond to the risk of outright deflation by trying the flood the
banking system with money to avoid a decline in the general price level,
which he described as the “radical monetarist rationale.”

This approach had several practical challenges: first, the Fed
would have to buy assets in vast quantities and it was not clear what
market they would come from, he said. Given the continued deceleration
of velocity that was already observed, the scale of these operation
might have to be vast, Fisher observed in further comments.

While the Fed might attempt to do this by buying foreign
currencies, Fisher told MNI he thought pursuing this strategy to
intentionally weaken the dollar might not be an effective means of
generating inflation, if a rapid and large rise in energy and commodity
prices served to weaken consumption — as had been the experience in
recent years.

–email: smullan@marketnews.com

** MNI New York Newsroom: 212-669-6430 **

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