There’s growing chatter about the Fed engaging in truly abnormal asset purchases: rather than just buy Treasuries or more mortgage debt, it could buy muni debt, pumping money directly towards states and cities.Arguably this would be way more effective than traditional QE, as traditional QE will just see more excess cash pile up on bank balance sheets, with little to show for it in the real economy. Making cities and states more flush wouldn’t have this problem.
But! The Fed can’t get away with this.
The moment Bernanke starts buying California debt, he’ll be setting the clock on the death of Fed independence.
Just imagine the howls of outrage in Congress when the Fed PRINTS MONEY to bail out liberal California. Bernanke wouldn’t do that.
Also, for what it’s worth, the Fed alone can’t save the state budget crisis. It can reduce the cost of funding, but if tax receipts can’t match debts, that won’t matter too much.