The Pros and Cons of the Fed's Action Last Week
Last week has a historic week for the Federal Reserve. Going back to the end of the previous week we learned that one of Wall Street's oldest and most venerable investment banks was basically bankrupt. Over the weekend we learned that JP Morgan was working to buy Bear. And then we learned that JP Morgan purchased Bear for $2/share with a $30 billion guarantee from the Federal Reserve in the event some of Bear's loans were bad (which some pretty much have to be in the current environment). Now that all of this is over, let's look at the pros and cons of what the Federal Reserve did.
First let's look at what the Federal Reserve did. On March 16 they made this announcement:
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.
Second, the Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent, effective immediately. This step lowers the spread of the primary credit rate over the Federal Open Market Committee's target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.
With this action the Federal Reserve greatly broadened their lending program. Before this action the Federal Reserve only made loans to member banks. In addition, the Federal Reserve only accepted high-grade debt instruments (think US Treasuries) as collateral for those loans.
Now the Federal Reserve will lend to "primary dealers". That means the largest Wall Street investment banks will be able to borrow money from the Federal Reserve. This means firms like Merrill Lynch and Bear Stearns can borrow directly from the Federal Reserve.
Secondly, these loans will be "collateralized by a broad range of investment-grade debt securities." That simply means the instead of only accepting Treasury securities for loans the Federal Reserve will now accept any investments with a rating of A or better. It's important to note that a lot of the problems in the bond market have been caused by high-rated paper, so this qualification isn't worth what it once was.
Third, in addition to the above mentioned action, the Federal Reserve helped to facilitate the Bear Stearns transaction by guaranteeing up to $30 billion of Bear Stearns' portfolio. That means that after JP Morgan buys Bear and takes charge Bear's investment assets, if up to $30 billion of those assets goes bad the Federal Reserve will pay JP Morgan for the losses. In other words, the Fed is essentially guaranteeing up to $30 billion in losses related to Bear Stearns portfolio.
So -- what's good about this deal?
The central reason why the Federal Reserve acted like it did was to prevent a financial sector meltdown. While there is no way of knowing for sure there was a strong possibility that a Bear Stearns bankruptcy would have frozen the credit markets. This would have had chilling effect on the credit markets and could have frozen them solid. This could have sent the economy which is already teetering on the edge of recession (if it's not already in one) into a very deep recession. It's important to remember that leading up to this event were signs of extreme distress in the credit markets. Auction rate securities -- a primary way that municipalities obtain short-term funds -- pretty much dried up over the last 2-3 months. Structures Investment Funds -- SIVs for short -- were experiencing the same problems. In effect, the Bear Stearns situation occurred at the end of a building problem in the credit markets. If Bear had failed there is more than a small likelihood that the end result would have been a much deeper recession than we will have.
On the con side, the Federal Reserve clearly bailed out a firm who's own decisions were responsible for its downfall. Bear decided of its own free will to get involved in the hedge fund and mortgage market. That was a bad decision and they have paid the price. In a free market economy (which we're supposed to be in) stupidity of this type is supposed to fall by the wayside by being unprofitable and therefore eventually going bankrupt. Some commentators have correctly noted that the Fed's action essentially "privatizes the gains and socializes the losses" of the investment community. Finally the Fed's action creates what economists call a "moral hazard". This simply means that by bailing out stupid behavior the Federal Reserve is essentially allowing it to happen again.
In conclusion, I will first note that I called Ben Bernanke a socialist for his actions. Frankly, I couldn't resist that line. As a financial writer the irony was just too rich to ignore. However, the situation is far more complicated than merely labeling a free market advocate a socialist. Bear's collapse would have had far-reaching implications and ramifications that no one would want to be responsible for. If Bernanke had let them fall he would have been burned in effigy for not doing anything. But letting them collapse would have been a sure way to make sure the reckless lending practices of the last 2-3 years wouldn't happen again. But by bailing out the situation Bernanke is now called a "socialist" -- which is probably deeply insulting to him. In other words, this is the economic no win scenario. Whatever you do you're damned.
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The new green jobs will no doubt include millions of workers who will be returning to the work force as “government regulators”. I look forward to the day when I can stand over corporate executives and make them squirm as they explain over and over again how the most recent deal went down and then I will gleefully turn them over to federal prosecutors. Get ready for forms, more forms, and form wars.
No, saving the economy is not socialism taking over but those who subscribe to the theory that the “free market” is the only key to salvation should take careful note of what just happened and they deserve to have their noses rubbed into it a little bit.
The FED is a private Corporation. We the people do not even know who the owners are. The FED is illegally printing our money because the Constitution states the the coinage of our money is the responsibility of the US Government.
When I do the math of our fiat money I conclude that the US Government is broke as are most of our citizens and many of our businesses. Please go to google video and watch:
The Money Masters and Freedom to Fasism
Invest 4 hours in these two videos and you will learn how ugly our fiat money system really is.
First, the Fed is a private corporation just like the Post Office is a private corporation. Yes, they are technically seperate, BUT the leaders are appointed by the president, and confirmed by the Senate. Further, they are HEAVILY regulated by the federal gov't, much more so than a regular corporation!
Second, the fed is not printing ANY money. The Bureau of Engraving and Printing prints the money, and then SELLS it to the fed. The fed then releases it, theoretically in the best interests of the country.
I hope that Wall Street is bowing their welfare lord and masters. And, if another conservative person has the nerve to talk about individual welfare/social program recipients being the scourge of this country, I hope they take time to look at themselves in the mirror.
It disturbs me greatly to see what appears to be elation by Wall Street and by politicians that their problems have been temporarily padded. They can celebrate and make all the pronouncements that they want, but the bottom line is that THEIR economy may be better, but the average American is still enduring the wrath of the same destructive, greedy practices that are bringing these companies to their knees. Just because Wall Street is making healthy gains, does not equate to a "fix" of the American economy.
It appears that the current accepted means of correcting corporate bottom lines is selling out American labor. Too bad there weren't stipulations put on government bailouts to include requirements that money be invested back in this country, and not in foreign companies, funds, or American companies who are investing capital abroad. They are remaining solvent and making shareholders happy, but they are destroying the American economy. The American people are being subjected to what amounts to double jeopardy.
"Bloomberg News reports Fed Chairman Ben Bernanke's Capitol Hill home is slipping in value and may soon be worth less than he paid for it. An economist quoted by Bloomberg estimates Bernanke's house has lost $260,000 in value.
"Bernanke [pictured] lives in Washington's Capitol Hill area in a four- bedroom, 2,600-square-foot house he bought new in May 2004 for $839,000. Almost four years later, it may not be worth any more, according to real estate records and local agents."
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"t took some time for the Federal Reserve to acknowledge the severity of the housing problem, but they have come around. Days after I convened the first hearing of the 110th Congress on foreclosures, Federal Reserve Board Governor Susan Bies said she didn’t “think there will be a large impact on the prime mortgage industry.”
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"Federal Reserve Chairman Ben Bernanke warned on Tuesday that mortgage delinquencies and foreclosures are likely to rise, with more declines in house prices, and called for active measures to stabilize housing markets.
"This situation calls for a vigorous response," Bernanke said in a speech to the Independent Community Bankers of America, referring to government and private-sector initiatives to slow the rate of home loan failures."
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All of a sudden Ben Bernanke is interested in stopping the bust huh?
This had me laughing. The wealth redistribution upward stops at Ben's door. How Bush-like.
How long before the debtors prisons return? Or are they back yet and I missed the news?
Debtor's prison won't come back. They just wait till you get sick without health care and die.
What if you're a stubborn poor person? Tough bird who doesn't get sick? Gotta have somewhere to put us.
I take my vitamins buddy. I plan to be around awhile to aggravate the gubernment. Bring back the debtors prisons, and put the Republicans in it.
"2,600-square-foot house he bought new in May 2004 for $839,000. Almost four years later, it may not be worth any more"
"estimates Bernanke's house has lost $260,000 in value."
It also should be noted that tulip bulbs lost much of their value between 1636 and 1638. Houses are places where you live, not investment vehicles. That some small appreciation occurs does not alter the basic nature of home ownership. The whole concept of buying and selling your residence for profit; of mortgage equity withdrawals and rampant speculation in this most basic commodity is why we’re in deep shit today. Prices of homes should revert to their underlying value not to some artificially propped up value.
And to all this how to factor in: war driven debt; private debt, especially among young adults from education, transportation, and among the home owners, morgage debt; stagnant wages; trade inbalance deriving from lack of domestic product; costs of environmental degradation, costs of educational degradation; energy cost inflation; medical care costs, especially with an aging population; and negative effects on productivity of the impending retirement of the largest swath of American workers--I mean, I am not a market economist, but it baffles me--where are the offsets? Perhaps someone who is a market economist can enlighten me.
If Bernanke is offended at being called a socialist, too bad. Maybe this conservative created mess will at least get him to rethink his foolish conservative faith in "the markets" and abhorence of government "interference".
Conservatives have an economic belief system that has been proven time and again to fail in the real world. Yet, they cling foolishly to their myths. In modern economies, markets often fail and government must be involved to prevent or at least to limit the disasters.
Maybe Bernanke is learning something. As for the rest of the conservatives, not a chance--they'll stick with their myths.
But the markets fail LESS when the gov't interferes in the first place (which is called regulation). THEN they don't need to bailout ANYONE!
Bondad, let's look at this from the standpoint of what's likely to happen. The bush administration is DESPERATELY trying to avoid a meltdown until after Jan 20, 2009. To do that, they will do EVERYTHING that they can, mortgage the entirety of the US gov't (more than it already is!) and wiretap everybody's phone if they have to! The problem with this idea is that no matter what they do, there NEEDS to be some sort of correction. Unfortunately, at this time a correction will be veiwed as a meltdown. So, bush is insisting that we allow it to happen AFTER his watch, and then the democrat in charge will be to blame for it. However, since the only things that he can do to keep the market up are the things that he's done before, and those things cause inflation, next year we're going to have a market meltdown, coupled with hyperinflation! This is something that should have happened back in 2001, when we should have been allowed to take our lumps, which would have hurt, but not been dangerous. Now, it will be dangerous!
LeftRight is 100% correct here. The neocons are postponing the economic meltdown and corresponding hyper-inflation until 2009, when the Democrats control the White House and both houses of Congress.
The problem isn't that they are delaying it until Jan 09, it's that they are CREATING the hyperinflation in a desperate attempt to stop the market "collapse" which will simply be a correction. The further problem with the correction is the fact that they've gone out of their way to ensure that it will look like a collapse, by delaying it as long as possible..
My thoughts exactly. They don't need to wait until '09, just til the elections in November. This is all about tilting the election towards them. With Obama and Clinton at each other's throats, McCain could waltz into office. And I haven't seen anyone predict Democrats gaining two thirds majorities in either chamber.
I don't see anything good about Bernanke's decision. Merrill Lynch is in trouble. Are they too big to fall? What about Lehman Brothers? This could end up being a trillion dollar bailout and for what gain?
An 11 trillion dollar national debt and still no cure to the housing meltdown. And will it free up money for consumers? Will it cause the price of oil to drop? The answers are no.
Nah, they still gotta go to Jan, since he doesn't want it to happen on his watch at all, cause then there'll be NOTHING to shore up his legacy....
The fact that the "lender of last resort" is being dragged into the money pit tells us everything we need to know.
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Bonddad, while I agree with your analysis about the no-win situation, I think that your are correct about the Fed being "socialism for the rich." You shouldn't retract.
The Fed could have crafted a solution that did not require you and I as taxpayers to cough up $30 billion in guaranteees which only inure to the benefit of JP Morgan, and the investment banks who remain in CDO's with Bear.
The Fed should have demanded that the IB's with counter party risk put up the $30 billion by a write-down to their value. That was overdue. It may even be reasonable for the Fed to assign a value on what the debt actually was worth. Working with Congress that could serve the basis of a deal for valuing what bankers need to write off to get US backing for the "good" part of the loans of homeowners who are underwater.
I'm not an advocate of pure socialism, but if you need to use a little bit of social engineering, let's be sure that it is spread among us all.
Don't worry, by the time we cough up 30 billion it will only be worth ten.
First, as if the FED can force the IBs to do anything.
Second, where do the IBs get the $30B? Does is come from the base of their leveraging, further reducing their soundness?
Does it come from their unknown valued, over-debted holdings?
Nah, there's no way the "untouchables" will allow the FED to throw their holdings down the rathole.
Most importantly, only the JP, and its successors, can benefit from the use of the $30B pledge, and only WE THE PEOPLE can lose if they use it.
There's something WRONG with this picture.
We have to let these unregulated "entities" fall (they are NOT really banks, folks), and restore a public money system.
I am not an advocate of socialism, either.
But, what is a sovereign nation?
What is a United States Dollar?
Who is responsible for ALL US Dollar denominated debt?
WE, the taxpayers.
We, the people.
It's our country.
It's our money.
Nationalize, don't socialize, the US money system.
The sovereign Central Bank of the US.
joe, I think maybe we don't give the Fed enough credit for the power they have. Bear had no friends at the Fed, and was disliked by Wall Street as well. This looks more and more like a beautiful two-fer for the FEd: They get to look like public advocacy activists, saving the Economy, hoo-hah! And they get to even some old scores for themselves and their buddies at Morgan while looking like avenging angels by punishing one of those "evil" investment banks. You gotta love it.
Bonddad: We're seeing price appreciation in things we need, and depreciation in things we want. As I'm sure you're aware, the Econoblogosphere as been going back and forth about whether we're hurtling up towards inflation/
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