Friday, March 21, 2008

Personal Aside: Fed’s Opening the Discount Window to a Non-Bank Means the Game Will be Changed Forever.



The Federal Reserve’s intervention in approving the JPMorgan-Bear Stearns deal…opening the discount window to a non-bank for the first time in history…means the game will be changed forever. With this action the Fed substitutes for the working of the free market. The Fed also announced over last weekend that the discount rate had been cut by 25 basis points/ Bit the announcement that JPMorgan would acquire Bear Stearns for $2 a share or $236.5 million was a stunning shock especially since Bear Stearns had a market cap of more than $20 billion a year ago. Later on Sunday Carlyle Capital said it would liquidate its entire portfolio of mortgage securities, huge news since Carlyle had $940 million of client money but had leveraged that 24 times and held $22.7 billon of mortgage bonds.

This action shows two things: (1) aggressive Fed rating cutting has not been effective and (2) without liquidity and capital financial institutions and/or trading vehicles are in deep trouble. Increasingly it occurs to me that continued and aggressive Fed rate-cutting has been and is a mistake. There is no doubt that interest rate cuts since the past summer have been impotent. In fact they have supplied one powerful reason for businesses to delay activity—and consumers as well. Why act now when it’s likely that there will be lower interest rates next week? Besides, lower interest rates undermine earnings at banks, causing adjustable rate loans tied to prime to slide.

For the past decade the Fed has been on a different roll. It has been asset-centric in the words of Brian Wesbury rather than inflation-centric. This started in the late 1990s when the Fed hiked rates to deflate the stock market bubble, but it strengthened the dollar and caused U.S. investments to soar while in the last analysis tight money slugged the market severely and prompted deflation.

Then in 2002-03 it cut rates to 1% to accommodate the NASDAQ debacle and head off deflation—pushing rates below inflation and sitting on them not caring that hiking gold prices were telling us the worst of deflation had moved on. Then the Fed stalled and postponed raising rates while the Consumer Price Index moved form 2% to 4% and gold reached a 25 year high. So what happened? The Greenspan accommodative policy triggered the housing bubble and ergo today’s headache. I love McCain but his saying that when Greenspan dies he’d put that stiff back in the Fed shows he needs economic help. I am not sure he understands that the team of Jack Kemp the let’s-not-worry-about-deficits supply sider and Phil Gramm the deficit hawk won’t tie the McCain administration in knots—but one look at Barack Obama and Hillary and I’m signed on to McCain no matter what happens.

But still the Fed continues hooked on asset prices not inflation. Dunno but Uncle Ben doesn’t give me much confidence. Your comments please.


  1. I believe the game changed forever quite a while ago when formerly staid investment managers started worshiping the Young Guns of the grad schools, and embracing their novel ideas of linking one investment to others via "derivatives," often making no more sense than betting which crow will fly off the phone line next.

    I agree that this has not been handled well, but the fault lies at the clay feet of the greedy bastards that roared through town tossing money out the window to literally anyone.

    If anyone knows a safe haven in this storm, please advise!

  2. Mr. Roeser,
    You nearly sound like Dr. Paul, bemoaning that cartel, called "The Fed", and its disastrous actions.

  3. The New York Times said today, "The Federal Reserve not only taken has action unprecedented since the Great Depression — by lending money directly to major investment banks — but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling."

    I find this quote both stunning and shocking. Just what has the Fed and Wall Street done to the taxpayer?

    This whole thing smells like a typical sweetheart sleazy deal where the buck gets passed to some ignorant fool. And that fool is the taxpayer!

    It is called the shadow banking system. Well maybe we should shine bright lights on this. It is precisely this rancid type of elitist corruption that sinks the Republican Party and hands the country to the Democrats. But then these people are probably making huge contributions to the politicians so that the lights are shut off on the dirty deeds and the taxpayers are stuck with the bill. It makes one cynical and very very angry. Unfortunately it will cause many to go DEMOCRATIC.