Friday, March 21, 2008
Personal Aside: Feds Opening the Discount Window to a Non-Bank Means the Game Will be Changed Forever.
The Federal Reserves 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 activityand consumers as well. Why act now when its 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 deflationpushing 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 todays headache. I love McCain but his saying that when Greenspan dies hed 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 lets-not-worry-about-deficits supply sider and Phil Gramm the deficit hawk wont tie the McCain administration in knotsbut one look at Barack Obama and Hillary and Im signed on to McCain no matter what happens.
But still the Fed continues hooked on asset prices not inflation. Dunno but Uncle Ben doesnt give me much confidence. Your comments please.