Last week the Fed brokered a deal to sell failing investment bank Bear Stearns to JPMorgan Chase. At the same time, the Fed announced that it would be willing to lend directly to Wall Street brokers.
If you are a casual observer of financial markets, you will be forgiven for believing that the Fed’s move last week was a good one. After all, the stock market—which had been in danger of further losses—has, for the time being, been stabilized; many analysts have lionized Bernanke for making a sound and bold move.
This week Business Week put Bernanke on its cover and added to its headline “Bernanke reinvents central bank to avoid catastrophe.” If only that could be true. What Bernanke has done is to postpone the day of reckoning; and by so doing, he has set the stage for an even bigger crisis.
Last week, legendary investor Jim Rogers pulled no punches when he critiqued the Fed’s move. It is well worth 12 minutes of your time to listen to this very colorful interview.
No, Rogers is not exaggerating—the Fed has indeed bought hundreds of billions of dollars of junk assets. In the JPMorgan Chase case, the Fed has guaranteed $29 billion dollars of losses on the junk mortgage backed securities that Bear Stearns held.
As Rogers points out, none of this is in the Fed’s mandate. As the Fed bails out those who took bad risks, it is destroying the dollar; and it is setting the stage for a true collapse of the economy.
Indeed, it is also true what Rogers said about Wall Street bonuses. In 2007, Bear Stearns’ bonus pool was $2.06 billion dollars. Under bankruptcy laws, had the Fed allowed Bear Stearns to go bankrupt, all of that money would have had to have been repaid by the employees who took those bonuses home.
None of the Fed’s actions are legal, as John Hussman, president of Hussman Investment Trust, points out:
The Federal Reserve decided last week to overstep its legal boundaries – going beyond providing liquidity to the banking system and attempting to ensure the solvency of a non-bank entity. Specifically, the Fed agreed to provide a $30 billion “non-recourse loan” to J.P. Morgan, secured only by the worst tranche of Bear Stearns’ mortgage debt. But the bank – J.P. Morgan – was in no financial trouble. Instead, it was effectively offered a subsidy by the Fed at public expense. Rick Santelli of CNBC is exactly right. If this is how the U.S. government is going to operate in a democratic, free-market society, “we might as well put a hammer and sickle on the flag.”
What is a “non-recourse loan”? Put simply, if the homeowners underlying that weak tranche of debt go into foreclosure, they will lose their homes, and the public will lose as well. But J.P. Morgan will not lose, nor will Bear Stearns’ bondholders. This will be an outrageous outcome, if it is allowed to stand.
Paul La Monica, writing yesterday at CNN Money, observed that already other banks are lining up for a Fed handout:
Now other banks appear to be angling for a spot at the Fed trough. In an interview with the San Francisco Business Times last week, Wells Fargo Chief Executive John Stumpf said his bank “would not be averse to a Fed-assisted transaction” and added that “fixer-uppers don’t bother us.”
Well, who wouldn’t be interested in a fixer-upper if you knew that the Fed would be there to help you deal with all those losses? Heck, I’d buy the house from that Tom Hanks movie “The Money Pit” if a friendly central banker was willing to reimburse me for all the renovation costs.
Not surprising, others are arguing that if the Fed can bailout Wall Street, why can’t the government do more for the homeowner. Proposals are gaining traction in Congress that would forgive the amount that a homeowner is underwater. Congressman Barney Frank wrote this month in the Washington Post:
We propose to tell those who either originated or purchased mortgages that are now extremely unlikely to be repaid that they should write down their existing obligations to a level that represents current market value. After — and only after — the loss is taken, the government would facilitate refinancing mortgages for homeowners who could meet repayment obligations at the new, written-down level.
It is easy to forecast how all of this is going to unfold. More and more extreme proposals will be floated and implemented. When the economy collapses in exhaustion, those who learned nothing will tell us “if only we had done more.” This will set the stage for even more dangerous and draconian measures.
All of this economic madness is, and will be, fueled by the false beliefs that we hold collectively as a society. These beliefs include the ideas that the Fed can prevent economic cycles and that government should manage prices. Until these beliefs are finally examined and seen to be false, the economic carnage that these beliefs will cause is likely to be enormous.