Thursday, March 20, 2008

Fed Dispenses the Wrong Medicine

Watching the Federal Reserve intervene repeatedly in the free market to prevent the bankruptcy of firms “deemed too large to fail,” I am plagued with questions about what future problems they may be creating.

Failure Can Speed Up Recovery

I think he would say that the Federal Reserve is largely responsible for the current deflation in home prices. By keeping interest rates artificially low in the period of 2001 to 2004, the Fed spurred over investment in real estate and housing. This over investment is now being eliminated through the pain of a market bust. Had the Fed promoted price stability and a stable currency, instead of promoting economic growth, this bust wouldn’t have been the inevitable result of the earlier boom.

Political intervention in free markets results in the boom and bust business cycle that is so oft been repeated in America’s economic history. Solution is to allow the marketplace to correct imbalances and then to leave it alone and let the market decide its own course apart from political manipulation.

Yet Ben Bernanke, with his Ph.D. in economics, has failed to trust free market solutions.

When Wall Street investment banks believe that the Federal Reserve will step into the marketplace and protect them, they are more likely to make risky bets. If they instead believed that imprudent risks would wipe them out financially, they would have hesitated to make some of the reckless decisions that have been made in the last half-decade.

Failure can actually hasten a recovery...

During the 90s, several Japanese banks were allowed to limp on because the Bank of Japan intervened when they should have been liquidated more quickly. Today’s shareholders of financial firms with too much leverage, poor risk management and incompetent stewardship need to be wiped out. After bankruptcy, the assets can pass to more competent hands.

Reckless Borrowing Can Be Traced Back to the Fed

This type of reckless encouragement to borrow can all be directly attributed back to a Federal Reserve that was giving the large commercial banks too much easy money. In turn, these large commercial banks gave the mortgage banks too much easy money. Then the mortgage banks gave my mortgage broker too much easy money… that he was trying to pass on to me.

In fact, he once called himself “the evil banker that wants you to borrow more money.”

It all started with the Fed and ended up with the consumer. And every participant, just like teenagers, repeatedly used the excuse: “It’s not my fault.”

Over-Speculation Should Be Punished

Mortgage bankers haven’t exercised prudence in the last half-decade.

Today’s mortgage brokers enter numbers in a computer. The software program spits out an analysis, and then the mortgage broker thinks he has no accountability because the loan will be off his books in the blink of an eye. Once they unload this hot paper, they don’t have to worry.

What we shareholders are now learning is that the risk wasn’t decreased, only transferred. We all have accountability. Just look at the share price of Countrywide Financial, Indy Mac Bank, or even New Century Financial (New Century filed for bankruptcy in April 2007 and is currently being liquidated).

Call me callous or mean, but in financial markets, over speculation should be punished. Companies such as Bear Stearns and Countrywide should be allowed to go to the same graveyard as New Century Financial. If we don’t watch out, the new liquidity the Fed is pouring out will create a bubble in the current hot sector: commodities.

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