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AsiaTimes, 27th August 2008
One of the most popular programs on the American A&E cable television network is called Intervention, or as I like to call it, the Super Bawl. Every week a person with a different type of addiction, be it with narcotics, alcohol, gambling, shopping, chicken nuggets, blogging, whatever, is featured on the show.
The person's ever-worsening addiction has put him on an ever-steeper and steeper downward slope, until the addict's family, usually financially and emotionally supporting the addict through his travails, says enough is enough. They schedule what is called an "intervention", moderated by the latest well-paid avatar of the prevailing national ideology of never ending feel-goodism, an "intervention specialist". The intervention is basically a group meeting of the addict's family and friends, telling him to get his act together - or else. Either accept commitment in an addiction counseling program, usually as an inpatient on a locked hospital ward, or get totally cut off from further financial and emotional support from family and friends.
One wonders just how close the United States Federal Reserve and Department of the Treasury are now to offering the financial markets just one last chance to shape themselves up, or, failing that, from being ineligible for any further assistance or rescue.
On August 17 last year, US Federal Reserve Board chairman Ben Bernanke, like the Lone Ranger of old, rode onto Wall Street in a cloud of dust and with a hearty "Hi yo Silver, financial instability away!" undertook what has turned out to be merely the first of many financial system rescues over these past 53 weeks.
That first move, following an emergency teleconference of Fed members, was a 50 basis point cut in the Federal Reserve's discount rate, the rate the Fed charges its member banks for direct loans to enable the banks to meet their reserve requirements.
At the time, that first rescue move was pretty much a bolt out of the blue, for, just 10 days previously, at the midsummer meeting of the Fed's interest rate setting Open Market Committee, the Fed spread its gaze upon the land and saw nothing it could see not within its liking.
This from the Fed's statement following the August 7 meeting:
The economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
But the markets disagreed. Like the addict begging for money for another fix, from the close on last August 7 to the lows on August 16, the Dow Jones Industrial Average lost 1,050 points, about 7% of its value. That, and the voices of America's speculation royalty pounding on Bernanke's office door as if he was but a feudal vassal, caused Bernanke to move on that first rescue. (See Vox populi: Why the Fed did a U-turn, Asia Times Online, October 17, 2007, on the the pressures that caused Bernanke to make that first rate cut.)
How the summer sky had darkened in just those 10 days, as the Fed's then post-emergency meeting statement indicated.
Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.
How great and glorious was the exquisite high following that first sweet hit. The Dow rose 230 points just the day after that first Fed move was announced.
The high soon wore off, and the underlying physical need, in the case of the addict's body for the narcotic that produces the joy that he cannot experience in real life, in the case of the financial system for replacement of the capital and liquidity that was being subject to the ongoing destruction through what we have come to know as the subprime mortgage crisis, returned. The Fed was back in the markets once more, with its big dual 50 point cuts in both the Discount and Federal Funds rates, on September 18.
This pattern is essentially the dynamic of the financial markets' history this past year. The markets get nervous about the damage that the subprime crisis is doing to the financial system's balance sheets, its liquidity. The Fed moves in with support. The markets feel and act great for a while, but it always wears off, and the Fed has to move again. Any parent or loved one of a substance abuser knows just how painful and draining this is over the long term; likewise for Bernanke, now said to be able to be found in his office seven days a week, subsisting on Dr Pepper, trying to cure the markets' substance-abuse problem, namely, years of abuse of money and trust.
But like the early stages of dealing with any addiction, at first, the treatment was simple - the ailment didn't seem all that hard to beat. The Dow Jones Average rallied strongly off the September moves, rising over 800 points to reach its all time high over 14,100 on October 11.
Then the hit wore off. Renewed worries about the subprime crisis' effect on the financial sector, exemplified by sliding prices of financial sector stocks, caused the Dow to fall 1500 points between early October and late November. Then, it was time for the markets to get a good Middle Eastern high, as the November 27 announcement that the Abu Dhabi Investment Authority was taking a 4.9% stake in Citigroup raised hopes that foreign Sovereign Wealth Funds might come in and, with their now trillions of ever mounting wealth, save the financial system from its own excesses (see Selling the US by the dollar Asia Times Online, November 29, 2007.)
But that was not to be either. A brief, two-week rally was met by heavy selling that culminated in the third week of January with the SocGen trading scandal. By the end of January the Fed had cut another 1.25% off both the Discount and Federal Funds Target rate.
A brief high was then followed by heavy selling that culminated in the Bear Stearns crisis of mid-March. By then, however, it was seen that the old fixes just weren't enough to get that same high anymore. Besides another 75 basis points off the Federal Funds rate, and another 100 points off the Discount Rate, the financial markets, in essence, demanded the right to move back in with their parents.
A key part of calming the markets then was the de facto nationalization of Bear by the government (see A risk-free revolution , Asia Times Online, April 2, 2008, and Bear's death and the US way of banking, Asia Times Online, July 31, 2008).
The now-familiar pattern held following the Bear rescue, with a 1,700 point Dow rally that topped out in early May. Then, of course, the high wore off, the fear in the financial sector resumed, the selling intensified, the hunger at the addict's core would not be silenced. From mid-May to mid-July the Dow lost another 1,700 points.
Bernanke and Paulson had probably thought that the type of aggressive intervention exemplified by the Bear Stearns rescue was an extraordinary, once-in-a-lifetime financial necessity. Then came the crisis with Fannie and Freddie.
For a crisis that took seed and root in the practice of assessing value and lending to that value in the US housing finance system, it was probably always inevitable that a toll would eventually .be taken on Fannie Mae and Freddie Mac, the semi-private semi-public mortgage guarantor government sponsored entities (GSEs). When their stock values started plunging in June to mid-July, everybody knew what that meant - the financial system needed another hit.
But as many families of addicts have come to know to their misfortune, eventually, the addict's needs overwhelm the capability of their loved ones to help. By mid-July, the 325 basis points of interest rate cuts that the Fed had given to the markets in 10 months had essentially left it tapped out; it could not cut again without abandoning any and all credibility on inflation. Therefore, the Fed, working alongside the US Treasury and the Securities and Exchange Commission (SEC), had to come up with, in effect, financial system methadone.
Bernanke's portion in the rescue, as he had done with Bear Stearns in March, was to stretch the rules to allow discount window borrowing for Fannie and Freddie. Treasury Secretary Henry Paulson pledged an increased line of credit, as well as added government equity investments in the pair, SEC chairman Christopher Cox pitched in with his restrictions on short selling in the financial sector.
At first, the tripartite drug cocktail seemed to be producing its usual groovy effect. Stocks rallied over 1,000 points between the crisis lows on July 15 and August 11. But then, again, renewed concerns about Fannie and Freddie, and renewed selling in the shares once the short selling restrictions were lifted, started driving the general market down again. Both Fannie and Freddie's share prices are now well below the levels that provoked mid-July's rescue operation, and as they go down the share prices in the rest of the financial sector, along with those in the general market, are being dragged down along with them. Like any addict with any addiction, the need for hits is getting larger and larger, and the highs themselves are getting briefer and briefer.
So is it time for another government hit? Maybe not, maybe this time, the markets are going to get some tough love.
It is being observed that other than staving off a theoretical much-worse disaster the rescuers always warn about, none of this seems to be doing all that much good. According to Freddie Mac, the average rate on a new American 30-year mortgage now stands at 6.47%, down only 10 basis points from last August, even with the Fed taking off 325 points of short-term rates. All that money the Fed is trying to get into the system is leaking out long before it gets to mortgage finance.
Part of this is undoubtedly Fannie and Freddie's troubles, but more of it is most likely because investors in mortgage backed securities no longer see US real estate as the golden savannah promising riskless high interest rate returns from horizon to horizon.
The Fed's inability to drive mortgage rates down in the face of economic weakness, along with new, much more stringent borrower eligibility verifications (unlike in 2006, when you needed neither a pulse nor some semblance of human DNA to get a $500,000 mortgage) is of course, further suppressing real estate demand in the US, leading to more lower prices and foreclosures, more real estate loans turning toxic on the books of the financial system - in short, the next flight down into the black hole the financial crisis.
Beyond the opinion that the Federal government can't do much more to rescue the financial system, a growing and significant chorus of voices are now saying that the government shouldn't do much more.
The commonly referred to rationale for all this financial system support is what is called "financial stability" - that is, making sure that institutions exist that match up, that, in banking lingo, " intermediate" between lenders who want to lend and borrowers who want to borrow.
When a rescue is engineered for an individual financial institution such as Bear Stearns or Fannie and Freddie, the common rationale is that these institutions occupy such a vital and central role in the financial system that their sudden disappearance would lead to such financial market instability, such " disintermediation", that the crucial flow of new finance to the actual economy would be interrupted.
Is that true? It certainly was during the Great Depression of the 1930s, but that was three quarters of a century ago, and that lesson has begun to fade. Besides, who talks about the Great Depression anymore except old fogeys in nursing homes?
Many of today's economic voices, especially those of the still influential free market/laissez faire school who, in America's boundless economic ignorance, have still dodged the approbation they deserve for this entire catastrophe, say that too big to fail is wrong, and that it's bad economic policy.
The argument here goes that failure is not a circumstance that should be fought and resisted to the limit of the government's power but a healthy and necessary purgative that cleans the system of its fetid failures and misadventures, freeing up new resources for the next generation of ambitious entrepreneurs with hopefully better ideas. Turn of the 20th century Austrian economist Joseph Schumpeter called this process "creative destruction", and for him it was not just a theory; it was the way the capitalist economies of the world worked before the near universal expansion of government's role in macroeconomic management in the 1920s and 1930s.
Also, there is objection as to how these government financial institution support operations work. Most of them involve some sort of guarantee of the threatened institution's debts and other obligations, so that the institution can enter the debt market then borrow much more cheaply with the government's healthy credit rating rather than its own. Thus, if the institution subsequently does fail, the government, taxpayers, must foot the bill, but if it succeeds, and the institution prospers, the much more limited subset of the institution's bond and stockholders will get rich, while taxpayers will receive almost nothing. This "socialization of risk and privatization of reward" offends many economic observers, for it seems such a direct contradiction of how capitalist economies are supposed to work.
Around the time Fannie and Freddie were rescued in late July, a noted American casual dining restaurant -these are places for those who show up to dine in flip-flops and tank tops, and think that the place is "real classy" because, unlike in the TV commercials, "you don't have to ask for Grey Poupon - it's right there on the table" - Bennigan's closed its doors. Some wags wondered if this circumstance called for another Bernanke & Co emergency rescue operation, if only to forestall threatened chaos in the market for leathery steaks and watery beer.
Amazingly, in an American public that knows far more about Ellen Degeneres' wedding centerpieces than contemporary economic principles and debates, there has developed a grass roots, Main Street opposition to all these government financial system rescue operations the elite are doing for Wall Street.
Following on the now almost universally held belief in society that narcissism is not a vice but a right sanctioned in the constitution, that a government benefit to someone else, for whatever reason, is unfair if I don't get a piece of it, some say that these rescue operations, by indirectly supporting the real estate market, are unfair to renters since, by preventing real estate prices from promptly falling 50% or more, they continue to support the inflated real estate values of a few years ago that kept renters, particularly young and minority renters, from being owners.
The answer to that point, is, of course, to just see how easy it is going to be to get a mortgage if and when about $7 trillion of America's $15 trillion of home equity gets wiped out. With half or more of the world's mortgage backed securities then worthless, I suppose the holders of that new very expensive fireplace kindling will be just itching to get back into the market to underwrite new mortgages, won't they?
Among the lonely crowd on the American far right, those who value their constitutional right to bear guns as much or more as their God given right to bear children, another form of opposition to the manner in which the financial; system is being rescued has arisen.
All these efforts involve substantial expansions of the government's power and authority, especially its power to spend money without Congressional approval. Also, since these people have observed that with so much of the mortgage backed securities and associated debt issued by the GSEs owned by foreigners, particularly the foreign central banks of countries with very questionable intentions regarding the US such as China and Russia, defaulting on these obligations is more an example of patriotic serendipity and valor than welshing on a debt backed by the nation's honor.
All the various free-market opponents of the expanded government interventions to save the economy from the worst possible effects of the credit crisis coalesced into a fairly significant working minority in the Congressional Republican caucus, led by Senator Jim Bunning of Tennessee, that for months successfully stalled progress and eventual passage on the Dodd/Frank housing finance rescue bill (sponsored by House Financial Services Committee chairman Barney Frank and Senate Banking Committee chairman Christopher Dodd. During this delay, hundreds of thousands of American mortgage holders that could have been helped by the bill defaulted on their mortgages and thus entered foreclosure proceedings that are resulting in the loss of their houses.
The question then becomes, have all these factors, particularly the diverse, sometimes inchoate opposition to the manner in which the government financial elite have recruited from the private sector is reaching back to save their buddies (and their future jobs ) in the private sector sufficient to stop any further rescues of the financial sector? Is the next supplicant, maybe Lehman Brothers, maybe once again Fannie and Freddie, to knock on the door of Paulson, Bernanke and Cox saying that they're too big to fail going to be told that, in actuality, they're not?
It's not hard to imagine the consequences of such a denial. However soothing such a stand on free-market principle would undoubtedly sound to those seduced down the Pied Piper's road by ideology, for the rest of us the results would be catastrophic.
I've shown here how it has only been the US government's implied promise of support that has supported US, and to a certain extent world, stock prices these past 12 months; take that away and it's anybody's guess as to how far below current prices stocks would find their new equilibrium. Also, the wave after wave of mortgage backed security defaults that would follow upon the withdrawal of government support from the housing finance industry would undoubtedly raise interest rates on all US dollar corporate borrowing, pushing both a housing and/or economic recovery even further into the future.
At the annual meeting of Nobel Prize winners in economics, held last week at Lindau in southern Germany, both conservative Myron Scholes, the father of the modern options market and winner of the Nobel Prize in 1997, and former Clinton administration economic advisor and 2001 winner Joseph Stiglitz warned of more pain and retrenchments to come in the financial markets.
Against this backdrop, you might think it a form of madness for the government to withdraw support for the financial markets at a time like this. But madness, specifically, the madness of ideology over reason, is precisely what awaits America for the next 70-odd days (and many will be very odd, indeed!) until the presidential election on November 4. With the nation continuing to be polarized into an almost perfect 50-50 split between left and right, those on the right well know that opposing further government intervention to rescue the markets is a key way to prove the ideological bona fides that will motivate their base to win on Election Day.
In the same way that the New Testament's Book of Mark asked "For what shall it profit a man, if he shall gain the whole world and lose his own soul?", the thinking among this ideological point of view would be "what profit a party if it saves the financial system, but loses the election?"
So the financial system should not automatically assume further rescues, at least not for the next 70 days. It should not assume that anybody's too big to fail.
In 1979, Pink Floyd's song Comfortably Numb portrayed a feeling very much like the markets have been feeling recently following a government bailout: "There is no pain; you are receding ... I have become comfortably numb."
But if the government does withdraw support from the financial system, the markets will be feeling a lot more like John Lennon did in his 1969 song, Cold Turkey
Temperature's rising, fever is high.
Can't see no future, can't see no sky.
My feet are so heavy, so is my head
I wish I was a baby, I wish I was dead.
Thirty-six hours rolling in pain
praying to someone free me again.
Oh, I'll be a good boy, please, make me well.
I promise you anything, get me out of this hell.
Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at
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