Page 1 of 2 Tough love's fatal attraction
By Julian Delasantellis
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.
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
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