07.01.2008 0

Cure for Monetary Crisis: Do Nothing!

  • On: 07/16/2008 12:45:23
  • In: Economy

  • “The FED should have done nothing in 1914. It should have done nothing thereafter. If it had done nothing as a matter of policy, there would be no debt crisis facing the U.S. economy. There would be no advocacy of the creation of yet more moral hazards in the financial community.”
    – Gary North, “The Moral Hazard of Central Banking”, August 2007.

    In this brilliant essay, venerable economist Gary North notes how Big Government central banking policies tend to create financial dire straits – and how their “fixes” and “bailouts” only encourage future crises to occur into perpetuity.

    To drive home his point, he related today’s proposed government fixes to Japan’s financial crisis of the 1990’s, the so-called “lost decade”.

    Japan’s “solution” after their bubble burst was to set up super-low interest rates near zero, and use liquidity to keep the banks afloat, much like the Federal Reserve’s current policies today. North from his “Moral Hazard” piece tells us what is really going on with these bailouts:

    “This game rests on this slogan: ‘Too big to fail.’ It is more than a slogan. It is a mantra, a confession of faith. It is the shema Mammon… The FED will act to increase liquidity sufficiently to prevent disaster in the stock market. This will calm the markets. This will once again persuade investors that there is a safety net for them. Ironically, this perception is designated a ‘moral hazard.’ This is the only time the word ‘moral’ is seriously used in modern finance. A moral hazard – correctly named – occurs when central banks intervene to save specific industries, i.e., too-big-to-fail industries.”

    So, what’s the real solution? Economist Lawrence A. Hunter put it very well on WSJ’s message boards on March 12th, outlining that the markets could take care of the problem without any government intervention:

    “The vultures are out there, yes they are, but the government and banks are conspiring to keep the housing carrion hidden in the basement. If the Fed and the feds just stay out of this mess and allow the bodies to be laid out in the open, the market will clean up the mess as banks and especially Fannie and Freddie start selling off at a big discount the mortgages they bought and originated.

    “The constipation in the market isn’t being caused so much by the vultures holding back in search of a bottom; it’s the financial morticians keeping the bodies on ice in search of a federal bailout that is perpetuating the deep freeze and keeping the market from clearing at lower prices.

    “Allowing the market in mortgages to clear at a lower price will in turn permit VOLUNTARY workouts (including cram downs) as new mortgage owners with a much lower basis in their notes can work out the mortgages, keep homeowners in the houses and make money in the process. No matter how you slice and dice it, arguments to the contrary are simply excuses to prevent prices from falling to clear the market.

    “Bankers simply need to clean up their act; get a haircut; take their losses; enter a five step program; and get about the business of cleaning up their balance sheets.”

    If, instead, Big Government insists upon Big Bailouts, the U.S., like Japan, can say sayonara to solvency.

    ALG Perspective:
    As Gary North and Lawrence Hunter suggest, the Fed should just take a step back and let the chips fall where they may. The “invisible hand” of the market can work this crisis out, not the Fed, which played a gargantuan role in creating it in the first place. What is clear is that the more the central banks tinker and bail out the “too-big-to-fail” industries, the more these industries will engage in risky schemes banking on the safety net of government bailouts if things run awry. We say, let them fail. They’re not too-big-to-fail. They’re too stupid for us to allow this to happen again and again.

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