10.01.2008 0

Don’t Fear the Reaper

  • On: 10/22/2008 15:07:17
  • In: Economy
  • It looks like Wall Street, in lieu of actual investment, is looking for a handout.

    You could hear them whining, literally, when despite pressure from Wall Street for the Fed to slash interest rates in light of Lehman Brothers declaring bankruptcy, Merrill Lynch being bought by Bank of America, and AIG on the brink of insolvency, the Fed yesterday held the line on interest rates, leaving the federal funds rate at 2 percent.

    The Fed’s decision came on the heels of the Treasury’s decision yesterday not to backstop a rescue of Lehman Brothers. The non-decision on interest rates was good news for the free market and the dollar.

    But then, yesterday was a mixed bag, as after-hours it was announced that the Fed was stepping in with an $85 billion loan for AIG, similar to the $30 billion loan that allowed JP Morgan to purchase Bear Sterns. The difference is that AIG is an insurance broker, and the Fed got an 80 percent stake in the company, too. The Fed was originally designed to lend to banks. With Bear, it opened up to investment banks. And now that it’s open to the insurance industry, where does it end?

    This really is quite troubling, because all of the previous pro-active interventions by the Fed and Treasury have seemingly not prevented the financial crisis from continuing unabated, as ALG News reported in “The Inevitable Flood”.

    Will this latest loan to AIG prevent a market-wide collapse in the short term? And even if it does, what are the long-term costs of lending to the so-called “too-big-to-fail” industries? First the mortgage industry fails, and now the insurance giants are faltering. Why do we get the feeling this is only the beginning? What’s the sense of throwing money into the wind?

    What if they fail anyway? Does that mean they’ll have to be nationalized, too, like Fannie and Freddie? Really, where does this end? And what effects will this have on the federal government’s credit-worthiness? These decisions may only be buying time, prolonging a market contraction, and perhaps making it more painful in the end when there can be no more bailouts. Eventually, somebody is going to have to pay the Reaper.

    And it will be painful. We promise.

    Fortunately, the Fed’s non-decision on interest rates may have prevented another wave of commodities inflation. Previous moves over the past 13 months to cut interest rates in response to the subprime mortgage crisis saw oil rise from about $75 a barrel to about $145 a barrel until the bubble finally popped in July amid a global economic slowdown. Not so coincidentally, that was after the Fed stopped slashing rates. Oil has dropped to less than $95 since then.

    By doing nothing with rates, hopefully the overall market will finally find its bottom. With oil dropping precipitously, homeowners will have more of their income to spend on meeting their monthly payments. In that sense, fighting inflation helps to solve the credit crisis, as has been noted repeatedly by the eminent free market capitalist, Larry Kudlow.

    However, their pro-dollar moves may actually be trumped by their other bailouts.  Markets would respond if they knew it really was every man for himself. Right now, the message is, if you get so big as to endanger everybody else, you’ve lucked out, because government won’t let you fail. If there was no safety net, companies would never rationally take on so much risk.

    The AIG loan does not make us hopeful that the financial mess is over. The nebulous market bottom may remain so with these mixed signals from the government.

    It should have drawn the line in the sand. The bottom would come quickly if it had drawn that line back in March, and economic recovery would then be around the corner. If the Fed had never intervened, the current economic crisis would have happened anyway, as it was years in the making.

    But the difference is it might already be over. Since the $30 billion Bear Sterns bailout and bringing interest rates down, financial markets have still failed to recover. In fact, they appear to be worse than they were six months ago.

    Instead, these interventions sparked a bailout fever. It was used by lawmakers to justify the $300 billion Foreclosure “Prevention” Act. Which in turn did not prevent Fannie Mae and Freddie Mac from nearly collapsing, and another $200 billion (at least) bailout to take them over. Which in turn did not prevent Lehman Brothers from going down and seeking central bank aid on the way. And who’s to say it didn’t create the circumstances and market factors that prompted AIG to get its loan to prevent bankruptcy?

    By all accounts, the subprime crisis happened because banks gave out loans to those that could not afford to pay them back. Is that what the Fed and Treasury are doing now? It’s a question. Will the taxpayer ever be paid back?

    Because, if not, the government just spit out another $85 billion to “prevent” an inevitable flood. Instead, we should not fear the Reaper. Failure actually is an option.

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