10.01.2008 0

“The Inevitable Flood”

  • On: 10/22/2008 14:34:00
  • In: Economy
  • “How many times have we seen this movie in the last 13 months? Each time there has been a clamour to argue that this measure is the one that turns everything around and each time we see it followed by even bigger problems and bigger measures—exactly how a crisis tends to play out.”CitiFX Technicals – Bulletin, September 8th, 2008.

    Big Government is getting bigger. And it may take a gargantuan flood to wash it away once and for all, along with the American taxpayer, gasping for breath along the way.

    In the wake of Fannie Mae and Freddie Mac being fully nationalized by the U.S. Treasury, the Citi Foreign Exchange released a bulletin entitled, “Welcome to the U.S.S.R. (United States Socialist Republic)”, which outlines some serious risks involved with this dicey plan:

    “[W]e struggle to see how translating the exposure of a major part of the U.S. mortgage industry to the U.S. consumer is something we should be jumping up and down for joy about. Neither is the fact that yet another financial institutions(s) has common stock effectively worth nothing and a realisation that preferred stock is not a risk free investment. Tell the guy who is part of Friday’s 6.1% unemployment rate how a few basis points improvement in his mortgage (If that is actually what happens) makes everything o.k.

    “Do we honestly believe that another sleight of hand from the Treasury/FED suddenly makes all the problems go away? Do U.S. consumers realise that they have just involuntarily doubled-down on the U.S. mortgage/housing market?—because if this bet does not work they will be ‘carrying the can’ for this.”

    The bulletin goes on to outline some of the major moves by the Treasury and the Fed over the past 13 months that have failed to cure the credit crisis: reductions in the federal funds rate, reductions in the primary credit discount rate, “[s]ignificant changes in limits for SOMA securities lending programme”, the Bear Sterns bailout, the first Freddie/Fannie bailout, and then finally, the takeover of the two Government Sponsored Enterprises (GSEs).

    As the Citi’s market commentary notes, each of these tremendous moves by the federal government into the markets has been followed by a brief surge in the markets, followed by steep drop. In other words, the trend is down, and Big Government can’t stop it. From the bulletin:

    “You have only so many fingers to ‘plug the leaking dyke’ and eventually the flood overcomes you… There is a strong perception that today’s action is a ‘pivotal event’ and we tend to agree with that, but not in the way of the market reaction. We believe it will become apparent that this is just another reactive move to stem ‘the inevitable flood’.”

    In other words, Big Government, in order to prevent a recession that may be unpreventable, has put the taxpayer on the hook for over $500 billion in bailouts (and counting). Assuming that the worst is not over just yet—for example if home values continue to drop and the trend for foreclosures remains upward—will there come a point when policymakers conclude that recessions are not such a bad thing?

    To be fair, the Bush administration believes it is preventing not just a recession, but a catastrophic failure of the global financial system. But is that even the proper role of government? And are these actions just making things worse?

    If the problem is that this country lends too much money, causing inflation, and prints too much money, which also causes inflation, does propping up favorable lending conditions and engaging in big bailouts really make much sense?

    Isn’t that a lot like trying to cure a hangover by going on a binge?

    Obviously, inflation is not the only problem facing the economy, and the health of the financial system is of grave concern. But it may ultimately be beyond repair. And mostly because the market is not being allowed to correct itself. Instead the government is trying to “correct” the economy (which apparently is never supposed to go down). If the financial system itself—as managed by the Fed and Treasury—is the cause, inflation is the effect.

    Ultimately, the financial system is dictated by the terms of the monetary system. And the Fed and Treasury may only be treating the symptoms by propping up a faulty system.

    Only time will tell. But there could be a major flood on the way, and the American taxpayer may wind up at the bottom of the cataclysm.

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