Saturday, January 26, 2008

Bernanke Bet the Farm

Markets are still volatile, but a post rate-reduction rally buoyed investor's spirits and some recovery has resulted. Rather pressing questions remain. The sub-prime loan meltdown became a bigger problem when it began to involve a little-known segment of the insurance industry that provides protection for institutions against major loss. As mortgage losses mounted, so did claims and soon a couple of well-known insurance companies had significant loss problems. Suddenly, the problem had broken out from a single sector to involve the very core of the finance segment.

This resulted in a sort of institutional paranoia that threatened liquidity, as banks became wary of even lending to each other. Quite unheard of, that. Since economies in the developed world rely on the flow of currency; the constant, uninterrupted flow of money, the looming liquidity crisis was not tolerable. The down-side was just too great. So the Fed, in an extraordinary emergency intervention, lowered the rate by three-quarters of a percent, 75 basis points. First time that's happened in over 20 years. And it had an immediate effect. Whether it will be adequate to the task and thus promote lasting stability remains to be seen. And there's the rub.

Ben Bernanke has literally bet the farm. If this historic intervention fails, hyperinflation may follow and the Fed's basic tools to implement monetary policy will be viewed as broken and ineffective. And that, believe me, will be an entirely new world. Economists are already arguing about the decision. But for now, liquidity has been restored and the predicted rally ensued. All is well in Dodge. Ah, but how long will it last?

Point is: the fundamentals will determine the success or failure of this intervention, and forever color the tenure of this Fed Chair. I'm still parsing the entirety of it all, but several issues are clear. First, the depth of the crisis has yet to be accurately plumbed. We're just not sure how far these losses will extend, and just which companies and economies will be involved.

Now, we learn of a French, "rogue trader" at Societe Generale who, single-handed, amassed over $7 billion in losses. Read that story here. So we're also not sure where the crash will end. Will the credit card space collapse along with the mortgage loan sector? Will the losses suffered by cities, counties, pension funds, unions and non-profits with investment portfolios supercharge the collapse? Will our foreign bankers and underwriters cooperate with our efforts and collaborate on solutions, or will the rest of the world view this as an opportunity to eclipse our achievements and teach us a lesson? There are a lot of variables involved. How the chips fall will affect the outcome. Maybe it's time to consult the "long-wave" theorists and get out that old copy of Kondratieff from the bookshelf. Something tells me that John Maynard Keynes isn’t' going to cut it. If you've got an IRA or 401k plan, perhaps this is the time to increase your cash position and ratchet-back on all but recession-safe securities. If you're young, look into a good floor safe.

Second, the bi-partisan stimulus package is an exercise in feel-good politics that will have very little impact. What little impact it may have will also have to wait until May - arguably far too late to matter. In fact, the package will have the ironic effect of transferring more of our debt and our national assets off-shore. Sure, the pennies they throw my way will get spent, but the effort looks a lot like crumbs of cake for the peasants, and we all know what happened to Marie Antoinette.

Finally, it is striking that when faced with crisis, this administration hurries to bail-out the bankers, insurance companies and retailers in a big way - while throwing citizens a bone.

I've posted about the run-up to this crisis before: the looming recession in this post; blaming consumers for the sub-prime mortgage mess in this post; and, the prospect of our beloved country becomming a third-world nation in this article. I promise I'll get back to new music and the latest in technology very soon.

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