The Fed Deals A Card
August 18th, 2007 by 
reality
The Fed stepped in to support the share markets. Even though they are basically only flat for the year, the Wall Street boyz felt that they needed a bailout and so they got one. As I mentioned before, the timing of the Fed move and its surprise were chosen for effect, which admits of only one conclusion as to the intent of the move.
The Fed apparently went on to hold a conference call to urge the major banks to use the discount window, freshly rolled down, to borrow money and then to lend same to the mortgage industry. If there was any doubt about the Fed’s desire to reflate the bubble, set it aside. The Fed clearly understands the problem, that they can print all the money they want, but the credit industry must put it to work.
Unfortunately, burst bubbles don’t reflate easily. Nouriel Roubini puts it well: “The economic slowdown is already underway and given the glut of housing, autos and durable goods in the economy the demand for these goods will be relatively insensitive to interest rates.”
People liken this to the 1998 LTCM crisis, but it is very different. In 1998, a major player, LTCM, “got it wrong” in the financial markets and a derivatives crisis was narrowly avoided by the Fed’s intervention. It is different in 2007. First of all, the root of the problems is economic, not financial. Too much money has been badly invested, most visibly in residential housing, so that there is a glut. More than people can use or occupy, let alone afford. As a result, prices will decline and leverage will implode. The Fed may be able to slow this process, but it is very doubtful that it can restart the upward trajectory of debt that is needed to sustain the bubble economy.
Anyhow, enough whining. The Fed is now sitting at the table, helping the bulls with extra cards from time to time. It will be a rough ride for the bears, because the Fed can and will make life difficult for us. As Marty Zweig famously said “Don’t fight the Fed”. Well Marty, sound advice, but when the Fed is playing stupid, someone has to do it. The good news is that the Fed will keep the bear brigades thinned out, which will make it more profitable to tough it out. This is the end of a Ponzi finance bubble. It isn’t “subprime”. It isn’t just housing. It is a debt mountain four times the size of GDP, augmented by a derivatives tower so high no-one knows how tall it it.
Posted in Fixed Income, Manias, Nouriel Roubini, Real Estate, Stocks, Strategy & Scenarios, The Economy, The Fed | 
August 18th, 2007 at 8:40 am
Hmmm, so you expect the Fed to lower real interest rates in an attempt to keep the party going?
I do know that my rent and food bills have increased a lot more than official inflation figures would indicate. It reminds me of the rising prices during the 70’s. In response they raised interest rates which turned out rather badly in the 80’s. Perhaps they are going to try the opposite this time.
Or maybe the Fed needs to keep the economic party going for the election year before aligning economic policy with economic reality in 2009…
August 18th, 2007 at 2:23 pm
Bernanke believes (wrongly) that the Great Depression was the result of the Fed failing to ease early enough and hard enough. He has vowed that he will not repeat that mistake. He promised to have helicopters drop money on street corners if necessary. I take him at his word.
But it won’t solve the problem. The Bank of Japan tried it and it didn’t work.
August 19th, 2007 at 6:45 am
Hussman says the Fed are just doing their job.
http://www.hussmanfunds.com/wmc/wmc070813.htm
You seem to be saying there is a conspiracy with the boyz. Could it be incompetence? Or are the Fed just doing their job?
August 19th, 2007 at 7:18 am
When John Hussman wrote that I thought the Fed was just doing their job, too. See http://alamedalearning.com/reality/2007/08/11/995/. But the timing of this move, trying to “surprise” the markets, is childish behavior, obviously trying to manipulate the share markets and not worthy of a professional central bank.
August 19th, 2007 at 8:27 am
Dropping money from helicopters?
Didn’t Zimbabwe try that (4,530% inflation)?
August 19th, 2007 at 9:31 am
Well, yes. Zimbabwe, the Weimar hyperinflation and too many Latin American countries to list are a different syndrome. The inflation resulted in all cases from massive government spending and a decline in industrial and/or agricultural production. Zimbabwe, the collapse in agriculture due to the dispossession of the farmers; Weimar, a general strike in opposition to the French asset seizures; and so forth. The syndrome we are dealing with here (and in the 1920s US and 1980s Japan) is a credit bubble causing extensive overconsumption or malinvestment.