Does the FED Know That Their Balance Sheet is at the "Disposal Of the Investment Banks"?

Quite the ripper of a day, Yes? Wild times indeed. On the garden note, I was looking through a bunch of the websites suggested by loyal reader Kevin and I think that I will try to grow carrots and onions to go along with the potatoes. Seems easy enough, but those are famous last words! I think it might be nice to have super fresh veggies that I grew myself. Hopefully it will go well. I can splice genes together and sequence DNA, but growing veggies may be something more difficult! Wish me luck.

On Moral Hazard
There has been tons of talk about "moral hazard" as it relates to the current efforts by the FED to save the galaxy. To start, lets define what it is exactly and go from there, from WIKI:

"Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions. For example, an individual with insurance against automobile theft may be less vigilant about locking his car, because the negative consequences of automobile theft are (partially) borne by the insurance company."

Obviously the FED's action concerning the banks meets this criteria and then some. That is not the point I want to discuss. The issue I would present is the total disregard for the "moral hazard" concept. Major market players have been saying things like "The FED has to act to save the financial system, we can worry about moral hazard later" or other gems like "Forget moral hazards, the banks need a bailout". This is not fringe thinkers, but folks like those at PIMCO, Paul Krugman, and others.

When one disregards major concerns like moral hazard, they are behaving in a reactive way. It is of course impossible to think or correct a moral hazard AFTER THE FACT. Putting aside important questions is a good way to mask intentions and desires. Think of the following example:
"Forget about weapons of mass destruction, the war in Iraq is about spreading Democracy!"
See what I mean? Ignore important questions if you want, but do so at your own risk. It is a disturbing and bad omen for the future that the clear hazard invoked by bailing out banks that are broke is passed by without real debate. Which leads nicely into my main topic tonight........

Does the FED Know that their Balance Sheet is at the "Disposal Of the Investment Banks"?
" This kind of Government knows how to help business...to encourage it... What I am saying is, we have now what we have always needed, real partnership with the government." - Hyman Roth in "The Godfather II"

The dominant theme today on CNBC was the euphoria over what was seen as the FED now opening up their entire balance sheet of treasuries to the investment banks. Goldman Sachs and Lehman Brothers were on fire today with that thought in mind. I saw this idea repeated verbatim no less than 30 times in the 1 hour I watched of it when I got home. This "relief" for the banks was seen as the big catalyst for the upside move, even after a less than desired 75bps rate cut.

And thus, we arrive at the problems of avoiding moral hazard. Perhaps the FED thinks that they are doing nothing more than providing short term funding to supply "liquidity" or whatever they are thinking. The problem is that the investment banks now regard as part of the solution complete access to the FED's cash stash. I cannot stress enough the importance of this development. I expect better coverage of this meme in tomorrow's big blogs and maybe even the mainstream media.

Consider this progression;

1. Investment banks create CDO's, SIV's, MBS', and other exotic mortgage backed paper
2. The loans are terrible, and getting worse all the time
3. Massive loses start to pile up
4. The banks start hemorrhaging money as problems mount
5. The FED has to step in and save the banks
6. The banks reload with cash and can start the same behavior that resulted in the mess

This is the ultimate free pass of all time. At months end the banks can start to park their severely stressed assets at the FED, take out cash based on mythical valuations of their cruddy paper, and find new and exciting ways to lose it all. Can there be any real debate about this?

Right now the idea of having total access to FED cash has taken root. Once that happens, the problem for the FED become the infamous "managing expectations" game the FED plays. What if this idea is not what the FED wants? If they balk, the markets will tank as the illusion of endless cash evaporates. The FED has created a monster with their fast and not well thought out actions of the past few months. By promising ever escalating levels of help, they cannot fail to deliver on every whim of Wall Street unless they want to risk a major dislocation. It seems that the banks have been successful in making enough noise to pressure the FED to do exactly what they want.

The Hyman Roth quote above fits very well here. The banks, after screwing themselves royally, have now enlisted the government as new capital partners Things could not be worse or more fitting. How any of this is seen as a positive (regardless of stock prices; I am talking philosophically and ethically) is beyond me.

Odds and Ends

• Interest rates - Now at 2.25% after today's 75bps move. I have seen a ton of discussion implying that the FED is done cutting, or going to slow down the cutting. Simply put and in no uncertain terms, anyone thinking that way is F#ING BRAIN DEAD. No offense meant, just stating a fact. Don't bother me with parsing the language of the FED statement that included some crud about inflation. It usually is not standard procedure to cut rates by a whopping 25% if you are indeed concerned with inflation. The FED could not stop cutting anyway, the markets would crash. Not that rate cuts are helping, or will help, but that idea is still stuck in peoples playbooks. Rates will be at 1% by June, and then we can discuss a possible end to cuts.
• Bear Stearns - Given the bailout mania that the FED has now caused on Wall Street it comes as no surprise that the BSC stockholders might want a better deal. The action on the stock, which is set at $2, is amazing. I have read that this is some bond buying scheme or something, but that is not the talk on the street. Stockholders want a better deal, and heck if the FED's cash is now on demand (see this issue cropping up a bit do you?), I do not feel they are wrong! BSC bears (haha) watching.
• FED Out of Bullets - The more I hear Alan Greenspan talk, the more I am convinced he had no idea what the hell he was doing while at the FED. Can Bernanke be much different? The faith and confidence in the FED should be taking a beating, but alas, it is not. With only 2.25% to work with, there are not many bullets left in the gun. To borrow a Minyanville term, the FED only has a few bullets left, and the last one is of course going to pointed at themselves!

Comic Relief

Had to share this one:

see more crazy cat pics

Have a good night.