The Crutch that is Soon to be a New Appendage
I had an idea that perhaps the head of the FDIC Sheila Bair might just be reading Economic Disconnect. Today Mrs. Bair was out with some statements that wondered out loud as to when the US government may get out of the "lender of only resort" business. Recall my post from Tuesday November 25th (There is No Going back to a Free Market) where I said:
"To me the biggest issue going forward is that there will not be any way for the government to get out of the loan racket. Guaranteed cash and government backed debt is going to be both preferred and demanded going forward. Nobody will go into the private sector for funding when cheap money can be had at the FED. Is there any way the FED/Treasury cannot understand this?"
Today Sheila came out asking the same kinds of questions which were reported in the Washington Post:
FDIC head: gov't rescue plan needs 'exit strategy'
By MARCY GORDON
The Associated Press
Tuesday, December 2, 2008; 5:46 PM
WASHINGTON -- The head of the FDIC said Tuesday the government needs to devise an "exit strategy" for its massive financial rescue plan to avoid artificially propping up banks and other institutions over the long term.
"We really need to think through the exit strategy because (government guarantees) could become a crutch," she said. Weaker financial institutions "need to be allowed to fail," Bair added.
The government needs to decide which banks and other institutions receive the financial support, and eventually, "How do we get out?" she said.
Well that all sounds warm and fuzzy, but while Mrs. Bair was thinking about ways to remove the crutch that is a blanket guarantee for all things economic, other players were crafting plans to make that short term crotch a new market appendage. Since our economy does not seem to have one good leg to stand one, I guess that appendage leads the list!
While the FDIC was saying "exit strategy", the Treasury was thinking "how else can the US government get deeply involved?". I kid you not, here is the proof:
Treasury Considers Plan to Stem Home-Price Decline
Rates Could Be as Low as 4.5% for Newly Issued Loans
By DEBORAH SOLOMON and DAMIAN PALETTA
WASHINGTON -- The Treasury Department is considering a plan to revitalize the U.S. housing market by reducing mortgage rates for new loans, according to people familiar with the matter.
The plan, which is in the development stages, would use mortgage giants Fannie Mae and Freddie Mac to bring loan rates down as low as 4.5%, a full percentage point lower than the prevailing rates for 30-year fixed mortgages.
Under the plan, Treasury would buy securities underpinning loans guaranteed by the two mortgage giants, which are temporarily under the control of the government, as well as those guaranteed by the Federal Housing Administration. Fannie and Freddie guarantee a large proportion of all new home loans made in the U.S.
The Treasury thinks that mortgage rates are the reason homes are not selling and falling in price. We in the know are aware that a percentage point here or there made ZERO difference in the house price rocket on the way up, and will make ZERO difference on the way down as well. This is yet another action that if started will have to become a normal market mechanism. I mean when would you let rates float to normal? One year? Two? Ten? Who can say. Certainly not Hank Paulson who changes his mind daily about everything.
So you think government influence needs an exit strategy? Leading economists (or is it eKonomists) are calling for crazy government spending to save the world. People like Paul Krugman and even Nouriel Roubini are firmly is the "spend whatever is needed then do that 3 times over to make sure" camp. You do not believe me? Here is the proof:
How to avoid the horrors of ‘stag-deflation’
By Nouriel Roubini
Published: December 2 2008 19:53 | Last updated: December 2 2008 19:53
The US and the global economy are at risk of a severe stag-deflation, a deadly combination of economic stagnation/recession and deflation.
As traditional monetary policy becomes ineffective, other unorthodox policies have been used: massive provision of liquidity to financial institutions to unclog the liquidity crunch and reduce the spread between short-term market rates and policy rates; quasi-fiscal policies to bail out investors, lenders and borrowers. And even more unorthodox “crazy” policy actions become necessary to reduce the rising spread between long-term interest rates on government bonds and policy rates and the high spread of short-term and long-term market rates (mortgage rates, commercial paper, consumer credit) relative to short-term and long-term government bonds.
To reduce the former spread the central bank needs to commit to maintain policy rates close to zero for a long time and/or start outright purchases of government bonds; to reduce the latter it needs to spread massive liquidity, such as by direct purchases of commercial paper, mortgages, mortgage-backed securities (MBS) and other asset-backed securities. The Fed has already crossed that bridge with facilities that are aimed at reducing short-term market rates, such as Libor spreads; it has now moved to influence long-term mortgage rates by buying MBSs.
Traditionally, central banks are the lenders of last resort but they are becoming the lenders of first and only resort, as banks are not lending. Central banks are becoming the only lenders in the land. With consumption by households and capital spending by corporations collapsing, governments will soon become the spenders of first and only resort as fiscal deficits surge.
The statement "unclog the liquidity crunch" is especially annoying from Roubini as he has forever correctly identified the issue as a "SOLVENCY" issue and not one of liquidity. Why the change of song and dance now I could speculate, but I think you can figure it out (hint:he used to work for the new Treasury head; also he has been getting tons of publicity).
All told, I am going to be proven right. The Government will soon become a mega bank that controls almost all aspects of finance. Unintended consequences certainly will follow.
"Systemic Risk" Is Not an Option
This week is only a few days old and already we are being flooded with the good old "Systemic Risk" Ace of Spades Trump card. Today saw a new angle trotted out as the two following headlines show:
GM exec: bankruptcy not an option for industry
Pelosi Says Bankruptcy by Automakers ‘Not an Option’
So I gather a bailout is a sure thing? What if an automaker bailout was not an option? from about an hour ago:
Reid: Auto bailout lacks enough votes to pass
Someday the folks in Washington are going to get on the same page!
So the list of "Systemic Risks" has been updated:
-Insurers like Ambac and MBI going bust (Not!)
-Bear Stearns going bust (We will never know)
-Lehman Brothers going bust (Not!)
-AIG getting busted (property of US government now)
-Fannie and Freddie going under (property of US government as well)
-Automakers going bust (We might see)
And the list goes on and on. With Ben Bernanke getting set to use borrowed money to buy long dated Treasuries as to depress interest rates that are backed by issuing more debt (figure that one out and write to me!) I would say the only systemic risk I see is wild action by the US government. With all the calls of a second "Great Depression" running wild I will offer a new term to better describe where we are:
"The Great Confusion"
Nobody knows what is going on. Nobody knows where over 2 Trillion dollars has gone over the last 6 months. Nobody know what CDS exposure means. Nobody has an idea how California, New Jersey and other states are going to get through their issues. Nobody knows what nobody knows. In the Great Confusion what we need is a little thinking and a bit of light cast on the core issues. Then good policy could maybe be put together. Flying by the seat of your pants in the dark has proven to be a loser way to go up until now. The question remains, who can stop the ship USS Confused before it is too late? I see icebergs ahead.
Have a good night.