This is the most radical change and expansions of Fed powers and functions since the Great Depression: essentially the Fed now can lend unlimited amounts to non bank highly leveraged institutions that it does not regulate. The Fed is treating this run on the shadow financial system as a liquidity run but the Fed has no idea of whether such institutions are insolvent. As JPMorgan paid only about $200 million for Bear Stearns – and only after the Fed promised a $30 billlion loan – this was a clear case where this non bank financial institution was insolvent.[emphasis mine]
We should also remember to consider this Fed Action in light of Mr. Bernanke's area of academic interest; The Great Depression. In particular, the Fed Chair has accepted Friedman and Schwartz's argument that the Fed failed to stem the Depression in the begining by tightening the money supply instead of trying to make it more liquid. To wit:
Ben Bernanke, the now current Chairman of the Federal Reserve, later acknowledged that Friedman was right to blame the Federal Reserve for the Great Depression, saying on Nov. 8, 2002:
"Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." [8]
Bernanke also, (according to Wikipedia, your mileage on this information may vary), did some original research that would tend to support at least part of Friedman and Scwartz's argument:
More recent research, by economists such as Peter Temin, Ben Bernanke and Barry Eichengreen, has focused on the constraints policy makers were under at the time of the Depression. In this view, the constraints of the inter-war gold standard magnified the initial economic shock and was a significant obstacle to any actions that would ameliorate the growing Depression. According to them, the initial destabilizing shock may have originated with the Wall Street Crash of 1929 in the U.S., but it was the gold standard system that transmitted the problem to the rest of the world.[11]
According to their conclusions, during a time of crisis, policy makers may have wanted to loosen monetary and fiscal policy, but such action would threaten the countries’ ability to maintain its obligation to exchange gold at its contractual rate. Therefore, governments had their hands tied as the economies collapsed, unless they abandoned their currency’s link to gold. As the Depression worsened, many countries started to abandon the gold standard, and those that abandoned it earlier suffered less from deflation and tended to recover more quickly.[12]
Its logical to assume that Bernanke is going to interpret his mandate in light of these two points of view, which tend to reinforce a singular point, monetary liquidity is key. Now, we don't have an inflexible currency standard, and we have more levers to pull and buttons to push to inject liquidity. But that does not address the potential solvency issues. As Roubini points out, The Fed is now stepping into an area that is not regulated in any serious way. There is no way to know whether the solvency issues underneath will essentially cause these efforts at injecting liquidity to be futile.
And why are not having a discussion about serious regulation of these markets? It may be fair to argue that bailing out Bear or possibly Lehman Bros might be in the interest of the country as a whole, but that does not in any way negate the obvious fact that it was the unregulated parts of the economy that are most at fault here. It was lending outside that of traditional regulated banking that was the primary outlet for these bad loans, funds that are not required to disclose to the SEC that cooked up these tranch schemes and shipped them all over the world as risk free investments. And now we're on the hook for these A*&holes?
The game here is to hide behind the liquidity issues I pointed out earlier and pretend that the lack of transparency and lack of oversight had nothing to do with it. They clearly do, as they did in the thirties as well. We need to ask why we are assuming the risk, as we are when the Fed essentially guaranteed Morgan's risk to the tune of 30 Billion of our dollars, (Or China's dollars we are on the hook for). It's not too much to ask to require that if we are going to be the guarantor of these markets and institutions, that we can impose some reasonable guidelines over how these markets do business, and that they adhere to some legal framework other than, "I got mine, Frak YOU!".
And maybe our canidates for President could actually talk about these issues. Not to distract from the oh so important topics of belligerent pastors and cranky old New York Congresswomen, . Just sayin.....
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