The Fed's Real Job

"In days of yore, or 'back in the day,' there was an economic term of ill repute called jawboning. .... To fight inflation without loss of guns or butter, the administration announced that wages and prices ought to behave themselves. ... The success of this policy was, shall we say, limited. ... In a [1969] memo ... [William Safire] advised the White House to strike this pose: 'We deride 'jawboning' as (a) government wagging a finger at business and labor to act with restraint, while government acts without restraint; (b) government is asking labor and business to so what is against their self-interest and in the public interest, which is usually ineffective, and when it works rewards the greedy and penalizes the patriotic.' ... The Ford adminstration jawboned inflation with 'Whip Inflation Now' buttons--which became collectors' items as the nation whipped itself into a deep recession. ... Advising reporters that the White House ordered him not to use the word 'recession,' Chairman Alfred Kahn substituted the word 'banana.' After a banana company complained, Kahn switched to 'kumquat.' ... For a contemporary example of jawboning, please turn to the messages of the [Fed] and its Open Market Committee last week. While slaying interest rates and pumping money into the economy, the public statements of the Fed included a heavy dose of jawboning. ... Dallas Fed President Richard W. Fisher ... declared ... 'Talk of "cheap money" makes my skin crawl,' he said. 'The words imply a debased currency and inflation--and the harsh medicine that inevitably must be adminstered to purge it. So you should not be surprised that I consider the perception that the Fed is pursuing a cheap-money strategy, should it take root, to be a paramount risk to the long-term welfare of the U.S. economy'," Thomas Donlan at Barron's, 24 March 2008.

"Bill Dunkelberg, who runs Liberty Bell Bank in Cherry Hill, N.J., ... feels no constraints about criticizing the Fed. He opposes its recent rate cuts, which he says are punishing smaller financial institutions like his and legions of elderly people who depend on savings for income. ... In essence, savers are losing money to prop up the big Wall Street brokerage houses that claim to need cheap rates for liquidity and to rescue homeowners with adjustible mortgages, whose rates would have reset higher without the cuts. ... The Fed, he complains, is taking money out of pockets of little savers and small, well-run banks to help out giant financial institutions", Jim McTague at Barron's, 24 March 2008.

"Regulation follows crisis as surely as mushrooms follow the rain. The collapse of Enron led to the passage of Sarbanes-Oxley and to sweeping new powers for the [SEC]. Likewise, it now appears that the collapse of Bear Stearns will lead to new powers for the [Fed]. ... The Fed should not have the unlilateral power to bail out investments banks like Bear Stearns. The flawed process employed by the Fed in that unprecedented move violated the spirit of an important law--the Federal Deposit Insurance Improvement Act. ... But the FDCIA applies only to federally insured depository institutions like banks and savings and loan associations. When that statute was passed nobody in their wildest dreams thought that government bailouts would extend beyond federally insured deposit institutions to include investment banks--which unlike commerical banks have no small creditors and no federally insured deposits to protect. ... Large uninsured depositors, particularly foreign governments and non-U.S. corporations, began a run on the bank. Fearing that closing Continental would destabilize the entire banking system, the government organized a complex rescue package that provided $4.5 billion in permanent financial assistance in exchange for the transfer of $4.5 billion in non-performing loans to the Federal Reserve Bank of Chicago. ... After the Continental Illinois bailout, bank bailouts became routine until Congress put a stop to the practice when it passed FDCIA in 1991. ... First, and unlike the 1998 bailout of the hedge fund Long Term Capital management, the Bear Stearns bailout puts government funds at risk. ... The FDCIA was designed to minimize the use of the discredited 'too-big-too-fail' doctrine for a number of reasons. ... The too-big-to-fail strategy also creates significant moral hazard, as creditors have no incentive to monitor and control the flow of credit to large borrowers that are considered too big to fail. ... Indeed, unlike commerical banks, Bear Stearns never contributed a dime in insurance premiums in exchange for the protections it got from the government. ... Not only are large firms being favored over small firms, but investment banks are getting for free a better government bailout than commerical banks receive only after paying insurance premiums to the FDIC", Johnathan Macey (JM) at the WSJ, 31 March 2008.

"The securities backing a $29 billion [Fed] loan to Bear Stearns Cos. consist primarily of 'mortgage-backed securities and realted hedge investments.' the Treasury Department said. ... The Fed has declined to provide any underlying detail so far", WSJ, 2 April 2008.

"The government sought a low sale price for Bear Stearns Cos. to send a message that taxpayers wouldn't bail out firms making risky bets, a top Treasury Department official testified, as regulators offered Congress the first detailed explanation of the unprecedented rescue. ... 'This would have been far more, in my opinion, expensive to taxpayers had Bear Stearns gone bankrupt and added to the financial crisis we have today,' said J.P. Morgan chief executive James Dimon. 'It wouldn't have even been close.' ... Since the [Fed] made the deal possible with a $30 billion loan, critics have questioned whether the government was creating 'moral hazard'--encouraging Wall Street firms to take big gambles on the assumption that they could get a taxpayer-funded rescue if the bets went sour. ... 'There was a view that the price should not be very high or should be towards the low end ... given the government's involvement,' Treasury Undersecretary Robert Steel told a congressional committee during a five-hour hearing Thursday. ... Steel and other officials told the Senate Banking Committee that they didn't dictate the precise sale price, but wanted to see a deal done quickly to avoid a sudden market-shaking crash of the company. ... Officials rejected lawmaker's suggestions that they bailed out Bear Stearns, noting that shareholders took steep losses and many employees may lose their jobs. But under questioning, Mr. Bernanke agreed with a lawmaker who suggested that the Fed rescued Wall Street more broadly. 'We only allow sound institutions to borrow against collateral,' [Timonthy Geithner, NY Fed Head] said. 'I would have been very uncomfortable lending to Bear Stearns given what we knew at that time [March 16].' Dimon said the $2 figure was not based on the value of Bear Stearns, but 'was based on what protecting the downside' that J.P. Morgan faced. ... Dimon said ... the assets tied to the Fed's $30 billion loan were not Bear Stearns 's riskiest holdings", my emphasis, WSJ, 4 April 2008.

"The [Fed] has agreed to temporarily relax some rules about transactions with affiliates to make it easier for J.P. Morgan Chase & Co. [JPM] to complete its planned acquisition of Bear Stearns Cos. ... The goal is to prevent problems at the affiliates from endangering the bank's depositors. ... The exemptions will make it easier for [JPM] to provide liquidity to Bear Stearns and will also keep [JPM] from having to raise capital quickly after the merger. ... The approval was conveyed to [JPM] in a letter to the firm's associate general counsel posted on the Fed's Web site. The exemption will be phased out gradually and expire on Oct. 1, 2009, the Fed said", WSJ, 5 April 2008.

Note Richard Fisher (RF) says perceptions of what the Fed is doing "to be the paramount risk to the ... U.S. economy", not what the Fed is doing. I do not apologize, RF for my ignorance. I only know who gains from Fed policies and who loses. Anyone who read My Weekly Reader in the 1950s could tell you: Wall Street gains and savers lose. I don't know what the term "U.S. economy" means, it's just emotive rhetoric. As Barron's told us in 1979, "How do you know when the Chairman of the Fed is lying? Answer: every time he moves his lips". Et tu RF? Leona Helmsley is supposed to have said, "We don't pay taxes. Only the little people pay taxes". Similarly, obeying any law is only for politically disfavored classes. Attorney General Michael Mukasey, did you look at the Fed's actions to see if they are legal? Did you know that "hasty" actions are a "badge of fraud"? Ask any bankruptcy law judge.

Dunkelberg sees the Fed the same way I do. It's actions are really that simple to understand.

I disagree with one thing JM wrote. Bear Stearns (BS) was not bailed out. The rest of Wall Street was. The Fed denies the "too-big-to-fail" doctrine. See my 12 December 2007 post. So? who cares what the Fed says.

Robert Steel (RS), him again! See my 14 October 2007, 6, 7 and 13 February 2008 posts. Amazing, RS's told some truth here. He "wanted to ... avoid a sudden market-shaking crash". I add, of other investment banks, not BS. How does James Dimon know what would have been more expensive for taxpayers? He should know what's good for JPMorgan (JPM). Would JPM have bought BS had the Fed not permitted BS to unload $30 billion of its garbage, pardon me, assets, into the SIV it created, for which JPM will "assume" the first $1 billion in losses? Did JPM "cherry-pick" which assets went into the SIV? If not, JPM's stockholders should sue Dimon for breach of fiduciary duty.

I ignored the details of the Fed's TAF, TSLF, etc., actions. Why? Because they don't matter! The Fed will do whatever it has to do to protect those Wall Street houses it decided to protect. Period. Steve Waldman has a nice comment on the Fed's actions at http://www.interfluidity.com/, on 3 April 2008. It's comment 11 to this post. As to the Fed easing rules, no. There are no rules. I remember a line from "Blazing Saddles", 1974, "Badges? We don't need no stinking badges!". Similarly, the Fed don't need no rules.