The Fed Has Failed Us
March 7, 2008
Mortgage rates spiked to 6.75% on Wednesday, only today sliding back into 6.50% range (these rates with no loan fees). There is good reason to expect rates to fall back, and maybe a long way, but only in the context of effective intervention by Federal authorities.
There is no sign of such intervention at the moment. However, developments soon ahead will attract the attention of officials preoccupied with market solutions, ordinary monetary operations, opposition to any form of “bailout”, wishful thinking, denial, or the view from any of several ivory towers.
This week marked the transition from a relatively orderly seven-month repricing of credit and reduction of leverage to fire sale. Just plain panicked dumping. The Fed’s Number One responsibility is orderly markets. Beyond inflation or economic growth or any other objective, orderly markets come first: prevent at any cost a disorderly liquidation that leads to chain-reaction systemic failure.
The Fed has failed. As have the Treasury, Congress, and the White House.
The spread between government guaranteed (or effectively so) mortgage-backed securities and 10-year Treasurys reached an all-time, utterly non-economic 3.00%. The spread between AAA-rated municipal bonds and Treasurys is out of line by 2.00%. These and other credit markets this week for the most part ceased to function, the capital in the banking system effectively exhausted. Scott Simon of bond-giant Pimco, a calm sort whose remarks are usually limited to time and temperature, said, “Everything is telling you that the financial system is broken.”
The good news. I have believed since August that we would get to this place, and then obvious danger would overcome bailout resistance in both parties and the public. A financial accident would wake us up before grave damage would be done to the economy. We have all the tools crafted in the Depression, and in banking crises large and small since. These tools will work, and fast. A fire sale is a collapse of confidence, nothing-to-fear-but-fear-itself; confidence can be restored as fast as it left.
So what kind of accident will do the wake-up trick? The onset of credit-market fire sale is too technical for civilians, but they do get the stock market. The S&P 500 yesterday broke crucial support at 1320, made a half-hearted rally this morning after job-market news that was awful but not disastrous, fell short, and has little “technical” support for about a thousand points. A meltdown like that will get the attention even of the stock market ya-yas so oblivious to this crisis since August.
The obvious onset of recession should have opened the door to Federal action by now, but dissemblers have muddied the moment. Nothing like an honest-to-goodness stock-market crash to clarify the mind. S&P 1283 now, Dow down 205. Even better: a morning when they ring the NYSE bell, but can’t open the market.
The top Pimco investment officer, Mohamed El-Erian, raided from Pimco by Harvard to run its gazillion-dollar endowment, then raided back by Pimco (the guy is hot) said: “A decision is going to have to be made to cross two lines in the sand: to use the government’s balance sheet, and to breach rights of property and contracts.” The only way to stop a credit fire-sale is by government guarantee and outright purchase of illiquid assets; the contracts are mortgages to be re-worked (I’m opposed to that foreclosure solution, but you can’t have everything).
More good news. Everybody needs something not to worry about: inflation is NOT a problem. Wage growth in the last year has been 3.7%, a half-point below inflation. Huge increases in energy and food costs are compressing spending on everything else, which is deflationary for everything else. Drop a brick with my name on it on the nearest stagflationist: you cannot have sustained inflation without a wage-price spiral.
And another thing: stop worrying about the dollar. Europe is following us into recession, and as global demand falls, we’ll see whose currency is safe.
