The Fed Underwrites Asset Explosion

“That the economists…can explain neither prices nor the rate of interest nor even agree what money is reminds us that we are dealing with belief not science.” – James Buchan, Frozen Desire (1997)

The Federal Reserve is in disarray. Unsure of whether its QE2 strategy (quantitative easing – second round) should be tabled (see speeches of Thomas Hoenig, president of the Kansas City Federal Reserve Bank) or if it should pump $10 trillion into the economy (the unsolicited advice from economic columnist Paul Krugman), the New York Federal Reserve Bank has now asked bond dealers what it should decide at its upcoming November 3 meeting. Since it is the belief in the integrity and competence of the Fed that backs the dollar, asking Wall Street what it wants is another reason to sell dollars.

Two recent speeches by Federal Reserve officials clarify the dishonesty and paranoia of this debauched institution. Both were delivered on October 25, 2010.

Speech number one is a fabricated history of the housing crisis, delivered by Chairman Ben S. Bernanke in Arlington, Virginia. He gave it at the Federal Reserve System and Federal Deposit Insurance Corporation Conference on Mortgage Foreclosures and the Future of Housing. The conference title alone is enough to know that no good will come from this boondoggle:

“It was ultimately very destructive when, in the early part of this decade, dubious underwriting practices and mortgage products inappropriate for many borrowers became more common. In time, these practices and products contributed to problems in the broader financial services industry and helped spark a foreclosure crisis marked by a tremendous upheaval in housing markets. Now, more than 20 percent of borrowers owe more than their home is worth and an additional 33 percent have equity cushions of 10 percent or less, putting them at risk should house prices decline much further. With housing markets still weak, high levels of mortgage distress may well persist for some time to come.

“In response to the fallout from the financial crisis, the Fed has helped stabilize the mortgage market and improve financial conditions more broadly, thus promoting economic recovery.”

You may note, not a word of the Federal Reserve’s complicity – not its mad money expansion, not its one percent interest rate (the fed funds rate) that turned susceptible mortgage-buyers into highly leveraged speculators, not the Fed’s decade-long enticement of Americans out of savings and into “risk assets,” not its terrorist tactics at frightening the American people into saving the parasite banks, and then, having successfully terrorized itself, cutting the fed funds rate to zero, a condition that is suffocating the lower 99%.

In Bernanke’s final sentence (In response…), he claims the Fed saved the mortgage market and restored the American dream, or whatever the imposter is trying to sell. It would be more accurate to confess that if the Federal Reserve did not exist, there is a good chance there would have been no need to stabilize anything.

There are moments when Federal Reserve officials speak the truth. In 1934, Eugene H. Stevens, chairman of the board of the Federal Reserve Bank of Chicago, spoke clearly about ridding ourselves of zombie banks. Quoting the October 24, 1934, New York Times: “The cleansing of the American banking structure of the parasites of ‘occasional incompetency and dishonesty’ in the last year and a half has put it in the strongest position of safety and good management.”

Two years after the United States missed its opportunity to clean house, the banking system is in a weak position of instability and bad management.

Speech number two, by New York Federal Reserve President William C. Dudley, is an insult to anyone not getting rich within the parasitic Washington-Wall Street nexus: In response to a question from his audience at Cornell University, Dudley asserted:

“To the extent that we can do things to improve the economic environment, we certainly owe it to the millions of people who are unemployed to do so.”

In his speech, Dudley, a former managing director at Goldman, Sachs & Co., described how the Federal Reserve has amortized this debt to the American people:

“The Fed responded aggressively and creatively… [to the] financial crisis that broke in mid-2007…. [W]e took aggressive steps to ease monetary policy in order to support economic activity and employment…. When the Fed buys long-term assets, it pushes down long-term interest rates. This supports economic activity in a number of ways, including by making housing more affordable and boosting consumption in households that can refinance their mortgages at lower rates.”

In other words: the Fed has cornered markets in an attempt to induce overextended households to spend money again and restore an economy the Federal Reserve has hollowed out. Again, this is a warning to investors: any substantive rationale for holding assets that trade on markets needs to be weighed against the knowledge that prices are not real. There are consequences – intended now, unintended later – to trillion dollar experiments dreamt up by academic economists.

Dudley said what is demanded of Federal Reserve officials when they discuss the bank bailouts:

“A handful of times, we made the difficult decision to make emergency loans to prevent the disorderly failure of particular firms. We did so not because we wanted to help the firms, but because allowing them to collapse in a disorderly fashion in the midst of a global crisis would have harmed households and business throughout the United States.” [My underlining.]

Why does he use the word “firms” instead of “banks?” There is probably no Federal Reserve official who knows better the disorderly fashion in which the Too-Big-To-Fail banks collapsed. His then-current employer, Goldman, Sachs, an investment bank, had failed. It was saved by the dubious Federal Reserve maneuver of turning the investment bank into a commercial bank.

Dudley told his audience to leverage its portfolios:

“With regard to monetary policy, the Fed has in place a highly accommodative stance. The FOMC has said that it will keep short term interest rates at exceptionally low levels for an extended period of time. The Fed also retains large amounts of mortgage-backed bonds acquired in order to support the housing market and help bring down mortgage and other long-term interest rates to the historically low rates in place today.

“The FOMC and the Chairman have stated their commitment to take further actions to bring interest rates down further should economic conditions warrant.”

Dudley avoids typical Federal Reserve euphemisms here. He states the Fed controls short-term interest rates, is supporting long-term interest rates (is preventing them from rising), and is supporting the mortgage market (is preventing mortgage securities and house prices from falling). Not in this speech, but elsewhere, Dudley and other Fed officials have indicated they are propping up the stock market. It is doing more than that: U.S. stocks have risen 10% since this latest Federal Reserve, carpe diem, open-mouth policy debuted last month.

Federal Reserve ringmasters do not discuss how their capricious manipulations disturb the dollar’s relationship with other currencies. When foreign buyers have decided it is time, the dollar, the stock market, the mortgage market, house prices, long-term interest rates and short-term interest rates will respond to the Bernanke “puts” just as they did to the Greenspan “puts” (the Nasdaq in 2000, houses in 2006). They will explode.

Regards,

Frederick Sheehan,
for The Daily Reckoning

[For more of Frederick Sheehan’s perspective you can visit his blogs here and at www.AuContrarian.com. You can also purchase his book, Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009), here.]