When Should the Fed Bailout the Economy?

I agree with John. Even now we have Jamie Dimon saying its all right.

Anyone notice Brad Setser saying that while we crow about imports falling, notice that exports are falling also?

It is more disturbing that the two mandatory preceding questions are no longer even being asked.

1. Is government empowered to intervene? For instance, think about the following statement you’ve heard all the time; “the Fed manages the economy.” No, the Federal Reserve Act was last clarried in 1977 as being “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

2. Should government intervene? Not the trivial yes/no type of answer we have come to expect but an honest evaluation of the heavy hand and unintended consequences.

Only then should the third question even be considered; what should be done.

The above applies to the managment of other people’s money.

Just below Bernstein’s piece is Lim’s weekly column on whether the “rally is real”. Setting aside for a moment the issue of whether such a small, brief move in stock prices is even worthy of such parsing, the more interesting “disconnect” is the difference between the endless data points, semantics, academic arguments, etc. on the one hand, and the way pundits (bullish *AND* bearish) both go long stocks to make money through it all. e.g. A few days ago, there was a blurb somewhere about Honeywell, so BR takes the opportunity to mention that he’s been long the name for years, selling only very recently. Yeah, yeah, I know that BR is no Fleckenstein. He’s not going to swear off buying stocks out of some ignorant, demented grudge against Alan Greenspan or something. And I’m in no way saying that BR doesn’t understand that opportunities still exist even in bear markets. But Honeywell? It really calls in to question the value of the endless pedantic bickering about the vast sea of data points. That BR would spend so much time mining for bearish, gloomy interviews and graphs only to mention that he’s been a long-term holder of Honeywell all this time reminds me of that scene in Seinfeld when Elaine is telling her coworker what a bad seed George is. Elaine: “Oh trust me. He’s a bad seed. He’s a horrible seed. He’s one of the worst seeds I’ve ever seen!” Anna: “And you two are friends?” Elaine: “Oh yeah, we’re good friends.” The fact of the matter is that BR made a heck of a lot higher percent return on his HON investment than nearly all of the big-time bears have made on their downside bets over the past 4-5 years. Look, if you think Citigroup is pathetic, then don’t buy Citigroup. If you think Pulte’s goose is cooked, then don’t buy Pulte. But if BR telling us that he’s been a long-term holder of Honeywell is what we hear in the midst of the worst ______ since the Great Depression, then it makes so much of the CNBC, blogs, graphs, shouting, definitions, wagers, etc. seem like a sideshow to the real thing — finding stocks to go long.

how about this question:

“When should the fed KILL the economy?”

Volcker killed the economy, and it led to spectacular long term results.

the fed should have the authority to go both ways. it should punish people when they screw up, and reward them when they do well. that’s how capitalism works.

too often they do the opposite.

I think Peter Bernstein offers us a deliberate distortion of the historical record. He asserts that Andrew Mellon “opposed any government action to stem the tide of plunging business activity and soaring unemployment.”

Mellon, however, certainly didn’t seem to have any reservations about bailing out the banks and big corporations, that is as long as it was done with somebody else’s money. As Frederick Lewis Allen points out in “Since Yesterday:”

“Again Hoover acted, and again his action was financial. Something must be done to save the American banking system, and the bankers were not doing it; the spirit of the day was sauve qui peut. Hoover called fifteen of the overlords of the banking world to a secret evening meeting with him and his financial aides at Secretary Mellon’s apartment in Washington, and proposed to them that the strong banks of the country form a credit pool to help the weak ones. When it became clear that this would not suffice–for the strong banks were taking no chances and this pool, the National Credit Corporation, lent almost no money at all–Hoover recommended the formation of a big governmental credit agency, the Reconstruction Finance Corporation, with two billion dollars to lend to banks, railroads, insurance companies.”

So Mellon presided over, as Allen puts it, “a banking system dependent upon secret loans.”

And then there is the moral question Allen poses as to whether Hoover and Mellon were “acting with a tory heartlessness in permitting financial executives to come to Washington for a corporate dole when men and women on the edge of starvation were denied a personal dole.”

He goes on to state that: “What is certain is that at a time of such widespread suffering no democratic government could seem to be aiding the financiers and seem to be simultaneously disregarding the plight of its humbler citizens without losing the confidence of the public.”

Now, back to Bernstein. He concludes that “the debate over intervention is not ancient history. It replays in today’s headlines.”

But what Bernstein so conspicuously fails to point out is that, just like back in the days of Hoover and Mellon, there was NO debate over intervention to save Wall Street and the big banks. The debate, then and now and always, arises when we start pushing the envelope to help those farther down the feeding chain.

What an incredibly deep subject for Mother’s Day – certainly way too deep for our Sidebar Society to think about for long – after all, American Idol comes on in a few mintues.

As in any human concept, the problems occur when the extreme of that idea is indulged. Pure capitalism is not unlike law of the jungle; yet an ideal socialism is impossible due to the vagueries of mankind’s nature.

The best we can hope for is imperfect compromise. More regulation is required for the simple reason that deregulation is worse.

I’m not sure it’s a question of when the Fed should crash the party, per se, but that whatever they do, they do it consistently on both the inflation and deflation side of the bubble. That is, their policy needs to be symmetrical.

So if the Fed is content to not prick asset bubbles as they inflate, it needs to have a similar lassiez faire approach now, as it is deflating. Otherwise we risk creating moral hazard.

FDR’s Folly” by Jim Powell argues that FDR’s policies merely prolonged the Great Depression. Excellent book…

Posted by: LudwigVonMises | May 11, 2008 12:58:26 PM
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what folly was that???

feeding starving people…

halting the hemorrhaging of gold from us to Great Britain and buying gold above market price by force of law…

providing jobs that private businesses could not…

building infrastructure like grand coolee dam and bridges with the labor of desperate workers who alternatively could have become communists…

Nice quotes/point, DownSouth. Good points, mock turtle.

Dave54, don’t hold back. What comes next??

The Fed should prioritize their mandates, inflation first and full employment second. If that were the case, they would be much more careful bowing to pressure and lowering rates at this time. The European Central Bank is in a better position than the US. Their first and only mandate is controlling inflation and protection of their currency. After all, they have real world experience with hyperinflation. Our Fed seems to be hell-bent on heading us down that path, although we’re only in the 2nd or 3rd inning with the raging fires still a few years away.

«The Fed should prioritize their mandates, inflation first and full employment second. If that were the case, they would be much more careful bowing to pressure and lowering rates at this time. The European Central Bank is in a better position than the US. Their first and only mandate is controlling inflation and protection of their currency. After all, they have real world experience with hyperinflation.»

The reason for that is that the USA government refuses to do fiscal policy except through the military-industrial complex (“national security keynesianism”), just as the USA government refuses to do legislation in many areas.

The results are that the Fed and the Supreme Court have to step in with monetary policy and Constitutional policy as “technical” bodies which however do a lot of not-so-hidden politics because USA national politics are gridlock.

USA national politics are gridlocked because the South was defeated but did not accept the defeat, and are still waging a guerrilla war against the yankees, and the West allies with the South or the North but only to pursue their own interests, and to keep both weak so that the West can do as they damn please.

So the great socialization of the involvency of the investment banks (done leaving all the scoundrels in place to continue tunneling as hard as they can) is done by the Fed because this Dixie administration cannot bear to use fiscal means even to save their generous sponsors (and to fool the loser voters as to whom is paying for recharging the great Wall Street Bonus Machine), and so on.

«He is reviewing criticism of the treatment of the problem, namely, the Fed’s clean up duties. But there is a debate brewing on preventative measures, also.»

It is also a debate on punitive measures.

«What makes this go round somewhat different is that the Fed’s intervention was forced large numbers of people who were exceedingly reckless. Even by comparison to LTCM or the S&L crisis, the risk embracement was unusually widespread.
As we have seen, there is a cost to this.»

To say this more clearly, that the investment banks have become bankrupt has been due to their management tunneling away a lot of their their capital by underestimating the reserves needed thanks to exceptionally generous ratings on their loans, and thus creating imaginary profits of which they took 50% in compensation and bonuses, and even more as vested stock options.

Now the debate is not as Peter Bernstein puts it about whether the Fed should rescue the economy or “crash the party” instead, because there are more than two positions:

#1 When there has been a widespread insolvency due to widespread tunneling by management, effectively suspend bankruptcy provisions, by rescueing the creditors, the debtors, and even the shareholders of the banks while letting the management get away scott free, keeping 100% of what they have taken out of those banks.

#2 When there has been a widespread insolvency due to widespread tunneling by management, let them fail drag down the financial system and their creditors and their debtors too by letting them go bankrupt.

#2 When there has been a widespread insolvency due to widespread tunneling by management, let them fail drag down the financial system and their creditors and their debtors too by letting them go bankrupt, and initiate vigorous investigations into the causes of the crash leading to a massive wave of prosecutions leading to convictions and restitutions of the ill-gotten gains, to deter management from doing it again.

#4 When there has been a widespread insolvency due to widespread tunneling by management, effectively suspend bankruptcy provisions, by rescueing the creditors, the debtors, but not management, by letting those investment banks go bankrupt, recapitalize them but at the same time initiate vigorous investigations into the causes of the crash leading to a massive wave of prosecutions leading to convictions and restitutions of the ill-gotten gains, to deter management from doing it again.

And all of the above can be done stealthily by the Fed using pseudo-monetary means or explicitly by Congress using the commerce powers granted to Congress by the Constitution using the fiscal lever.

#1 is worse than #2 or #3, and the only sensible option is #4, done by Congress. But the need to keep the Republican campaign donor class safe and rich, and to delude the losers as to who is paying, has led to the Bush and Bernanke administration to choose #1.

The issue in other words is not whether to do a bailout of the “economy” as the vested sycophants do say, but whether to do a bailout of investment bankers as well as the economy, and whether to do openly via fiscal means or surreptitiously via pseudo-monetary means.

«Much of this school (anti interventionists) are either explicity or closet gold-standard folks, who would prefer no intervention either way. They don’t want the fed spiking the bunch bowl OR taking it away, as they will typically argue that these actions typically make the swings greater than they otherwise would be.
Even classic monetarists would argue that the fed should just be consistent and resistent to much moving at all. Remember Friedman’s claim that that the best thing to do would be to just set monetary growth to match long term GDP growth (about 3%) and leave it there.»

There are actually four schools:

#1 [The Fed and/or fiscal policy should be pro-cyclical: spike the punch bowl to make investment bankers happy, and then stand by when after those bankers have looted the financial system it collapses]

#2 [The Fed and/or fiscal policy should be pro-Republican donor class, spike the punch bowl to make them happy with higher asset prices, and then whenever asset prices threaten to go down because investment bankers have looted the financial system, spike it again and again and again and again]

#3 [The Fed and/or fiscal policy should be anti-cyclical, because wide swings in finance etc. depress productivity and investment by raising risks and the hurdle rate, and tighten a bit whenever the economy overheats for any reason, even “good” reasons, because too much growth is not fine, and loosen a bit when the economy slows down as underused capacity is not very efficient either.]

#4 [The Fed and/or fiscal policy cannot be trusted to do #3, as that is “fine tuning”, and therefore they should just aim to do the same with same by stabilizing two undefinable quantities, money and its velocity (usually the buffoons who write this forget “and its velocity”, never mind defining either).]

The ideal situation is #3, because it does not require fine tuning and there is ample literature that too fast growth is almost as bad a too slow growth, and it is technically realistic. #4 is technically unrealistic, but #3 and #4 are politically unrealistic, because #1 and #2 greatly benefit the party of inflation or anyhow the vast majority of real-asset holders who are generous Republican campaign donors, and who pays the pipers calls the tunes.

Interesting comment, Blissex, but it would help if you formatted into an easier read.

Your position leads me to a secondary question – if there is to be a rescue, which economy are we to save, the real economy or the banking economy?

I remember – as do most – how fervently Bernake, Paulson, and the rest denied that subprime would spill over into the “real economy”. As Barry has been pointing out all along, the reduction in home equity loan availability at some point in time had to work its way into the consumer’s ability to buy and hence into the “real economy”. (I hope that is close enough to an accurate depiction of Barry’s position not to be banned as an asshat!)

However, all the bailout plans involve one goal at their core – preventing further declines in housing prices. The further drop in housing prices will affect most the banking and the shadow banking industries. The consumer all along has been spending from a gift card that was issued on a bogus account – now that it is known that the account was bogus, no amount of hocus-pocus or accounting gimmickry will make the owners of those cards solvent.

The only true fix is the fix imposed by the marketplace – losses taken and falling prices – and any other solution is simply slight-of-hand deception while the rabbit is pulled out of the taxpayer’s oven and a day-old rat is substituted.

Hedonically, of course.

«In fact, these are redistributions from one public (prudent investors and savers) to another (imprudent investors, intermediaries, and debtors). The debate on whether to make the redistribution now appears moot. It’s happening.
All that remains is a debate on the mechanics of the redistribution.»

The redistribution may well be in the interests of the “prudent investors and savers” because the ruin of the system looted by the reckless (Republican campaign donors) may ruin them too, because nobody is an island. The prudent choice is not to risk it if the mechanics can be adjusted so that it is less likely in the future. But if the reckless (and often fraudulent) are not punished, who’s to stop the next generation of the reckless (and those tempted by fraud) to learn that looting and threatening the stability of the financial system is not only highly profitable, but risk free?

Estragon wrote, “Inflating away the real value of housing debt would do the trick, would it not?”

Only if there were a pass-through of the inflation to those who pay the mortgages; more of the same asset inflation without wage inflation would simply exacerbate the problem, would it not?

And as we know, the Fed is dead against higher wages because in the Kingdom of Fed higher wages cause inflation.

☺☺”And as we know, the Fed is dead against higher wages because in the Kingdom of Fed higher wages cause inflation.”–Posted by: Winston Munn | May 11, 2008 7:08:09 PM

Things look pretty grim for the working man. The unions have been defanged. The elite media gatekeepers work for the plutocrats, setting the agenda and framing the debate at major newspapers and television outlets. Politicians and policy makers (such as the Fed) on both sides of the aisle have sold out to the “economic royalists.”

The princes of Wall Street have spent years and millions of dollars in lobbying to create a shadow banking system free of government regulation. They will not give it up without a huge battle.

So the odds of any significant re-regultion of Wall Street seem remote.

But I wouldn’t consider it a knockout just yet. The reason is the internet, which I consider to be the greatest facilitator of democracy since the invention of the printing press.

Its use as a political tool is still in its infancy, but we have already seen its amazing potential:

1) Howard Dean’s meteoric rise from nowhere

2) Jose Luis Rodriguez Zapatero’s defeat of Jose Maria Aznar for president of Spain

3) Ned Lamont’s defeat of Joe Lieberman in the 2006 Democratic primary

4) And the latest: Barak Obama’s defeat of Hilary Clinton in this year’s presidential primary. As Frank Rich observed in today’s NY Times:

“The millennials’ bottom-up digital superstructure was there to be mined, for an amalgam of political organizing, fund-raising and fun, and Mr. Obama’s camp knew how to work it. The part of the press that can’t tell the difference between Facebook and, say, AOL, was too busy salivating over the Clintons’ vintage 1990s roster of fat-cat donors to hear the major earthquake rumbling underground.”

So I am of the firm belief that, if there is any deliverance for the working and middle classes in America, it will be acheived through this incredible new tool called the internet.

Winston asks – “if there is to be a rescue, which economy are we to save, the real economy or the banking economy?”

Its got to be the real economy. Gaming will not continue to provide.

Educating up to a job and then Laboring in that job must be properly rewarded.

Barry:

This is a most interesting story, thanks.

However, The aspect of the tone that I read into this story is, that the Fed has successfully intervened. I’m having a problem with this for two reasons. The first is a question of velocity, or better said discounted velocity. And the second is a question of inflation.

Can the Fed reasonably announce “MISSION ACCOMPLISHED….!”

Perhaps the regulation should be focused on the Fed.

My best regards,

Econolicious

Kwikpop wrote, “It is my understanding that the Federal Reserve is a banking cartel in partnership with the US government. Why is everybody always shocked and dismayed when the banking cartel protects their interests first at the expense of the public?”

The Federal Reserve is a quasi-governmental agency that is in essence an intermediary for the Trasury Department.

Our monetary system is not a strict fiat but is debt-currency, i.e. that value of the note is in the worth of the debt it represents. A debt-currency system is dependent upon debt expansion for continued growth. The reason the Federal Reserve has a bias toward banking is because that is where the debt-currency is created – without solvent banks there is no real economy under this system. (While it is true the Federal Reserve has the right to issue debt-currency, it does so in response to demand from commercial banks and the U.S. treasury.)

The questions to me are not of conspiracy but ones of limits of power,Congressional reposibility, moral hazard, and systemic risk.

“It might very well herald the end of a 60 year long super boom in financial markets.”

or the end of the super-debt cycle?
in the 60’s, a dollar of debt would get you 90 cents of GDP yes?
What is it now? Something like 20 cents of GDP…..
Do i hear zero?

To the question/premise of a contemporary debate on “regulation versus deregulation” , that seems like a no brainer to ME but what do i know?
If there were no referee in hockey could you still call it hockey
or would it just be 2 1/2 hours of cage fighting on ice?
Also an exciting pastime i’m sure but could you call it “Hockey”?

Of course you need refs/regs in the game. That is, unless one is more interested in fleecing people as opposed to participating in a “free market” (i get a lump in my throat every time i say “free market” don’t you?)

For any who are interested by the way, there is an EXCELLENT indirect object lesson on the topic (and the housing/credit catastrophe directly) at “This American Life” here….
“The Giant Pool Of Money”

http://www.thislife.org/Radio_Episode.aspx?episode=355

In reading through the comments I was struck (but not surprised) by the ratio of emotional content to intellectual content. More heat than light, as usual. On the other hand, Peter Bernstein is someone who began his career in financial markets in the 1940’s. He lived through the great depression as a child. He lived through the runaway inflation of the late 70’s-early 80’s. It is always refreshing to read his views.

you just need to take economy 101 or be 20 yo+ to know that the economy goes through cycles. There are ups and downs. When is an up moment, you take more risk, grow and set something aside for the downs. If you are lucky, you get rich. But if you are smart and prudent enough, at least you won’t starve in the downs. Now, if you took too much risk and pretended to live like a rich during the up, please don’t knock my door during the down. I can’t understand why I should pay up the debts you accumulated to live in largess with the money I put aside by bein prudent during the very same years you were westing your bucks! And please, don’t pretend you didn’t know, cause if you didn’t, then you weren’t worth the credit you had been given!

“I was struck (but not surprised) by the ratio of emotional content to intellectual content. More heat than light”

Yesss. I quite agree Guesswerks…..snuff? No?…
…at any rate for intellectuals such as ourselves, (so clinical, so…detached and yet, unerring) the Big Picture can seem such a small pond…(sigh)