What the Bear Stearns resolution tells us abou the Fed
Submitted by A Dash of Insight
At “A Dash” we read and respect sources reflecting many different viewpoints, trying to find the best sources on various subjects.
The market was shocked today by the terms of the Bear Stearns “rescue.” It certainly was no bailout for the shareholders or management. There are those who expect government actors to behave like a deer in the headlights. We have the uncomfortable feeling that some pundits actually want our economy to fail and for many average investors to lose their money, their jobs, and their homes. Why? To prove their uber-bearish predictions to be correct? To sell books? To lock in short positions?
Our perspective is quite different, directed at the mainstream of investors. This is not a game between bulls and bears. It is about life chances for the many. We wish that those who are most vocal in criticizing policy would also offer some solutions.
The Reality
The Fed is not playing by the rulebook of the bearish pundits. At “A Dash” we have maintained that it is not wise to fight the Fed, and that Bernanke will to whatever it takes to solve the various problems. It is unfortunate that we do not have a stronger President right now, or even better policies would be available. There are proposals in Congress, but progress might be difficult.
Today was a day when there could have been a major systemic failure and a stock market collapse. Instead, timely action stabilized credit markets and counter-party risk. It was no help to Bear Stearns shareholders, but it was good for the U.S. and global economies.
John Mauldin, collecting information and writing in his widely-disseminated thoughts, observes as follows:
As I have been writing, the Fed gets it. Their action today is actually re-assuring. I have been writing for a long time that they would do whatever it takes to keep the system intact. As one of the notes below points out, this was the NY Fed stepping in, not the FOMC. The NY Fed is responsible for market integrity, not monetary policy, and they did their job. And you can count on other actions. They are going to change the rules on how assets can be kept on the books of banks. Mortgage bail-outs? Possibly. The list will grow.
Yes, tax-payers may eventually have to cover a few billion here or there on the Bear action. But the time to worry about moral hazard was two years ago when the various authorities allowed institutions to make subprime loans to people with no jobs and no income and no means to repay and then sold them to institutions all over the world as AAA assets. And we can worry in the near future when we will need to do a complete re-write of the rules to prevent this from happening again.
This is exactly what we have argued for months. The Fed will not be constrained by the “old rules” and will basically do whatever it takes. It is not just about the level of interest rates.
The Logic of Government Action
As we have observed, none of the leading bloggers or media pundits has any real expertise about how government policymakers behave. Here is a key concept:
Government leadership is difficult!
It is frequently the case that the “best” course of action, selected on some rational basis, is very unpopular. This is the current case with the subject of “bailouts.” These might be bailouts of investment banks, investors, bad lenders, bad borrowers, and other folks who have screwed up.
A large portion of our society is more interested in punishing those who have made mistakes than they are in looking at the systemic effects. This pervasive sentiment makes it difficult for political leaders to act. Getting the average citizen to see the general interest is a major political challenge, beyond the capability of a lame-duck president.
Once again, John Mauldin has an argument, even drawing upon a theme we had planned for a future article (scratch that!):
But for now, we need to bail the water out the boat and see if we can plug the leaks. Allowing the boat to sink is not an option. And get this. You are in the boat, whether you realize it or not. You and your friends and neighbors and families. Whether you are in Europe or in Asia, you would have been hurt by a failure to act by the Fed. Everything is connected in a globalized world. Without the actions taken by the Fed, the soft depression that many have thought would be the eventual outcome of the huge build-up of debt would in fact become a reality. And more quickly than you could imagine.
Our Take
We are delighted that a sophisticated observer like Mauldin has grasped the fact that the Fed will continue to take imaginative and aggressive actions.
This contrasts sharply with most of the media coverage, which continues to portray everyone in government as stupid, naive, and ineffective.
One of the reasons that people in government choose those jobs over private-sector finance is the desire for power and policy influence. This is something that is little understood by those who took different career paths. We suspect that the hedge fund and media critics of the government and the Fed will be getting a lesson about this in the months to come.
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