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December 13, 2007

The Fed to the Rescue – But of Whom?

The news is full of stories of people who may lose their houses because they can’t keep up payments on mortgages and can’t resell at a profit or refinance. The problem is likely to get worse rather than better because there’s a huge quantity of floating rate mortgages out there with initial “teaser” rates which are about to bump and get even harder to afford. The holidays are coming up; the elections are coming up; politicians are fulminating and competing to exhibit their compassion and economic ignorance.

Ta-Da! Here comes the Federal Reserve to the rescue leading a team which includes the European Central Bank, the Bank of England, the Swiss National Bank and the Bank of Canada. The Fed has at least $40 billion for its rescue effort and the other guys over $50 billion. They know where to get more if they need it.

Who are the central bankers of the West rescuing? Bankers, of course. A little extra liquidity might actually help some of the over-extended to foreclose on mortgages without becoming illiquid or failing to meet their reserve requirements. And of course it is time for bonuses to bankers. Those might have been in danger as well.

Phew! Good thing we have a Fed.

You know how expensive it is to get rid of a bank president: CitiGroup ex-President Charles Prince cost $40 million to sack. Stan O’Neal of Merrill (not the kind of bank the Fed helps directly but dependent on the liquidity that the Fed is creating) reportedly got over $160 million for leaving. But, if the Fed sneaks a little liquidity in, maybe everyone else gets to keep his (sorry, it’s almost always “his”) job. Of course these guys get pretty good bonuses for staying, too.

Things were getting tough. A private equity group backed by JP Morgan Chase and Bank of America backed out of a deal to buy Sallie Mae even though they may have to pay a $900 million breakup fee for walking. According to the WSJ, other private-equity firms like Kohlberg Kravis Roberts & Co., Goldman Sachs Group Inc. and Cerberus Capital Management LP “have jerked the rug from under agreed-to leveraged buyouts”. Maybe if the Fed opens the spigot, the vulture capitalists can ride high again and go back to worrying about whether Washington has the guts to make them pay the same tax rates as anyone else (in which case they might make the same political contributions as everyone else).

My inexpert opinion is that the sub-prime mortgage market is taking the rap for lots of stuff, including unwisely leveraged buyouts, which has already resulted from too much liquidity sloshing around. Hard to believe otherwise that a relatively few housing loans in the US, most of which are NOT in default, could shake the whole banking structure of the West.

Seriously disturbing is the fact that the Fed intends to keep secret which banks make use of the facility (might be taken as a sign of weakness; might BE a sign of weakness). A NY Times story explains that banks don’t like to use the Fed’s existing source of low-cost funds – called the discount window:

“During the credit crisis, few banks have voluntarily borrowed at the discount rate because it was seen as a sign of weakness. Policy makers say they will be releasing auction results so that the participants know only which Federal Reserve bank made the loans, not which commercial bank borrowed the money.”

The rationale is, of course, avoiding panic. The result is likely to be avoiding both accountability and some needed fiscal constraint. Panic will best be avoided by more transparency and accountability, not less.

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