Bailouts, seizures and pushing on a string

I’m wondering whose resignation Jim Bunning will be calling for tomorrow. Last week he was calling for Bernanke and Paulson to resign after the Fannie Mae/Freddie Mac seizure/bailout. At least Fannie Mae and Freddie Mac were Congressionally chartered institutions, if not exactly government entities. I’m still not entirely clear who, other than the Chinese central bank, got bailed out. It looks to me more like a 5 trillion dollar eminent domain, minus the just compensation or the public use.

Now the Fed is bailing out AIG or more correctly buying it at a bargain. (A 2-year loan at a pretty hefty interest rate plus 79.5% ownership. This would be a good deal for any buyer, but for the Fed, which has essentially unlimited cash to make sure the thing stays afloat until the returns can be realized, it’s a steal.) The rule the Fed used to justify the loans allows the Fed to “discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank:” That’s pretty broad. Sounds like the Fed can buyout anything it wants with one of these sweetheart (for the Fed) loans. Private property is dying a death of a thousand cuts and this one is somewhere in the high 990s.

The flip side of this is that the Fed is in the classic “pushing on a string” scenario. Despite very loose monetary policy, money supply (M1) has been flat to down the last two months. The broader money supply figure, M2, has been up moderately, but the collapse of Fannie Mae and Freddie Mac securities would have reduced it substantially. Abnormal risk, lack of transparency and accountability and a general uncertainty that’s making even “safe” loans risky has banks not lending and borrowers not borrowing at rates that are below zero after inflation adjustment.

Of course, there is the option of doing nothing, but this mess is almost entirely of the Fed’s own making, with a bit of help from Congress and HUD, so doing nothing to clean it up seems irresponsible at best.
It’s the latest in a cycle of Fed engineered booms and busts. There’s not much the Fed can do about the current situation other than make sure there’s liquidity in the markets, avoid monetary deflation. With banks unwilling to lend and the private components of the money supply in danger, that means pushing the money out there directly with loan packages that may seem a bit absurd.

Longer term, what’s more important than new regulations, new financial regulators, new FDIC-like insurers, is bringing the Fed’s tendency to change rates faster than the rate changes can move through the economy under control to prevent them from doing this in a new way every few years.

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