Decoding the Bernanke Fed's Agenda

Finally, Fortune magazine came up with a slew of articles revealing the myths behind the Bernanke Fed's recent moves regarding the Bear Stearns' (BSC) bailout and providing in-depth analysis on this credit crunch.

The first article, The last days of Bear Stearns, provides a timetable of the Bear Stearns meltdown in great details: On the afternoon of March 7, a major bank had rebuffed Bear’s request for a short-term $2 billion loan. On March 10, the firm had $17 billion in cash. The following day, another blow came from Goldman (GS) by stepping in for institutions nervous on Bear derivatives deals via an email to its customers. With the email leaked the next day, the floodgates opened. March 13, CEO Schwartz contacted J.P. Morgan (JPM) CEO Jamie Dimon in the evening with Bear facing bankruptcy. At that moment, Bear only had $2 billion cash.

If the article is true, it provides two major evidences:

• The Fed didn’t hand-pick J.P Morgan for rescuing Bear Stearns.
• The Fed didn’t have the knowledge of the issue until March 13.

Here is the reason for the buyout as detailed in the next article, On the brink of disaster:

Bear had about $13 trillion of derivatives deals with counterparties, according to its most recent financial filings. If Bear had croaked, large parts of the world could have croaked. And the economic damage could have been catastrophic.

Well said. $13 trillion is too big to fail! The buyout is unavoidable. The article further points out:

Fedniks tell their friends - yes, many Fed folks have both social consciences and friends - that they’re furious about the Wall Street enablers of the mortgage mess and other financial excesses being able to escape the full cost of their folly, with the public picking up the cost.

If we check Bernanke’s track record, we can see that he keeps jinxing the market. While it is true that, so far, the Bernanke Fed provides short-term money supply at the expense of taxpayers for the stability of the financial system, he, personally, tells the utter truth on the economy, which, in turn, hammers down the market, especially after the April Fool’s run-up

At this moment, the Fed has no choice. The Fed’s best hope is to let the stock market correct itself gracefully instead of a sudden 40% drop in a day or two, which definitely will crash the financial system, as happened in previous financial crisis. Since Bernanke “made his academic bones writing about the Great Depression”, so far we are in good hands, since we haven’t experienced a market free fall yet.

However, the risk of having the second Great Depression is still likely since this crisis is very similar to the previous one:

Normally the economy goes bad first, creating financial problems. In this slowdown the markets are dragging down the economy - a crucial distinction, because markets are harder to fix than the economy.
……
When was the last time it happened in the U.S.? In 1929

The biggest issue is the high leverage of investment banks. We can find the numbers in this next article, What’s wrong with Wall St. - and how to fix it:

Since 2002, the five firms’ leverage, measured by assets as a multiple of equity, jumped from 30 to 41 (see chart on previous page).

……

Half the huge gains in Wall Street’s profits from 2003 to mid-2007 could be attributed to increased leverage - otherwise known as gambling with borrowed money - that magnified earnings in a boom. Again, it’s the curse of too much debt: If a firm’s portfolio is leveraged at 33 to 1, it takes a mere drop of 3% to wipe out its entire capital.

To the end, the Fed has the subprime mess well contained. However, there are still enormous amounts of ARM resets in the pipeline, as this blog post tells us. We need to cross our fingers, hoping that the Bernanke Fed won’t run out of ammunition before the end of this year.

Disclosure: none

Comments

[nukldrager:]

Are there any rules when it comes to the Feds ability to create money? Why can't it just hand out enough money to solve the credit crisis. It must mean that even though there is this ebb and flow of fiat currency, that there is also a point where value is a real concern. Does it mean that the cdos $535 trillion reported, has to be worked through in terms of value, somehow? The fed might have to borrow some ammo from the military to get through that number. Someone is going to get mad when they find out that the agreement they made with the government, that a $20 bill = $20 dollars, was a bad one.

2008 Apr 07 09:03 AM

[Jason Rines...:]

You said it right Nukldrager. And the first big price we'll pay at default of trillions (or the dollar being worth 10% of what it was five years ago) is the Arabs decoupling the dollar. This will cause a massive increase in oil commodities, more to the tune of $200 which is exactly what GS and Deutche are predicting in the not-so-distant future. For our Congress and Administration to NOT be creating an emergency energy package NOW is gross negligence. It is a matter of when and not an if one or more of these Central Banks goes up in flames, causing the systemic dominoe effect of trillions of dollars becoming de-leveraged (defaulted). This will be a global financial collapse with really only one nation not effected. It's Russia. I guess we all trust the Russian's as the new international monetary beacon right? Americans will be screaming for blood in the next two or three years but will feel fine as Socialism and massive wealth redistribution bails them out in the short-term. So far the Fed has done all it can do, America must innovate it's way out of this mess and the political leadership is inept beyond measure.

2008 Apr 07 02:55 PM

[drdent:]

Well, I dunno about the rest of this post but one thing rings as false as a mustache on Paris Hilton (or pick your favorite female model/actress/whatever... You say, in part, "Well said. $13 trillion is too big to fail!" This may or may not be true but either way the Fed has been hugely inconsistent in this regard since the US housing bubble created about $8 trillion in bubble wealth. This is in the same ballpark and the root cause of the current problems. If this amount of money is "too big" then why didn't the Fed do something years ago (like, oh, say, publicly admit there _was_ a bubble developing) to deflate it? On the other hand, if the Fed figured an $8 trillion housing bubble wasn't that big a deal then why worry about $13 trillion in bad bets at one investment bank? Sorry, you just can't have it both ways.

Personally, I think both Greenspan and Bernanke were/are inept and failed to recognize either bubble. Then when the schtuff hit the fan they hurry in to rescue Wall Street rather than the economy. Witness the fact that inflation is up, unemployment is rising, wages are well behind inflation, and GDP is at a virtual standstill ... but we just had a remarkably nice rally on Wall Street. _Perhaps_ when Bernanke _speaks_ it "jinxes the market", but when he _acts_ it's another story altogether. Never mind the fact that the Fed's approach will most likely leave the bumbling idiots that ran their bank(s) into the ground still earning multi-million dollar salaries while helping people who got sucked into buying houses at bubble inflated prices not one whit. I think it's pretty clear where the Fed's loyalties lie.

2008 Apr 08 02:58 AM