Thread: We and the FED, Must Face Reality, and Soon!

We Must Face Reality, and Soon!

As I mentioned recently, I had a most interesting interview in Switzerland last week with members of the Bank of International Settlements (BIS), the research and coordination working body of the world's central banks.
Of course, the interview was off the record.

However, I can tell you this: It is clear that there is deep international concern that, despite massive injections of liquidity, the credit crisis is still causing a stubborn "log-jam" in some of the most important lending markets, particularly for less-than-prime borrowers, the bulk of basic companies.

Surprisingly, banks are even loath to lend to each other for fear that the bank borrowing from them could be hit severely by the undisclosed levels of so-called "toxic waste" — high-risk, nearly worthless mortgage-backed instruments — contained in some of their supposed investments.

At the BIS, I sensed that there was something in the works but could gain no definition of what was coming, only "nods and winks" that they hoped that whatever it was, it would work.

I have often alerted readers to the fact that our problem is not one of liquidity but of credit credibility.

Indeed, it was irresponsibly excessive and cheap liquidity that caused the series of asset bubbles (which we confused with prosperity) we have experienced over the past 25 years.

I therefore find it hard to agree with the idea, considering that excessive liquidity was the cause of the problem, that more of it will provide the solution. More alcohol will not cure drunkenness!

It is true, however, that the near-fraudulent abuse of liquidity caused the problem of toxic waste in subprime derivatives, many now held in the financial inventories of major financial institutions, including some of the so-called prime banks.

Most shocking is the growing evidence that one of the largest banks in the world, Citigroup, is increasingly considered to be doubtful viability.

On Dec. 12, Morgan Stanley named Citi as its top short sell. According to reports, 165 million of its shares (more than twice the daily volume) traded that day, and Citi's stock price plummeted 43 percent from its high and lost $1.2 billion in market capitalization. How's that for confidence in a global financial giant?

It all goes to show that in the coming financial turmoil it is not size but quality that is likely to win.

Also on Dec. 12, the Fed announced a novel solution, one very carefully coordinated with other important central banks.

With short-dated U.S. Treasuries now yielding less than the Fed rate, something had to be done. But how could the Fed lower its key rate without both killing the U.S. dollar and unleashing inflation?

The answer appears to be to allow the free market to operate, by allowing "auction bids" for a series of three tranches of $20 billion of Fed funds.

In addition, there are swaps of $20 billion and $4 billion with the central banks of Europe and Switzerland to make yet more U.S. dollar liquidity available overseas.

The details of the new plan are not yet quite clear, but it has apparently caused great uncertainty in the pricing of market credit risk

At first sight, it appears that our government is prepared, on behalf of U.S. taxpayers, to accept a large slug of toxic derivatives risk in order to bypass the banks' unwillingness to lend. In short to "bypass" the free, professional lending markets to force yet more liquidity and so put off the day of reckoning.

If true, it represents quite a philosophical change for a Republican, free-market government.

However, I see it as a sign of desperation — desperation to avoid recession and the possible financial meltdown that the Fed now sees looming ahead.

I also see it as just one more gimmicky plan, following the "strong dollar" plan; the bank SIV "enhanced value" plan; and the "strong mortgage" plan. I fear that all of them are signs of deep official concern but merely token moves. None of them addresses the real, underlying problem.

The awful truth is that, as I have said before in this column and on the Larry Kudlow show, it is increasingly apparent that our Fed has been check-mated.

The Fed has been boxed into a corner by the wild excesses of the Greenspan liquidity bubbles. These bubbles, which felt like unprecedented prosperity, were often financed by debt piled upon debt and financial duplicity piled upon financial irresponsibility, even fraud on a massive scale.

The unwinding is likely to be painful.

In short, the Fed must lower rates dramatically and fast, if it is to avoid a looming recession or worse.

But our Fed is hamstrung in lowering rates. Clearly, it fears unleashing latent inflation and a catastrophic collapse of the dollar.

In other words, the Fed, still the most important central bank in the world, can do nothing — nothing except try to boost confidence by means of soothing words and gimmicks.

By their very nature, Fed initiatives that fail to face economic reality will all be destined for economic failure.

All the while, the clock is running.

Now we hear from cable financial news reports that the richest consumers are cutting back on jewelry purchases and even country club memberships — not a good sign!

The reaction of investment institutions to the Fed's actions and words of the past two days, mimics those of TV stock picker Jim Cramer: "Sell, sell, sell!"

I am not sure Jim agrees fully with my forecast, but I can almost hear him crying out, and I would agree with such a cry!

In summary, although much of the financial media are still in a state of denial, I still believe we face a recession and that the Fed will not act decisively until too late.

It will therefore be a very bad recession.

Our readers should be forewarned and arm themselves appropriately.

I apologize for the bad news, but I feel it is best not to run but to turn and face the enemy — the reality of recession.

http://moneynews.newsmax.com/money/arch ... 150407.cfm

More alcohol will not cure drunkenness!

Love this quip.