Fed up with the Fed
The Federal Reserve May Be Hurting Us More Than They Think

Yesterday--Halloween--the Federal Reserve Board of Governors decided to lower the prime rate by an additional 1/4 point--bringing the total reductions to 3/4 point in merely six weeks time. This is a pretty dramatic and scary action in the realms of monetary management. Similar reductions have occurred in the Fed Discount Rate and the Fed governors have also seen fit to pump literally hundreds of billions of dollars into the money supply over the last few months. All the while, bankers, hedge fund managers, and traders clamor for more.

All of this gives Huckleberry some pause... and a little additional clarity is, I believe, in order (see previous post).

The Fed is not being encouraged to lower interest rates because they are too high. Rather, rates are being lowered because the spread between the cost of funds paid by financial institutions and the interest rates that they are charging their customers is too small.

This applies to Subprime Mortgages, Credit Cards, and all riskier loans. The subprime mess--arguably at the root of all this consternation--has been caused by banks, brokers, and hedge funds not charging enough to cover the amount of risk already incumbent upon the borrowers that they have courted--proving once again that denial of risk does not mitigate it. Since (in most cases) contracts prevent the unilateral and/or unscheduled raising of interest rates, the only way the Fed can bail out these select financial institutions and companies is by lowering the cost of funds to provide some room for them to absorb the losses that should have reasonably been expected in the first place. The Fed is the only available source for this bailout because those loans--once touted as the belle of the ball--now have their blemishes on full display and the private equity markets no longer think that they are very pretty at all. Again, this should have been fully expected with a little math and due diligence evidently missing from their efforts to date.

Credit cards are in the same boat, but are even riskier. As the economy worsens/slows credit cards are usually the first to feel the default pinch. Prime credit cards are likely to remain in the same interest rate range and the lower credit (riskier) credit cards are likely to push up a bit to protect the banks from losses (the only thing worse than less profit at a bank are more losses).

But Won't My Payments Go Down Now That Rates Are Lower?
Not likely. This current round of rate cuts is designed to protect financial institutions--not consumers--and therefore consumers should not anticipate interest rate relief will be felt in their monthly loan payments. In fact, consumers will likely suffer higher costs overall as the dollar concurrently weakens and inflation bares its teeth. Statistically the argument can be made that mortgage and credit card payments were not high enough to cover the inherent risks. The current reductions show every indication (to this author) of being earmarked to stem the flow of blood on Wall Street.

This little insidious protection racket shifts the costs back onto the consumer-at-large in the form of lost buying power (inflation) and economic turmoil. The prevailing thought seems to be that it is better to squeeze a few drops of blood from each of us rather than take the heads (and robust profits) from the subset of us who wear pin-striped three-piece suits. The Fed obviously believes that they are choosing the lesser of two evils. I think that they are incorrect and that a greater evil is being done on many fronts.

Certainly more to come....

Be well,
Huckleberry

Government Mortgage Bailout Betrays Conservative Principles and Common Sense

Risk = Cost, Always
President Bush has decided to ask for allowances in federal programs to “protect” home owners. According to a recent MarketWatch article, the President’s plans include allowing stressed borrowers to refinance into government-insured loans, a related change to the tax code, the potential creation of a new government agency (the oddly New Deal-sounding “Reconstruction Mortgage Corporation”), and allowing government-sponsored mortgage giants Fannie Mae and Freddie Mac to provide greater liquidity in the mortgage markets. More proposals may be on the horizon.

One of the biggest problems facing contemporary economies is the public’s disassociation from the Free Market/Value/Risk/Return equation. It is a fundamental law of economics. In a way, it is the economic equivalent of forgetting that gravity works. If one is foolish enough to leap from the rooftop, nature will not care if you have neglected to study Newtonian physics—down you will go.

Feeling loss-risk of one's home or equity—or any loss really—reaffirms this vital principle (yes, I have personal experience). This is the same argument against most welfare policies in general. For example: The age-old principle of "If one does not work, one does not eat" has been worn down by the latent brand of American-style Socialism that is present in our society (yet is still somehow alien to our true selves). What we forget is that even if one does not work and We The People ensure that such still eats—someone somewhere is indeed still working to trade value for that service.

The danger here is well understood in the realms of economics. The Administration’s proposals would only serve to transfer risk from one party to another (us)—and substantial risk it is. To coin a phrase, Risk can be neither destroyed or denied—it can only be distributed or transferred. I dare say that, in reality, the home owner is not the intended party being protected. Rather, the home owner is the palatable "face" being placed in front of the media and teaming crowds to better protect the banks, hedge funds, and big-ticket investors.

It is important to understand those financial institutions and individuals we are thus protecting have been well compensated for the risk in that they have been paid higher interest rates than they otherwise would have, and the sub-prime loans at the center of today’s troubles carried significant, often onerous, fees and charges. The financial big-wigs were paid an amount commensurate with the chances of loss so that they freely accepted that risk in order to obtain the rich rewards that might have resulted.

They forgot that these rich rewards were not ever, in fact, guaranteed. Guaranteed rewards do not have the potential to generate large fees and interest payments.

It is my opinion that We The People are being prepared to swallow hard the incumbent risk (risk always = cost) to protect those who were aware of the risks and justly compensated for it—even if they are not so good at math or statistics. Funny how no one has suggested that the financial institutions return the interest rate premiums and other dollars they have collected in the mean time. As these spoiled and recalcitrant hedge funds dip their soiled hands into our collective coffers, they should well consider that a government willing to bail them out from such losses now will certainly return to collect a disproportionate share of the profits when the sun shines again. If we sell our souls for a little temporary financial stability now, we will all pay the price in freedom and tyranny later. This is another law of economics and politics.

I am glad that Milton Friedman and Ronald Reagan are not here to witness the GOP abdication of the principles which ushered in repeated Conservative political victories and decades of economic success.

Be well,
Huckleberry