Injections of Futility or, Bail and Fail

The big central banks are injecting temporary liquidity into the system, at around $150 billion a pop, most of it as O/N loans to banks (i.e. here today, gone tomorrow). This amount is large when compared to normal CB money market operations, but it is less than a drop in the bucket when compared to the size of the credit market, currently in turmoil. For the US alone, total credit market debt outstanding is $46 trillion, an amount so unfathomable that it defies comprehension (it translates into $400,000 of debt for every single US household).

The global liquidity injections thus amount to 0.32% of this debt alone and given the size of the still developing credit crunch, they are but mere exercises in futility. Of course, they must be undertaken if only because that's what central banks are obliged to do under their role as lenders of last resort (Prof. Bernanke has written two books on the subject), but I do not for an instant believe they are going to make any real difference. In the end, they act mostly to underscore the extent of the problem and the Fed's predicament.

This is not a repeat of the 1998 LTCM situation, where a single large player made a wrong bet and was quickly bailed out to avoid more serious consequences to an otherwise sound financial system. Rather, today it is the whole system that is in deep trouble: it relies on too much debt piled on top of overinflated assets, further complicated by monstrous amounts of derivatives. The most apt analogy I can think of is a runaway nuclear reaction, with central banks in the role of small lead rods - too small to contain it once it gets going.

There is nothing within the sole purview of the Fed, or any other central bank, that it can do to transform and rectify the system; its relative size is too small in comparison to the modern financial behemoths. Goldman Sachs alone has balance sheet assets of $943 billion, an amount larger that the GDP of every country in the world except for the top 10. But, tellingly, their equity is a mere $38 billion, so their leverage is a troubling 25x and this is before the off-balance sheet items, like various swaps. Nevertheless, the days when a large private financial house could act as de facto central bank (e.g. Morgan in the 1890's) are gone forever, even if some fervid neo-conservatives would like to see the government drowned in a bathtub.

There is a glaring paradox here: those same free market enthusiasts that ardently proclaim the supreme efficiency of modern finance in allocating capital where it's best utilized, go begging to the government to save them when their capital evaporates due to their own folly. It is actually not a paradox at all, of course - since time immemorial such behavior has been known simply as childish, or wanting to have your pie and eat it, too. Actually, since central banks are owned and financed by governments (i.e. taxes), they want to have their pie and eat everyone else's, too. Laissez faire when it suits, sauve mon derriere when it doesn't. That's called virulent capitalism, not free market economics.

There is certainly a strong ethical dimension in the divisive question that has come up in recent days: should the CB's bail out the big financiers and their rich customers with public money, or should they let them learn a sharp lesson about risk vs. reward? There are firm proponents of both opinions, but there is also a third one: Even if they bail, they are still going to fail. The reason was made clear above, i.e. it is the whole asset-credit system that is in trouble, not just a few players within it.

We need a Plan B to deal with this situation and we need it ASAP, but...

(a) I am certain there is currently no Plan B. Ideologues with blinders are running the show right now and they can't even fathom that Plan A could be wrong. Witness the extremes to which Plan A could theoretically be taken, if all else fails (helicopter cash). This is not novel thinking, just much more of the old.

(b) Any Plan B would by necessity seriously damage the vested interests that reign within Plan A and would immediately be painted as dangerous, radical and unpatriotic.

(c) Individual human thought may leap, but society's habits change only gradually and then only after the proof hits them hard over the head. Witness global climate change, for example.

Attempting to close on a more humorous note, maybe the central banks could start by changing how they name their money market operations. For example, the ECB calls the injection of an unprecedented 95 billion euro "a fine tuning operation". The whole orchestra sounds like a dozen buzz saws ripping through rusted sheet metal and they worry about A sounding flat?

So, in this hot summer season, here's my own suggestion, inspired by a film by Lina Wertmuller:

Travolti da un insolito destino nell'azzurro mare d'Agosto

or, in English,

Swept away by an unusual destiny in the blue sea of August.

P.S. For the reader comment section: If you have seen the film, who do you think should play the market-equivalent parts of Gennarino the sailor and signiora Raffaella?