Tuesday, September 18, 2007

Central Bailout Banks

The Fed's FOMC is meeting today to decide on its interest rate policy. Setting the benchmark cost of money is always an important decision, but recent events have fundamentally altered the main role of the Fed, ECB and BOE (and the BOJ, though indirectly). Currently, they are acting mostly as lenders of last resort and less as arbiters of monetary policy.

The injection of hundreds of billions of dollars into the interbank market, the permission to 3-4 major US banks to lend $25 billion each to their brokerage subs, the acceptance of highly questionable ABCP as collateral and the latest bailout of Northern Rock, all point towards a role that was once reserved only for dealing with extreme crises. And if the BOJ is not participating directly in the bailouts (at least not yet), it is doing so indirectly through being the largest global lender of last resort of them all: keeping yen interest rates at absurdly low rates they pump hundreds of billions of cash into the system, through the so-called yen-carry trade.

In those rare instances in the past when central banks had to step in and play this "bailout bank" role, they did it quickly and immediately reverted to their monetary policy duties. There was no reason for them to "linger" on the stage, simply because there was no overall threat of systemic risk. Clearly, this is no longer the case and anyone can see that the trouble is spreading, not receding. Late yesterday the British government had to step in alongside the BOE to guarantee all deposits at Northern Rock, plus those at Alliance and Leicester - another lender that got into trouble.

Viewed from that perspective, today's FOMC decision on interest rates is mostly symbolic for financial markets, but it is highly important for Prof. Bernanke's image and reputation going forward as Chairman. It will be his first test under pressure and everyone will be watching to see how he does. If he listens too much to the siren songs of the various politicos and bond daddies and proclaims the Fed as Bailout Central his credibility will be worth less than the equity tranche of a leveraged SIV.

If I may be so bold as to make a suggestion, he should probably be calling on Paul Volcker for advice and support.


Ben's Bail Bonds cuts 50 bp:

(a) stocks rally 3%,
(b) the dollar makes a new low vs. the euro (1.3980),
(c) gold goes to a 28 year high ($735) and
(d) oil rises to an all time high ($82.10).

Ben's economic prescription for survival based on the above:

(a) Since the vast majority of Americans do not own any stock, skip (a).
(b) Buy only cheap Chinese goods.
(c) Sell your wedding bands, bracelets and gold teeth and with the proceeds...
(d) Immediately buy some heating oil futures to prevent freezing this winter.

As Jim Rogers said today before the FOMC announcement, Bernanke spent his entire academic career studying the monetary printing press - and he just got his hands on them.


  1. Will Debt Addiction Finally Crash the Monetary System?


  2. Once again a very insightful post puts everything into perspective.


  3. 100 BPS increase today would put a nail in the coffin to this nonsense.....

  4. "If I may be so bold as to make a suggestion, he should probably be calling on Paul Volcker for advice and support."

    BRAVO....! As I posted yesterday in the comments section of Economist's View, "Paul Volker is the real Maestro."

    Large cojones are a prerequisite of a great man.


  5. I have a tiny suspicion that Bernanke will not throw caution to the wind and get wholly into bed with the Paulson crowd. He may just surprise everyone by cutting 25 bp and put any more cuts on hold. (As a sop he may also cut the discount rate 25 bp). In the CB business if you lose credibility early on you have to do very, very tough things to gain it back and that is not the smart way.

    Let's also not forget that Bernanke is going to be around after the Bush crowd leaves DC in one year and will have to work with - most likely - the Dems. If he wants a second term he has to be very, very careful here.

  6. So much for transparency.....

    "The investment bank (Lehman) did not disclose how far the valuations have slipped for some of its asset-backed securities, including bonds that repackage subprime loans."


    The lies and deception continue.

    Yet the market rallied on the "positive" news.


  7. Here in Finland we are safe. Our finance watch dog (e.g. a state organ) just announced that the Finnish banks have only investen 20 million euros in the US subprime market.

    Nice to know that nothing bad is going to happen in the Finnish economy. We are no dominos, after all.

  8. Wait a few days, maybe a week or two at most, and watch this thing fall apart as the equity market-with an IQ of about 94 figures out what is being unleashed. In a word, Weimar. This is unsustainable cubed.

  9. Now we are just waiting for Mr. Bush to divert our attention from ecomomic foes to political ones. Attacking Iran is just what the US needs right now.

    Let us hope for a warm winter...

  10. Ummm, hellasious

    Would it be OK if I post some of your stuff in other forums, provided that I give full credit and post a link to the original article?


  11. re: posting in other forums

    Sure, go ahead.