Tuesday, August 28, 2007

Fed bailouts = capitalism?

We're going to follow up Monday's post on the 2007 liquidity crisis with some reactions to the recent Fed interventions in the markets and the economy.

Should the Federal Reserve and other leading central banks help bailout the investment funds, banks, investors, and homeowners that have been caught in the fallout of the recent credit crunch? That is the question at hand. But first, a summary of Fed actions and stimulations carried out thus far.

IHT.com carries a useful and brief summary of the Fed's bailout actions to date. As the article details, the Fed reacted to the credit squeeze with a series of "liquidity injections", followed by a 50 basis point cut in the discount rate (the rate at which member banks borrow from the Fed), before removing certain regulatory caps on loans to the brokerage affiliates of large banks.

Excerpt from, "What looks like a bailout?":


The cap on loans to an affiliate is a tenet of prudent banking. So waiving it, even temporarily, is a significant escalation of the Fed's rescue efforts. Under normal circumstances, a bank is limited to lending any one affiliate an amount equal to 10 percent of the bank's regulatory capital. Fed documents released last Friday disclosed that the banks would be allowed to lend up to $25 billion apiece, or about 30 percent of their capital.

Compromising the cap to that extent attests to the Fed's belief that a bailout is necessary to avert greater harm to the financial system and the broader economy.

So, as you can see, the Fed is clearly concerned about the effect that the credit market fallout will have on the economy. Which is interesting, because so many of these leading lights now calling for, and enacting, the bailouts were prominent among those who suggested that the subprime/CDO mess was well "contained".

And since so many have been inundated with the hypocritical rescue cries from Jim Cramer and the like, we offer you some opposing viewpoints on the issues of Fed bailouts, and how the credit market bubble got started in the first place.

1. "There's no such thing as a free bailout", by Paul Kasriel.

2. "How regulators fed the credit mess", by Bill Fleckenstein.

3. "The Fed's Subprime Solution", by James Grant.

4. "Deflating the credit bubble", a Financial Sense interview with Doug Noland.

Consider these arguments carefully, as they are the ones which reveal the truth.