Friday, January 25, 2008

Just how powerless is the Fed, hypothetically?

Ilargi: If I were to name my favorite writers on finance, Henry C K Liu would be right up there in the top 5. His articles are long, but that’s because he shares so much information. Kudos also go to the little known Asia Times, a truly high quality publication with gusto, which publishes much of his writings.

That said, I seamlessly move into an area where I tend to hypothetically disagree with what Liu says in the piece featured below, and where Stoneleigh and I kind of disagree. Yes, that happens.

The title of Henry Liu’s January 26 2008 article, Fed helpless in its own crisis, implies something that I’m hypothetically, and strictly for entertainment purposes, not necessarily comfortable with, namely that the current financial crisis happens despite the Fed, which can do nothing but stand by helplessly, hands in their sparse hair, implementing last minute desperate measures that are doomed to fail.

Yet, it was this same Fed that lowered interest rates to 1% from 6.5% some five years ago, and whose chairman, a certain Greenspan, subsequently went public, waxing poetic about the too numerous to mention benefits of homeownership in the US, as well as the great innovations in the derivatives markets that would spread the risk of investment so broadly across the spectrum that risk would in reality disappear altogether. Hypothetically.

Then, the Fed, the one and only organization out there that gets all relevant economic numbers on its desks everyday, all the time, supposedly sat back and watched the mayhem come to fruition, for years, without changing or correcting a thing. And now we are to believe they didn’t know what happened right before their eyes, that they are more clueless than a whole slew of writers and economists who have warned for a long time about what was going on?

I don't think it's overly presumptuous to hypothetically question that presumption, if only because accepting it at face value would mean that the arguably most powerful financial organization in the world is run by hundreds, if not thousands, of highly paid alleged experts, who, all of them combined, have less insight in the field of economics than some writers have all by themselves.

Maybe, hypothetically, and strictly for entertainment purposes, we could consider the possibility that the Fed isn’t so helpless after all, that their focus is simply not on keeping the US economy going smooth as can be and steady as she goes. For if that were their goal, they certainly are doing a much worse job than you and I would. So maybe, hypothetically, and strictly for entertainment purposes, we can try seeing events unfold with a view to what things would look like if we hypothetically presume that they are going exactly the way the Fed planned. Strictly for entertainment purposes.

Fed helpless in its own crisis

After months of denial to soothe a nervous market, the Federal Reserve, the US central bank, finally started to take increasingly desperate steps to try to inject more liquidity into distressed financial institutions to revive and stabilize credit markets that have been roiled by turmoil since August 2007 and to prevent the home mortgage credit crisis from infesting the whole economy.

Yet more liquidity appears to be a counterproductive response to a credit crisis that has been caused by years of excess liquidity. A liquidity crisis is merely a symptom of the current financial malaise. The real disease is mounting insolvency resulting from excessive debt for which adding liquidity can only postpone the day of reckoning towards a bigger problem but cannot cure. Further, the market is stalled by a liquidity crunch, but the economy is plagued with excess liquidity. What the Fed appears to be doing is to try to save the market at the expense of the economy by adding more liquidity.

The Federal Reserve has at its disposal three tools of monetary policy: open market operations to keep Fed Funds rate on target, the discount rate and bank reserve requirements. The Board of Governors of the Federal Reserve System is responsible for setting the discount rate at which banks can borrow directly from the Fed and for setting bank reserve requirements. The Federal Open Market Committee (FOMC) is responsible for setting the Fed Funds rate target and for conducting open market operations to keep it within target. Interest rates affects the cost of money and the bank reserve requirements affect the size of the money supply. [..]

On Monday, January 21, a week before the scheduled FOMC meeting, global equities plunged as investor concerns over the economic outlook and financial market turbulence snowballed into a sweeping sell-off. Tumbling Asian shares - which continued to fall early on Tuesday - led European stock markets into their biggest one-day fall since the 9/11 terrorist attacks of 2001 as the prospect of a US recession and further fall-out from credit market turmoil prompted near panic among investors, forcing them to rush to the safety of government bonds.

About $490 billion was wiped off the market value of Europe's FTSE Eurofirst 300 index and $148 billion from the FTSE 100 index in London, which suffered its biggest points slide since it was formed in 1983. Germany's Xetra Dax slumped 7.2% to 6,790.19 and France's CAC-40 fell 6.8% to 4,744.45, its worst one-day percentage point fall since September 11, 2001. The price collapse was driven by general negative sentiments and not, so far as was apparent at the time, by any one identifiable event.


jografy said...

Teasing out your elegant prose do I reach the correct conclusion that perhaps, in a hypothetical way of course, that the Fed actually wants to cause a train wreck?

Ilargi said...


Just for entertainment purposes, ask yourself this:

If the Fed had been hell-bent on keeping the US economy intact, alive and sailing along on course, would they ever have allowed the run-up to where we are now, that has taken place over the past decade?

They have the numbers, they have the stats, more so than any other party. They have the power to stop or stimulate events in the US markets.

The 1998 Glass-Steagall repeal allowed banks, for the first time, to branch out to other, often formerly competing, sectors of the money markets. Banks now became institutional investors and all sorts of other things, basically being both a player and the house at the crap table. This would never have happened without permission from the Fed.

When Washington needs more money, they have to go to the Fed and ask them to buy more bonds. That's the whole range of options it has, in that one simple phrase.

The Fed can still say no. But the government promises to pay interest over what the Fed buys, and since the Fed simply creates the credit it supplies, it can't lose.

The US government can only go belly up if its citizens stop paying taxes, so all the have to do is keep the economy rolling.

Of course all this is pure hypothesis, but I'm sure you got this by now.

More hypothesis, strictly for entertainment purposes: suppose the Fed foresaw an event that would make it impossible for the US taxpayers to keep on forking over the interest on the loans. What would it do?

Such an event, purely hypothetically, could consist of a few things, perhaps in some sort of combination. I think Chalmers Johnson's article we posted in today's Debt Rattle might give a hint: military expenses have overpowered the entire economy. 83% of the value all manufacturing infrastructure in 1990 was military based.

But still, why let that happen?

How about Peak Oil? How about they saw this 25 years ago, and brought in Greenspan to liquidate the whole kaboodle?

Strictly for entertainment purposes, but that goes withour saying.

Ric said...

Catherine Austin Fitts puts it well. You can pump and dump a stock, a company, a city, a country...the world...

The Creeping Financial Coup d'etat

A Comment on the American Economy

Greyzone said...

Just for a moment imagine that the people at the very top know about the Limits to Growth, have every single bit of available data about it, have run every single model of which they can conceive, and can see clearly that within the first 25 years of the 21st century that the world as we know it is going to end.

Now let your imagination go one step further. What would a sociopath do in that situation?

Of course, this is all imaginary, hypothetical, and has no real bearing on reality today, right?

Here's hoping I see you on the other side.

OuttaControl said...

Damn you, ilargi. Just when I thought I was understanding how this clusterf^&k came to be.

In 2001, did the Fed lower interest rates unilaterally or did it follow the bond market? Or did the bond market follow what it assumed the Fed would do with interest rates or what the Fed would encourage/permit the goverment to do in creating credit or, simply, the right market psychology? Did the Fed engineer this because of dwindling energy supplies?

Is the Fed (including a few hundred rich and powerful people in the corporatocracy) purposely engineering the collapse of the financial world ... or do they simply beleive their own lies?

What is the end game? Will all these very smart people who engineered this collapse (if that premise is true) really want to live in a world where millions of people are corralled into Blackwater prisons to become organic slave-farmers? At what point will they understand that it's really cheap to become a terrorist these days? 'Eat the rich' would become very fashionable again. Is it possible that these rich and powerful people figured everything out except that? Or are they that psychopathic that they don't care? I'm reading 'Confessions of an Economic Hit Man' at the moment and it would lend credibility to the latter.

But I suspect it's a question that is unanswerable.

jografy said...

ilargi, I am easily convinced on this, even in the ilargithetical land (is you name Alice? :) ). It makes lots of sense given that none of our "leaders" know how to lead anything but they are good at manipulating the truth and coercing dissent. A reral sheherd woiuld lead a flock of hundreds by simply walking in front of them with a little dog nipping the ocassional wanderer. The animals trust the shepherd because they are always led to something good. Our politicos are like modern sheep farmers who use fences, electricity and false promise to keep the flock in, forcing them to over graze for extra profit.
I hope this bunch is as good at leaving a paper trail as the Nazis were so that my grand childrens generation can tease out the true history of what will loikely be the most horrible few decades in human history. Thank you both for the work here, it is m ore than good.

GliderGuider said...


I'm quite sure that Naomi Klein would agree with ilargi's interpretation of these events.

A few nights ago I had dinner with the MPP who is the energy/environment critic for the Ontario NDP. During the discussion he revealed that he is completely clued into Peak Oil, as is the Liberal Government of Ontario. Hell, he has copies of David Hughes' ASPO Powerpoint about Peak Oil and Gas on both his work and travel computers. He even understands that we're at the beginning of a converging multifactorial global crisis, and that the timeline is much too short to prevent it.

Now what do leaders do with knowledge like this? If you're the Canadian NDP you try to use it politically to steer a course that makes life better for everyone. If you're the ex-CEO of Halliburton your world-view and goals could well be a bit different.

The idea that we're actually looking at the largest deliberate incident of Disaster Capitalism ever conceived in human history isn't all that far-fetched. Like all those nasty conspiracy theories about the source of 9/11, it suddenly gives a lot of jigsaw puzzle pieces homes that they didn't have if you went just by the manufacturer's picture on the box top.

Speaking strictly as an entertainer, of course.

Greyzone said...

"Will all these very smart people who engineered this collapse (if that premise is true) really want to live in a world where millions of people are corralled into Blackwater prisons to become organic slave-farmers??

Step outside your 20th century molded world view for a moment and apply basic biology. Review the human population growth curve from 10,000 B.C to the present. Graph it. Go ahead.

Once you have done that, please refer me to any mammalian population whatsoever which has created an equivalent massive overshoot and did not experience 90%+ dieoffs. I'm waiting...

Once you realize where we are biologically, go back and find a copy of Limits to Growth. Read it, really, for the first time rather than listening to pundits who never read it themselves dismiss it. Read Admiral Rickover's comments from the 1950s. Read Hubbert's comments about energy and population from the 1950s through the 1980s.

Then step back and just remember that Glenn Beck, Rush Limbaugh, and all those other talking heads just cannot be wrong and these scientists must be wrong. Go back to sleep. Everything's going to be ok, right?

Ilargi said...

Now, now, Gliderguider, I have no interpretation of facts, I don't even have facts come to think of it. It's all nothing more than a hypothesis. I was merely playing a game, the kind that's not for money, let's call it a zero-sum game.

With all the heavy minded things that pass through this revue, it seemed a good idea to show people that no matter what, above all, we aim to please.

That clear, let's hypothesize, strictly for entertainment purposes, that my hypothesis is completely off, as in 180 degrees off. If that is so, and I would not be offended if it were, since it's only a game, that would mean the Fed, for 95 years now, has been led by the most utterly incompetent litter of dunces you or I have ever seen, or even heard about.

If you have all the tools in the house at your disposal, including the cards, the chips, the tables, the bank, the croupiers and the waitresses, and you are the only player in the entire house, and then with all that going for you, you still manage to lose money at the end of the day, that's nothing less than redefining incompetence.

ThousandMileMargin said...

You know, we do seem to be experiencing a boom in Treasury debt at the moment. If interest rates go to 1%, people who bought bonds when rates were 5% will do very well. You might say they will make a killing, especially if they were using leverage.
So somebody is getting rich right now. All you need is a patsie to sell to at the top. And wouldn't that be the US taxpayer - as the Fed buys up bonds via open market operations to hold rates down/prices up?

CrystalRadio said...

Hey Greyzone, you say,

Now let your imagination go one step further. What would a sociopath do in that situation?

First invade Iraq?

On thinking about the unthinkable, I am quite happy not to be in charge of making any decision about how to play out the dilemma us 6.5 billion and rising are facing.
It seems to me that there are two choices with neither very jolly ones. First to continue the present course of thinking that with a few technical changes, like a windmill in every pot, we will avoid a heat death style meltdown and just sweetly muddle through. Better we hope for an alien from space intervention. Second is the premeditated 'culling' by extraordinary means such as that oldie but goody 'preemptive nuclear strike', which seems to be having a revival in the theaters these days.

Call me irresponsible but from a purely rational point view the latter seems to be the optimum choice. Lovelock, while he doesn't come right out with anything quite so horrible, makes mention of nuclear war not being quite as bad from a planetary point of impact as usually thought. If that is any comfort.

I am glad I don't have any power in the matter, as if I did I would need to, like Pontius Pilate, rush for the washbowl and weasel wash my way out.

BTW I don't really consider Bush a sociopath, but more a religious maniac with hell-fire on the mind.