Fed Bail-Out: “Throwing Gasoline on The Fire”


Reuters posted this article today, reporting on financial analysts’ reactions to the emerging details of the proposed financial bail-out plan.  (Just so you know, this article contains many typos and grammatical problems – uncharacteristic of a Reuters article.  It seems clear that it contains unedited transcripts of phone conversations with these analysts.) 

First of all, here’s some sketchy details of the plan:

KEY POINTS: According to a draft of the proposed legislation obtained by Reuters: * The government could purchase as much as $700 billion in mortgage-related assets from U.S.-headquartered institutions. * Decisions by the treasury secretary related to the buyback program could not be reviewed by any court. * In a related move, the U.S. government’s debt limit would be raised to $11.315 trillion from $10.615 trillion.

The following are excerpts from the analysis of Michael Pento, Senior Market Strategist at Delta Global Advisors in San Francisco.  I’ve singled out his remarks because they’re right on the money (no pun intended). 

“The plan is pretty much what I thought it would be and it is a very poorly crafted plan. When you go into negotiations the last thing you want to do is assure that you will purchase the assets — now the bargaining power of the Treasury is left on the curb. So the banks will be able to negotiate a much better deal than they would normally have got.

“Another poorly crafted bit of this: when you plan on issuing $700 billion that amount is accrued the already skyrocketing annual deficits. Now these skyrocketing annual deficits will put pressure on the federal reserve to monetize the debt away. If the Federal Reserve refused to monetize the debt, the sharply rising annual deficits will lead to sharply rising Treasury yields which will counteract and negate all what Treasury is trying to do to reignite the housing market. When you have the national debt at $9.6 trillion and you are adding a trillion plus a year to the debt then the amount of debt outstanding outstrips the tax base.

“What is the end game? You are trying to recapitalize the banks by exchanging non viable and non performing assets putting them on the balance sheet of the tax payer and recapitalizing the banks by sending them cash. Here is where the plan has faults: you are trying to compel the banks to make more non performing loans at a time when the banks are over leveraged and consumers are overleveraged.. Trying to get these banks to lend more money to a consumer who already is overleveraged, its like throwing gasoline on the fire and it is kicking the can down the road a few feet and the problem is going to be a lot more pernicious the next time.

These are exactly the points I’ve been trying to make.  The government isn’t interested in restoring responsiblity to the financial system.  It’s only interest in all of this is to re-ignite the debt machine and resume making bad loans – whatever it takes to drive demand for housing, reinflate the housing bubble and maintain the status quo.  And the Fed has no choice but to begin printing money at a furious pace, to prevent the rates on Treasury bonds from soaring through the roof, which is exactly what would happen when foreign buyers decide that they’re practically worthless. 

Mr. Pento closes his analysis with this:

“In the long run this is an extremely poorly crafted plan and it will be much worse than it was. You’re just kicking the can down the road and we have to deal with the a much worse problem further down the road. This is what lies in store for this country: higher inflation, slower growth, higher taxes, just because you didn’t allow the free market to work.

“We are just rolling asset bubbles. There’s no magic here.”

There’s lots of other interesting analysis and opinions in the article, but Mr. Pento’s is dead on.

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