Pontificatus Interruptus

Author: David Kotok, Post Date: September 27, 2008
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Here we are with another intense weekend to add to the pile of 7-day work weeks. 

Washington Emperor Barney Frank says “Follow me.”  He looks around and no one is there.  Result: blame someone else.  So he points fingers and seeks scapegoats.

Did he mention he added 4.2 basis points to the Fannie-Freddie bailout for his pet projects?  Did he say he controlled the bill in his committee so that his projects would be paid regardless of profit or loss in the revitalized FF?  Did he mention that he and Chris Dodd also have the profits from this $700-billion plan headed for his special project funds and not to the US Treasury or the taxpayers?  No.

The Emperor would not remove his clothes to show us these warts.

CNN (last night) removed some outer garments when it reported the amount of campaign contributions Frank has received from the financial related industries is $2.5 million.  His Senate Counterpart, Chris Dodd, was listed at $13 million.  These Emperors have some very fine clothes.  You and I are the ones who will ultimately pay for them.

This is Washington, where Emperors fiddle while the rest of us burn.  When the music stops briefly they engage in Pontificatus Interruptus and then resume the closed-door negotiations. 

Transparency?  Fuhgedaboudit!  We don’t have any.  Markets know it.  That is why in London on Friday the British pound denominated credit default swap on the United States traded higher than the one on McDonalds.  That is why some money market funds on Friday would not tell their customers if they were going to “break the buck” or not.

Credit markets are seized and they are waiting.  That is why we are going to get a $700-billion deal. 

It will function as a way to replace or infuse capital into the banking system.  The system is $200 billion short right now if you take losses to date and subtract capital raised to date.  So the $700 makes up for the $200 billion shortage and adds another $500 billion, which is sorely needed.  It will be consumed by more recognition of losses.  That may seem circular.  It is, but that is what we are going to get as a policy.  $700 billion may not be enough in the end, but we are now getting closer to the correct number if we add it to the rest of the federal initiatives.  We are well over $2 trillion now.

Yes, indeed, there will be a $700-billion deal.  It will have lots of things wrong with it but it will become law.  Perhaps it will have a 9/11 type commission of independent and bi-partisan folks who will drill into the forensics on Bear Stearns and Lehman.  Some Congressmen are trying to get that into the law right now while the iron is hot.

Meanwhile the Fed is engaged in a massive, startling, and extraordinary use of its powers and redeployment of its balance sheet.  Several hundred billion of high-powered money has been injected worldwide this week in an attempt to blunt the contraction of the credit multiplier.  This is a partial amount of the price we all will pay for the failure of Lehman, a primary dealer.  That is the most tragic and awful policy mistake made so far in this two-year period of turmoil.

We track the Fed closely at Cumberland and try to make all this easily understood for our readers.  See www.cumber.com  for the latest graphic.  We must caution that changes are coming so fast now that we are in a constant struggle to keep things current for our readers.  We think we have most of it current after the Thursday afternoon reserve report.  We are trying.  Readers are invited to email me if they see an error.

Adding several hundred billion in raw cash by the central bank is normally an inflationary event.  But when the credit multiplier is shrinking faster than the money is added, the result is not inflationary.  In fact, if the Fed didn’t do this the result would be deflationary in the style that we saw for a decade in Japan.  Bernanke will use all the power of the central bank to avoid a Japan experience.  Of that we can be assured.

The problem will come in the future, when it is time to start extracting policy from this stimulus.  That is not for 2008 and may start in 2009 if the economic indicators begin to stabilize.  We will deal with that later. 

As Bill Dudley, the NY-based Fed officer who supervises the System Open Market Account described it, “we are in interesting times.”

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