Page 2 of
3 A rate cut with a shoeshine and a
smile By Julian Delasantellis
streets, will be the pain suffered
by the lenders at each successive level further up
the finance food chain.
I've written about
this issue many times since last March, but it was
only in early August that the financial markets
decided that this was a situation that really
warranted their closest attention. After the Dow
Jones Industrial Average topped out over 14,000 on
July 19, it proceeded to fall 1,600 points, more
than 11%, before bottoming out on August 16. Since
then the market has nervously
thrashed between the lows and
the recent highs near 13,500.
But the
damage in US equity markets has been a mere
appetizer compared with the main meal that the
monster is consuming in the US debt and money
markets. Here, the carnage has been much more
severe and it is clearly still ongoing, as many
mortgage-finance-related companies, along with
those that established financial relationships
with these companies, have been in essence closed
out of the capital markets they need to access to
finance their ongoing operating requirements.
On the horizon is a virtual tidal wave of
financial-sector layoffs; the personnel-staffing
firm Challenger, Gray and Christmas reported
31,000 financial-service-sector layoffs in August,
and that does not include the 15,000-20,000 pink
slips falling like autumn leaves out of the sky
from US mortgage-industry leader Countrywide
Financial, nor the 15,000 layoffs announced by
Lehman Brothers and National City Corp.
The rabid histrionics of US cable
network CNBC's James Cramer on August 3, imploring
Bernanke to take rapid action to ease credit
conditions, were a plea to help this endangered
and oppressed white collar/green suspender class.
It was also remarkable in that the video of his
meltdown even made many local television news
broadcasts in the United States, doubtlessly
pushing many other important stories of giraffes
caught in trees or chipmunks riding on surfboards
off the US airwaves.
The hope is that
aggressive Federal Reserve action, lowering
interest rates, or finding some other way to
increase the amount of liquidity - money - in the
system, might be the life preserver that could
reflate the financial system before its storm
waves sweep over the vulnerable for the last time.
But the Fed and Bernanke have other
constituencies to serve, other than those
investment bankers now staring longingly at the
oven doors of their US$6,000 Delonghi
platinum-plated gas ranges.
There are some
people who believe that nothing, specifically no
interest rate cuts, should be done by the Fed to
alleviate the current crisis. These people, most
prominent among them seemingly being the outgoing
president of the regional St Louis Federal Reserve
Bank, William Poole, oppose immediate action for
two reasons.
One is that the
US economy doesn't really need it. At least
until the September 7 US non-farm payrolls
report, which showed that, for the first time in four
years, the US economy actually lost jobs this
August, Poole and others were arguing that, far from
being an economy just about to topple over
into recession or worse, the US economy was doing fine.
In terms of both industrial and human capacity,
the US economy was far closer to its
constraint limits than not; the real danger was
still inflation, needing to be countered with
higher interest rates, not recession, which would require
the standard central bank policy remedy of lower
rates.
If the economy really
doesn't need the support, this argument goes, it would be
even worse to cut rates now.
Clearly, this
crisis, whatever its current extent, has its
origins in the financial markets, not in the
"real" economy. (Does this common nomenclature
imply that the world of the financial markets is
unreal? In my 30-plus years of active trading and
participation in financial markets, I'd say that
was about right.)
Following the example of
financial manias and panics redolent through
history, a few years ago a large number of
investment bankers (a number that we find is
larger and larger, and more and more dispersed
across every corner of the globe, every day)
thought that they had discovered a neat new way to
make a lot of money. That idea was to buy
corporate bonds backed by mortgages taken out by
subprime borrowers.
They were wrong
- big time. On the secondary market,
these subprime mortgages are now selling around 50%
of par, assuming you can get someone to put in a
bid for one even at a much lower price.
So they made bad investments, and now are
in trouble. Isn't that, the no-cut argument goes,
the essence of capitalism? If we bail out
capitalism's losers, there will be less around to
reward the winners - so we don't. If I stake my
fortune on a chain of slide-rule repair shops or
coin-pay-phone franchises, no one's going to save
me when they go belly-up. Shouldn't the principle
be the same in financial investments?
If
people are allowed to believe that the
all-powerful US government will always be around
to bail them out of their bad investment
decisions, it will create a perverse incentive to
make ever riskier and riskier investments;
eventually, so much capital will be invested in so
many risky and non-productive investments that not
even the Fed will be able to save them, or the
financial system as a whole, when they fail.
Economists call this dynamic the "moral
hazard" argument; our students, taught it in
Economics 101, probably believe it right up until
they actually go out into the real world and get
their first job. If this employment is in the
field of investment banking, they soon learn that
they are now inhabitants in a dimension where hard
money trumps amorphous morality every time.
That's why Poole and the
moral-hazard/no-cut crowd are going to be thrashed
this Tuesday. For allied against the morality
sticklers are the forces of Weltanschauung
- the way things are now.
The entire
market rally off Dow 12,450 has been based on the
market's expectation of a rate cut; if Bernanke
does do a John Gait or Howard Roark and stands up
for the dangers of moral hazard by not cutting,
well, maybe Rand wrote sunny Hollywood endings,
but the current carnivorous media culture will not
be so generous.
A Fed meeting that
produces no cut could easily lead to a 1,000-point
Dow selloff in the 105 minutes between the
announcement and the close of trading on Tuesday.
This story would lead the main US news network
broadcasts for days afterward; it would absolutely
convulse the three 24-hour US cable news networks.
News consultants tell TV news
organizations that whenever they broadcast bad
news they should preferably accompany it with
coverage that shows the station working to right
the wrongs on behalf of the viewer. This is the
background of the ubiquitously fatuous "Channel X
on your side" promos that all the stations run.
Thus if a school bus leaves the lot
without enough air in its tires, the mechanic or,
preferably, the weasely-looking school bureaucrat
in charge, will be hunted and stalked down to
ground wherever he goes; NBC (National
Broadcasting Co) News' Chris
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