Reply #49: Fed bailout makes matters worse [View All]

[DemReadingDU]

3/13/08 How a lender bailout hurts the economy
The Federal Reserve's efforts to ease the credit crunch risk stoking inflation - and letting reckless, well-paid execs off the hook.

The government is showing considerable ingenuity in devising new tactics to fight the credit crunch. But some observers fear that the innovations risk making matters worse - by fueling inflation and insulating executives who made reckless bets from the full wrath of the market.

The Federal Reserve set off a ferocious stock market rally Tuesday with its plan to lend banks as much as $200 billion over 28 days later this month. The plan sent shares of hard-hit lenders such as Fannie Mae (FNM), Freddie Mac (FRE, Fortune 500) and Washington Mutual (WM, Fortune 500) soaring, because the Fed will allow borrowers to use privately issued mortgage-backed securities as collateral. Investors have fled those securities because they see a rising risk that mortgage bonds will become impaired as housing prices slide and defaults tick higher.

Tuesday's plan, dubbed the Term Securities Lending Facility, wasn't the first Fed move aimed at loosening up the debt markets. Late last year the Fed rolled out a similar plan called the Term Auction Facility that briefly succeeded in bringing down the interest rates banks charge one another for overnight loans.

"Think of Ben Bernanke as action hero," Felix Salmon wrote this week at Portfolio.com. "Every time the credit markets seize up and threaten to bring down the U.S. financial system, he pulls out a new weapon."

Not everyone is a fan of Action Ben, however. David Rosenberg, chief North American economist at Merrill Lynch (MER, Fortune 500), wrote Wednesday that this week's Fed action will do little to counter the impression that Bernanke & Co. is struggling with problems that the Fed ultimately has little control over.

"This latest experiment, as with the others undertaken thus far, does not address underlying credit problems, does not materially improve the solvency of the institutions exposed to assets under stress, does nothing to put a floor under home prices," Rosenberg wrote in a note to clients. "We see no reason based on this for anyone to change their economic or earnings outlook despite the stock market's initial reaction to this latest initiative."

Rosenberg, who has been predicting for some time that the economy will slip into recession this year, expects the Fed to cut its fed funds rate to as low as 1% later in 2008, down from 3% now and 5.25% back in August. Observers expect the rate cuts to continue next week, with a cut as deep as 75 basis points at the Fed's regularly scheduled meeting. But there's little optimism that the cuts will do anything to stimulate demand for houses, which remain pricey by historical measures, or even bring down mortgage rates, which have been rising since the Fed's slashed rate by more than a percentage point over eight days at the end of January.

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http://money.cnn.com/2008/03/12/markets/fedfollies.fortune/index.htm?postversion=2008031304