Seeking a Wrench To Stop the Drip

By Steven Pearlstein
Wednesday, August 15, 2007; Page D01

One day it's Bear Stearns or BNP Paribas. Another day it's the "quant" hedge funds like Renaissance Technologies and ACQ Capital. Yesterday, the distress signals came from Coventree, a Canadian commercial finance company, and Sentinel Management Group, a commodities-oriented mutual fund. Is Lehman Brothers next?

This is how it's going to be, a steady drip, drip, drip of news about this or that financial institution closing off redemptions or drawing down emergency credit lines or even closing its doors. And with each one, more lenders pull back, more credit markets cease, the prices of stocks and bonds decline further and even more institutions fall into the soup.
   
Wall Street pulled back sharply Tuesday. A vicious cycle unleashed by the credit crisis is bound to bring days that begin full of hope and end calamitously.

It's called a vicious cycle, a self-reinforcing downward spiral in which problems beget problems, fear begets fear and bad news begets more bad news. There will be some good days like Monday, and some calamitous days like last Thursday, but mostly it will be like yesterday -- a day that starts out full of hope that maybe things have finally stabilized only to show that they haven't.

At the moment, many parts of the credit markets are still effectively shut down. It's almost impossible to sell a new junk bond or securities backed by mortgages of any sort, while secondary markets for collateralized debt obligations and leverage loans are in turmoil. All that makes it impossible to tell what all sorts of outstanding securities are really worth.

Without prices, big banks and investment houses are reluctant to roll over the loans that were used to buy those instruments, effectively shutting down the $3 trillion global market in short-term commercial paper that is the major source of financing for hedge funds and Wall Street trading desks.

Without the ability to access the commercial paper market for their short-term money, corporate borrowers have begun to tap backup lines of credit with major banks, whose scramble to raise the extra cash prompted the Federal Reserve and other central banks to have to pump billions of dollars into the global banking system.

One of the more amusing things to watch this past week has been the steady parade of Wall Street bigwigs who have stepped forward to complain that markets are acting irrationally, that investors have overreacted in withdrawing credit and that the sell-off of financial assets is not supported by the "fundamentals."

You have to wonder where these apostles of rationality were when the markets were on the way up, when home prices were rising at double digits years after year and mortgages were being made with no money down and no docuмentation, and private-equity firms were paying premiums of 50 percent over market prices for publicly traded companies. But of course we know exactly where they were: They were collecting billions of dollars in exorbitant fees while spinning elaborate theories on why trees could now grow to the sky. And they were as credible then as they are now.

Now, as you might guess, Wall Street is demanding that the Fed move aggressively to end the turmoil in the markets by lowering short-term interest rates, even as others criticize the Fed for bailing out the bankers and hedge funds with last week's intervention.

We can deal with the bailout charge quickly -- it was nothing of the sort. In the face of a temporary shortage of cash in the system, the Fed and other central banks lent money to some big banks, taking as collateral bonds issued or backed by the U.S. government. When the markets returned to normal a couple of days later, the banks got their bonds back and the Fed got its cash back, with interest. By fulfilling its mission as the prudent lender of last resort, the Fed did nothing to prevent the inevitable reckoning that awaits investors and lenders who made bad decisions.

Rushing to lower interest rates, on the other hand, would be the wrong move for the Fed. It would interrupt at a too-early stage the process of wringing out the excessive debt that has built up in the economy and in the financial system during the years of cheap and easy money. And it would send the dangerous message that the Fed will be there to ride to the rescue the next time Wall Street decides to gorge on big fees and excessive risk.

That doesn't mean that, at some point, the Fed won't have to lower interest rates to cushion the broader economy from a serious slowdown.

As recently as last week, a majority of the Fed's policymaking committee clung to the fading hope that the housing crisis could be contained and that the "repricing of risk" could proceed in a slow and orderly fashion. But in the past week, key policymakers have come to realize that the problems in credit markets run deeper than they had hoped and that continuing to downplay the seriousness of the situation -- and its implications for the economy -- runs the risk of undermining the Fed's credibility.

I'd look for Chairman Ben Bernanke to lay the groundwork for a possible easing of monetary policy at the opening session of the Fed's annual retreat in Jackson Hole, Wyo., later this month. The timely topic of this year's conference: The wacky world of housing finance.

A recession is still likely in a few years. It could be needed then.

It is never "needed" in a sane system.  It only happens when you play according to a messed up set of rules, designed to benefit a few at the top.

Quote from: dust-7

If one had the wealth, the money, who wouldn't want a 6.5% fixed?

Hardly anyone has any real wealth, dust.  It has all been stolen by the financiers.  That is the whole point of the present system.

Isn't wealth determined by asset valuation? And accounts don't always have to be in markets, like equities, collectibles, even real estate. You can buy debt, etc. Are you arguing a complete collapse of the currency, then? I would put anyone with assets under 5 million in the upper middle class. Others might extend that to around 10-20 (just a single multi-unit income property could be valued at 10 million). The wealthy are worth billions, and I would think certainly more than 5 million.

With even a million dollars, seen as cash, one is able to pay bills, afford leisure time, travel, even invest in enterprises.  

The point of the present system - as I see it - is hyperinflation. But a million is still worth something, even for all that, just as example.