One of the dominant myths of America is that we practice one of the
freest forms of capitalism on the face of the planet. Hard work and
prudence are rewarded, while Schumpeter’s ‘creative destruction’ quickly cleans out the mistakes.
Unlike most myths, this one apparently lacks a kernel of truth at the core.
As the details emerge over the various bailouts and market distortions,
it is becoming clearer that moral hazard has been increased, not
lessened, and that those who behaved prudently during the credit bubble
insanity are going to be punished.
Some are getting angry:
[quote]Community banking executives around the country responded
with anger yesterday to the Bush administration’s strategy of investing
$250 billion in financial firms, saying they don’t need the money,
resent the intrusion and feel it’s unfair to rescue companies from
their own mistakes.
And in offices around the country, bankers simmered.
Peter Fitzgerald, chairman of Chain Bridge Bank in McLean, said he was "much
chagrined that we will be punished for behaving prudently by now having
to face reckless competitors who all of a sudden are subsidized by the
At Evergreen Federal Bank in Grants Pass, Ore., chief executive Brady
Adams said he has more than 2,000 loans outstanding and only three
borrowers behind on payments. "We
don’t need a bailout, and if other banks had run their banks like we
ran our bank, they wouldn’t have needed a bailout, either," Adams said. [/quote]
Free markets? Fair competition? No, not really. Not at all.
This next article puts that in high relief. The Fed was going to buy
corporate paper in an attempt to loosen up the flow of money in those
markets, which would have been an admirable goal, in and of itself.
But the Fed, for some reason I do not yet know, decided to insert a
massive distortion into the market at the same time.
[quote]Oct. 15 (Bloomberg) — The Federal Reserve may subsidize
America’s companies by purchasing their short-term debt at rates below those demanded by private investors in the $1.6 trillion commercial-paper market.
Fed officials yesterday set the yield they will pay for commercial paper at about 1.6 percentage points less
than the average cost for financial companies, weekly central bank data
show. Policy makers last week announced emergency plans to buy the
securities after the market shrank to a three-year low.
The discount cuts the cost of cash to 2.2 percent from 3.7
percent for General Electric Co. and from 4.7 percent for Citigroup
Inc., data compiled by Bloomberg show. One possible unintended
consequence: private buyers are shut out. [/quote]
Citigroup has a gigantic "Level 3" asset pool of more than a
trillion dollars, and the free market decided that, because of the
additional risk associated with those past decisions, Citigroup should
pay a higher rate of interest on their debt. The Fed has now decided
that Citigroup and GE (a very sound company) should pay the same rate
to borrow. What’s next? Dictating that everybody should pay the exact
same mortgage rate? Isn’t that exactly what got us into this mess in
the first place, a distortion of the market’s ability to properly price
The Fed may have had good reasons for this, but it is one more very
large intrusion of the government into a formerly free market. Such
interventions distort true pricing, and it is a virtual certainty that
the Fed will both subsidize this market and end up the owner of a lot
of defaulted debt. This monetization of bad debts is among the most
inflationary of all possible Fed actions.
And even as real problems mount in the real economy, all of the
Treasury Department’s and the Federal Reserve’s attention seems to be
focused on the banking system, to the almost complete exclusion of the
needs of regular people.
To put all this in context, I am going to repost a snippet from a comment made yesterday by reader Davec007 (Dave Cohen):
I have not commented up to now, but now that we see the trajectory of the Fed’s "intervention", I have a few things to say.
From an energy perspective, it is now clear that any adequate response
to the oil supply/price problems we will have after this U-shaped
recession is over will be impossible. Most of the funds that might have
been put into infrastructure changes (long-haul railroads, light rail,
restructuring the geography of living & work, adding large amounts
of renewables to the grid, etc.) have already been given to the banks.
The "save Wall Street to save Main Street" rhetoric has not only served
to facilitate one of the largest rip-offs in history, but it has doomed
the "real economy" to a state of perpetual recession, or worse. We had
a taste of Things To Come when oil hit $147/barrel, and we had another
in the last few weeks when crude oil production in the United States
fell below 5 million barrels per day for the first time since 1946.
This latter was due to the hurricane disruptions, but such production
numbers will become routine after 2012. You read that correctly —
I only wish and hope that when our true emergencies in energy and
infrastructure are made clear to the DC crowd, they respond with the
same urgency and magnitude as they have in their near-immediate
multi-trillion dollar bailout of the reckless and the imprudent.