Tuesday, December 26, 2006

Is The Fed Behind The 8-Ball Here?

The Federal Reserve Board has just revised a "Consumer Handbook on Adjustable-Rate Mortgages." I would say they're about three years late.

[Thanks to kilroywashere.org and Donald Heiduck for the image.]

According to a Joint Press Release from the Board of Governors of the Federal Reserve System and the Office of Thrift Supervision, and '[i]n recognition of the growing use of nontraditional mortgage products that allow borrowers to defer payment of principal and sometimes interest, the agencies have substantially revised the CHARM booklet [Consumer Handbook on Adjustable-Rate Mortgages] to include discussions about "interest-only" and "payment option" mortgages.'

"Charm booklet." That's cute.

The last few years have seen an explosion of adjustable-rate mortgages that is not only obscene, but that is criminal, IMHO. I believe the Fed is indirectly the instigator of these mortgages, which makes this feeble last-minute gesture of theirs all the more hypocritical.

One the one hand, they've been helping to create one of the biggest global liquidity bubbles in history, causing cash to flood so profusely that even people with bad credit scores can drown in it.

On the other hand, their holier-than-thou attitude pushes them to abuse free-market logic. Instead of attacking the real problem, which is the Fed itself, they decide that things have gotten a little out of hand and that it's time to warn people against -- whom? The banks? No, against themselves. I guess the Fed never heard the dictum, "A fool and his money are soon parted." As a rule, fools don't listen to good advice ... because they're a fool, remember? (Duh.)

Interesting how laissez-faire economics holds weight with those at the Fed only when it is convenient. They will intervene in the marketplace over and over, creating surperfluous money supply at the drop of a CPI hat; but when it comes to depriving the banks of the wherewithal to milk every spendthrift that walks in the door, "Oh no, that would be intervening in the marketplace. Let's print another booklet that no one will read." Do they really think consumers can ingest one more word on those mortgage applications that weigh in at about 20 pounds already, even without the Charm?

Tsk tsk, Federal Reserve Board. Shame on you. I agree you should never intervene in the marketplace; but you should abide by this golden rule even when it applies to yourself. Stop printing money whenever you feel like it, under the pretense that you're just "controlling the economy" -- something that you yourself admit is impossible.

Stop the charade, guys. Fools may be fools; but the balance-of-power minority (i.e. my readers) is not as stupid as you think.


Blogger Idaho_Spud said...

Hahaha. Yeah this is tantamount to a dog owner telling a stranger "Careful! that dog bites!" While the stranger is being treated by paramedics for blood loss inflicted by said dog. Apparently this particular dog owner had no idea that his pet dog had been misbehaving so badly ;)

I have a couple of questions for you though - not questions intended to be hostile, just curious. If the Fed didn't control liquidity, what would? I trust Goldman Sachs (and their ilk) to do the right thing even less than I trust the Fed - and that's saying a lot!

If liquidity is controlled strictly by the quantity of gold or gold/silver available at the moment, then money might not be available when a great new idea is brought forth. Would not economic expansion regardless of its potential, be limited to how fast gold could be mined?

Secondly, I have only a vague understanding of how monetary policy (or lack of?) was handled pre-Fed. But I do understand there were a number of runs on banks and crises. What do you envision having in place to prevent such crises? Because if it comes down to a simple choice between the Fed or chronic economic crises and panics, the Fed would seem to be the lesser of the two evils...

Obviously they failed to avert the Great Depression, and our dollar is worth only about 3 cents in 1900 money, so there is a lot of room to improve on that record. Still waiting for them to get around to devaluing the last 3 cents... you know it'll come!

7:49 PM  
Blogger Katy said...

Darn good questions, Idaho. See? I told you my readers were smart.

Here's how I'll attempt to answer them.

(1) If the Fed didn't control liquidity, who would?

As it stands, the Fed is only one factor behind liquidity. You may have glanced at my article over at Prudent Bear on this very subject. They themselves admit that they don't have a real handle on it all. (See here and here.)

The banking system has always been the real money machine, and rightly so. The Fed is a catalyst, if you will.

So the answer to your question is, the unfettered monetary system already controls liquidity. The Fed is just messing it up.

If you'd like me to delve into how the system creates liquidity, I'll be glad to oblige.

(2) If liquidity is controlled strictly by the quantity of gold or gold/silver available at the moment, then money might not be available when a great new idea is brought forth. Would not economic expansion regardless of its potential be limited to how fast gold could be mined?

I think not. First of all, I maintain that the fractional reserve banking system works just fine, when it is part of a sound commercial banking network. This means that you don't need a one-to-one ratio of gold to production; you only need about 10%. This takes a lot of pressure off gold under the circumstance you describe.

Second of all, don't forget that gold is just another product, i.e. the real base for the money supply is everything that is produced, plus gold. This means that the stored wealth that can be invested as venture capital doesn't have to come only from gold; it can come from all stored wealth in general. That should be plenty.

And thirdly, gold production would increase with demand for it. Just like any other commodity or good, when there is demand, there will be supply. Mining industry technology advances as fast as demand for it increases, just as with computers.

(3) What could handle runs on banks and other crises of this nature?

First of all, some of my economics professors explain that the stories you hear about bank runs and failures before the existence of the Fed are pretty much fairy tales, and the actual money lost is tiny compared to what you might imagine (although of course they did occur.)

Whether or not this is true, my position at this point is that the Federal Reserve could still serve two functions: That of banking policeman, and that of crisis management, with a very strict definition of "crisis." Obviously, no bank in the US today could respond to a panic run on their accounts with full restitution of cash to its account holders. I can envisage some situations where it might be useful for the Fed to open the floodgates of cash for a panic run, on the condition that the cash must be restored to the Fed and destroyed at the end of the scenario.

Then you also have the FDIC, which as you know is the federal deposit insurance program. This is a very unhealthy agency of the federal government, because it could not respond in case of emergency today; so the Fed is trying to encourage banks to obey stricter international banking guidelines. (See post.) On the other hand, what about a privately run insurance system? Because the government runs this federal FDIC program now, the banking insurance industry doesn't exist. If the FDIC were to cease operations, I bet such an industry would blossom. But that's pie in the sky.

Hope I answered your questions. Thanks for the stroll.

9:54 PM  
Blogger Idaho_Spud said...


Thanks for taking the time to write such a thoughtful and enlightening response. I appreciate it very much, and learned a bit besides ;)

Enjoy the holidays!

6:56 PM  

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