Fed Up. Federal Reserve Chairman Ben Bernanke is the man of the hour. The stock market has rebounded in recent days because everyone now expects that the Federal Reserve, at the regularly scheduled meeting of its policy-setting open market committee Tuesday, will cut interest rates by a quarter-point or even a half-point. Some financial insiders even think Bernanke will cut more than that, in order to signal markets that he will do whatever it takes to contain the current credit meltdown. The Fed Chairman, facing his first serious financial crisis since taking office last year, was behind the curve in its first weeks, and is determined not to repeat that mistake.
However, even if the Fed delivers a big rate cut and the markets respond with a big rally, there is so much rot in the financial system that we are not out of the woods. The entire system of banks lending short term money to hedge funds, mortgage companies, and private equity firms was based on the premise that prices of assets would keep rising, and that some patsy could be found to buy the paper. Even with lower rates, that wild ride is over for now. Even cheaper money can't pump that bubble back up. The only question is how far is down.
The Fed itself is highly culpable in this crisis -- not for failing to give us low enough interest rates, but to failing to use its available powers to regulate the permissible temptations of cheap money. Every link in the daisy chain that brought us this crisis is essentially non-regulated. The mortgage companies, the hedge funds, and the process of private bond rating agencies certifying the soundness of the exotic investment instruments that banks created. Yet that banks that create, buy, and sell this stuff are in fact regulated and when they get into trouble the whole financial system is in trouble.
The Fed was given the mandate by Congress in 1994 to set lending standards for otherwise unregulated mortgage companies. Despite periodic prodding by Congress, the Fed failed to issue regulations. Only several months in to the sub-prime meltdown did the Fed finally, belatedly, reluctantly, promise to put out regulations by the end of 2007, long after the damage has been done.
Fed Ex. The big story of the weekend was the publication of former Fed Chairman Alan Greenspan's memoirs, in which he criticizes President Bush's tax cuts. Lovely of him to tell us now. At the time, Greenspan's Delphic testimony could be read as supporting tax cuts or being worried about deficits being too large. But when the deficit question came up, Greenspan invariably chose to warn about public spending, and not about the tax cuts that were then on the legislative table. Democrats repeatedly pressed him to oppose the Bush cuts, and he declined. The support of the prestigious Fed Chairman helped give Bush the necessary cover to get the cuts enacted.
Greenspan's memoir also makes a big deal of deficits per se, and faults Republicans for abandoning their heritage as the party of fiscal discipline. But this contention also misses the point. In the aftermath of the dot-com bust and the attacks of 9/11, the economy needed a big fiscal stimulus in 2001-2003. What was wrong with the policy was not the big deficits -- they were required to get us out of a slump -- but the make-up of those deficits. Far more effective public policy would have been increased public investment and tax cuts for moderate income people. That would have produced more stimulus for the same deficit. In a "60 Minutes" interview promoting the book, Greenspan declared:
"Smaller government, lower spending, lower taxes, less regulation -- they had the resources to do it, they had the knowledge to do it, they had the political majorities to do it. And they didn't."
Less regulation? Bush failing to reduce regulation? Please. Greenspan was also the Great Enabler of both the market collapse of 2000-01 and of the current credit crunch, because his signature was to combine cheap money with scant regulation of its abuses. When a bust came, Greenspan would just bail out the mess with even cheaper money. At some point, this routine runs out of gas. Let's see whether Bernanke will try to repeat the trick, or whether the Bernanke Fed will rediscover the Fed's other responsibility, as a setter of standards.
Fed Lines. Speaking of regulation, the Sunday New York Times led the paper with an absolutely bizarre story that would have the reader believe that corporate America has suddenly become a crusader for tougher government regulation because voluntary standards (dangerous toys, fetid spinach, etc.,) just don't do the job.
If you read between the lines, the authors, Eric Lipton and Gardiner Harris, hint at the real story -- Business is mainly seeking federal pre-emption of lawsuits and of tougher state regulation, and trying to preemptively capture the federal regulatory process. There is just a little of this counter-story in here, but for the most part the writers buy the corporate line with far too much credulity; and the misleading thrust of the story is: "Hey, wow, here's business calling for more regulation! Gee whiz, man is biting dog."
If the financial wiseguys (and the Fed!) were to turn around and call for regulation of hedge funds, private equity, bond-rating agencies, mortgage underwriting standards -- now that would be a man-bites-dog regulation story. But that's the dog that isn't barking, and that's the bigger story we're not reading.