14 September 2009

And No Dialing Back

Nolan says it still looks crook!@

And No Dialing Back:

CNBC's Steve Liesman: "Mr. Secretary, how much concern do you have right now - how much pressure are you under right now to dial back on these programs. Dial back spending. Dial back - getting to the audience question right there that I think is critical and that is really indicative of how Americans feel: Get the government out of the private sector. How much pressure are you under right now?"

Treasury Secretary Geithner: "No one is going to be more eager than I am. You're just not going to care about that more than me. We do not want to be in any of these institutions a day longer than is necessary. And look at what we have already done. We already have $80bn of capital coming back into the Treasury. If you look at what I said today in my testimony on the hill, we've seen these emergency programs we put in place already be used at a tiny fraction of their scale in emergency. We designed these things so that they would not be used a day longer than necessary.

But we're going to be careful not to withdraw too soon. Again, the classic mistake countries make in crisis is that they put on the brakes too early and reignite the recession, ultimately at much greater fiscal cost and much greater damage to the economy. So that's the balance we've got to get right. And we are not now at the point - even though the challenge is shifting - we're a bit moving now from emergency to the harder challenge, frankly, of repair and recovery. That's going to change the mix of what we do. We're going to get out and walk these things back as soon as we are confident we can get out of this thing."

September 10 - Bloomberg (Jody Shenn): "'Credibly' privatizing Fannie Mae and Freddie Mac... may be too difficult given the precedent set by the Treasury Department's financial assistance, according to a Government Accountability Office analysis. 'The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency,' the GAO said... 'Consequently, such privatized entities may continue to derive financial benefits, such as lowered borrowing costs, resulting from the markets' perceptions.' The Treasury today reiterated that the government intends to make recommendations on Fannie Mae and Freddie Mac next year... 'Any transition to a new structure would need to consider the enterprises' still-dominant position in housing finance and be implemented carefully (perhaps in phases) to ensure its success," the GAO said."

My interest is not in taking shots at today's policymakers. They have been faced with incredible challenges, and proceed now on a course they hope and believe is best for returning the country to sound footing. And while I disagree strongly with the current path of policymaking, it has been predictable. From a policymaking perspective, the greatest error came with the Greenspan/Bernanke Fed's failure to act to rein in systemic Credit excess, asset inflation, and financial Bubbles. Many belatedly recognized the Fed's failings, yet few today appreciate that the costs and risks of flawed analysis and theories only keeps mounting.

I retain keen interest in debunking the Fed's thesis - articulated most clearly by then Fed governor Bernanke - that central banks should avoid the business of popping Bubbles and instead focus on post-Bubble "mopping up" strategies. It was, after all, post-Russia/LTCM "mopping up" that fueled the tech Bubble, and then the post-Tech and 9/11 mopping fostered the Wall Street/mortgage finance Bubble. And the latest big mop up job sets the stage for perhaps the greatest Bubble all them all - the Global Government Finance Bubble.

They appear as free lunches at the time, but there are myriad financial and economic costs associated with government intrusions into the marketplace. Most are subtle and tend to remain quiescent for years. When (market pricing, resource allocation and economic impairment) distortions do eventually manifest into a crisis, policymaking will have a strong proclivity to treat misdiagnosed ills with only greater government manipulations and intrusions. And the greater the degree of intrusion into the markets, the greater the ongoing costs involved. Huge intrusions ensure open-ended government involvement and increasing governmental command over the economic system.

As much as I believe Secretary Giethner is speaking earnestly, there is no way at this point government influence in the marketplace can be meaningfully dialed back. The damage has been done - historic distortions to both the financial system and real economy. The damage began with the activist Greenspan Fed manipulating interest rates, promising market liquidity, and pandering to the leveraged speculators. The damage worsened as the government-sponsored enterprises came to dominate our nation's market for housing finance. And the damage turned unmanageable when the markets listened back in 2002 to Dr. Bernanke profess the virtues of helicopter money and whatever other unconventional measures the central bank might deem worthwhile.

Federal government finance (Treasuries, agency debt and GSE MBS) has expanded about $2.0 TN over the past year. I expect it to inflate another $2.0 TN over the coming twelve months. The private sector Credit apparatus is simply not up to the task of generating the necessary $2.5 TN (or so) of total system Credit expansion necessary to sustain the current economic structure. In this post-Wall Street Bubble environment, only government and government-related Credit retains sufficient "moneyness" in the marketplace. Systemic reflation today depends on a massive inflation of this government helicopter "money."

This week's GAO analysis on the GSE's was spot on and certainly applies to more than just the GSEs: "The financial markets likely would continue to perceive that the federal government would provide substantial financial support to the enterprises, if privatized as largely intact entities, in a financial emergency." Over five Trillion - and counting - of GSE securities are valued and traded in the marketplace as (money-like) government-backed obligations. Policymakers would not today risk the negative financial and economic ramifications from dialing back from Washington's explicit and implicit guarantees.

And as much as moral hazard and "too big to fail" are recognized as fundamental facets of the previous Bubble excess, our policymakers have nonetheless been compelled to expand only further toward backstopping the entire Credit system. Obviously, the GSE's were too big to really fail, while markets appreciate that policymakers now believe it was a mistake to allow Lehman to collapse. The markets - more than ever before - operate with the view that policymakers have no tolerance for a major financial institution failure.

When one contemplates the issue of "getting the government out of the private sector," these various market liquidity support programs being wound down are an insignificant issue. Fundamentally, for the economy to move toward sounder and sustainable footing would require at least a semblance of a market-based Credit pricing mechanism. Regrettably, the vast majority of system Credit today is "public." Government intrusion chiefly dictates the cost of finance and the allocation of financial and real resources. Furthermore, I would argue that the limited amount of private sector debt being issued these days is dependent upon the system-stabilizing effects of massive government debt issuance and spending.

As I have stressed repeatedly, in the neighborhood of $2.5 TN of non-financial Credit growth is required to stem systemic implosion - a massive Credit expansion with only our federal government up to the challenge. It is this fundamental facet of Bubble economies - a maladjusted economic structure sustained only through ongoing Credit excess - that prohibits Washington from extricating itself from very public "private sector" intrusions. Fixated on the notion of sustainable recovery, policymakers will not be dialing back from massive borrowing, spending, or market backstopping endeavors. And this gets to the core of the unquantifiable costs of failing to rein in Credit and asset Bubbles.

As I have written over the years, the entire notion of "mopping up" is as flawed as it is dangerous. Clearly, the notion of inflationism remains as seductive as it has throughout history. If, God forbid, deflation ever becomes a risk the central bank must aggressively raise the price level to preclude a downward spiral. We heard this dogma in the early nineties, heard it again earlier this decade, and have had it repeated too often over the past year.

And the more intense the necessity to reflate - the greater the government's evolving role throughout both the financial and economic systems. This is a fact of life, human nature and politics. And at the end of the day inflationism tends toward socialism. And there is only one way to reverse this course; it is anything but painless. The economy must be weaned off of Credit and financial excesses and government intrusions - and allowed to proceed through the arduous task of adjustment and rebalancing. Choosing instead a course of sustaining current financial and economic structures implies a huge and ever-expanding role for the government. There will be no dialing back.

Many hope the private-sector can again rise to the occasion. It is expected that as recovery gains a foothold private sector borrowing and lending will increase, tax receipts will rise, and the government enjoy the luxury of dialing back as the system normalizes. I don't expect this dynamic to work as it has traditionally because of the confluence of Bubble economy Credit requirements, acute private sector Credit system impairment, and the government's predominant influence on the recovery.

The dynamic today is one of a shallow recovery induced by a flood of government borrowing and spending and marketplace intrusions. Rampant financial speculation has reemerged, which leaves the marketplace increasingly vulnerable to any serious move to dial back. In a normal recovery, the system tends to gain strength and stability over time. Credit requirements are manageable, and speculative excesses have been largely wrung out of the system. In stark contrast, today's combination of huge Credit expansion and a highly speculative financial backdrop ensures only more acute systemic fragilities over time. And the distorted marketplace will simply not function well at even the notion of fiscal and monetary exit strategies.

Conceptually, somewhere along the line there reaches a tipping point where government intrusions are no longer stabilizing. They become invariably destabilizing, as the quantity of government monetary inflation becomes massive and uncontrollable. This is the nature of inflationism, although this dynamic is nowhere to be found in Keynesian doctrine. It is my view that this tipping point was reached some time back. It is with this analysis in mind that I fear the emerging Government Finance Bubble risks destroying the creditworthiness of our entire economy.

Doug Noland
The Credit Bubble Bulletin


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