Sunday, May 24, 2009

Fed Defends Its Mistakes

The Fed is in defensive mode regarding its purchases of mortgage-backed securities (MBS) and Treasury securities, and continues to point the economy in the wrong direction.
Speaking in Princeton, Fed Vice Chairman Donald Kohn said in a speech that:

“The preliminary evidence suggests that our program so far has worked . . .”

He insists that all the money-printing will boost the economy. As reported in,

Purchases may increase nominal gross domestic product as much as $1 trillion “over the next several years,” Kohn said in a footnote to his remarks.

Other Fed interventions to aid bond dealers, mutual funds and credit markets also “have been successful in supporting economic growth” by lowering rates and “preventing fire sales of assets,” Kohn said.

The Fed did not see this catastrophe coming. It did not regulate its banks well. The Fed's bailout of Bear, Stearns (and therefore probably of JPMorgan Chase) has caused it substantial losses, as has its AIG bailout. The New York Fed exists for the benefit of its member banks, not the public or even the Federal Government, and the New York Fed under Tim Geithner ran the show. Mr. Geithner continues to do everything he can to favor the banks. (See: Geithner Adopts Part of Wall Street Derivatives Plan (Update1.)

The Fed has no charter to prevent "fire sales" of assets. Consenting adults are allowed to trade securities freely. The Fed has made a serious mistake in buying MBS.

First, the economy has become internationally non-competitive. In order to compete successfully, preferably without relying on military superpower status to cow the rest of the world into submitting to our terms, the country needs to cease its wild and crazy love affair with housing and direct more effort toward exports (or else expect a permanent diminution in imports both of oil and of finished consumer products).

Second, the quality of the MBS the Fed is purchasing is suspect, and more important, the price is even more suspect. A "fire sale" is a ridiculous term. The securities are worth the price at which a willing buyer and a willing seller will exchange ownership. The Fed has no role in its charter to print money to pay above market prices in order to own pools of mortgages. If it prevented a fire sale, it therefore overpaid.

Let us now come back to Dr. Kohn's comments that all this buying of MBS will probably boost
nominal GDP a great deal.

"Nominal" means without reference to the effects of inflation.

Is he predicting inflation, or is he predicting real growth? Not that he will say . . .

With regard to Dr. Kohn, Mish today has a lengthy post that examines various comments of Dr. Kohn and of the Fed in general, and this is well worth a read. See Fed's Vice Chairman Admits Fed Has No Exit Strategy both for information about the Fed's asset quality (referred to above in this post) and for cogent commentary.

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