The Journal Goes After The Fed!

by Karl Denninger

Hell has frozen over.

These columns have defended the independence of the Federal Reserve from attacks on the right and left, but after last week the central bank is on its own. It’s impossible to defend the Fed’s rank electioneering as it lobbies for more political and taxpayer intervention in the housing market—just in time for the election campaign.

This extraordinary political intrusion came in the form of a 26-page paper that the Fed sent to Capitol Hill last Wednesday, without invitation, graciously offering what Chairman Ben Bernanke called a “framework” for “thinking about certain issues and tradeoffs.” He was underselling his document. The paper is a clear attempt to provide intellectual cover for politicians to spend more taxpayer money to support housing prices.

I didn’t Ticker that paper originally as it was simply too outrageous to bother with.  There’s a point at which The Fed’s actions reach into the realm of rank politicking and attempts to protect their “chosen many” from their own foibles; we’ve certainly seen plenty of games played in the last three years.

But this paper, sent to Congress unsolicited, apparently went too far for even the Journal’s bankster-crank-stroking reflexes.  Among other things it said:

In this report, we provide a framework for thinking about directions policymakers might take to help the housing market. Our goal is not to provide a detailed blueprint, but rather to outline issues and tradeoffs that policymakers might consider. We caution, however, that although policy action in these areas could facilitate the recovery of the housing market, economic losses will remain, and these losses must ultimately be allocated among homeowners, lenders, guarantors, investors, and taxpayers.

This is where the problem is, of course.  Where does the government get the right to “allocate losses” through interventions?  The dirty little secret about the housing mess is that:

  • The Fed was largely complicit in causing the housing bubble.  In fact, Greenspan intentionally stoked this speculative orgy and further, both he and Bernanke intentionally averted their eyes from the monstrous credit expansion that “maintained” economic output and which was utterly unsustainable — a mathematical fact that was obvious to anyone who bothered to look at the very data The Fed maintains!  In other words The Fed is now trying to find ways to evade responsibility for what it did.
  • The losses are real but being hidden by further Fed actions!  Just one example is the hundreds of billions of dollars of second lines (Home Equity and “Silent Second” mortgages) that are behind underwater, non-performing first line mortgages.  These have an actual net present value in a foreclosure of zero, as they’re not entitled to one penny of recovery until every dollar of the first is satisfied, and the first is underwater and thus will not be fully recovered.  All of our large banks have monstrous exposures in this regard — almost none of these loans were securitized and thus they are all sitting on bank balance sheets, most at nearly 100 cents on the dollar.  These accounting values are fictions.

The reason that The Fed and our Government are desperate to hide these losses, praying for a miracle to somehow keep them from being recognized, is quite simple — these long-duration investments are typically held by insurance companies and pension funds.  Recognition of these losses will cause the allegedly “healthy” firms and funds that hold this paper to be shown to be severely impaired or worse.

Yet there is no evading these losses.  I’ve been pounding the table on these issues for five years and yet the alleged “extend and pretend” game has not led to value recovery.  Instead, the value of homes has continued to decline!  At some point the games end as these notes mature and an actual accounting must be made.  The idea that The Fed would propose that “taxpayers” eat these embedded losses is both an outrage and a circular argument – do you really care if you have your taxes raised to the point that you go bankrupt or you lose your pension and go bankrupt?  Either way you’re bust!

The only solution is to accept that which we cannot change.  Bad loans create losses when the loans are made and nothing can be done about that later on.  You can change who eats the loss, but when it all devolves back down to the public then which hand you pick someone’s pocket with makes no difference at all.

The more important issue here is holding those at The Fed personally and professionally accountable for this massive cock-up.  There is a long history of intentional evasion of the law, including Alan Greenspan’s “approval” of the blatantly-unlawful Citi/Travelers merger that was later made retroactively legal by Gramm-Leach-Bliley and evasion of reserve requirements with sweeps.  These sorts of machinations are nothing more than allowing a gambler to double down on a lost bet, and when one looks at the history of leverage in the financial markets and The Fed’s active and outrageous actions in this regard, given their charter which mandates that they control credit aggregates, it is clearly time to stick a fork in these mendacious bastards and remove the Board of Governors wholesale.