Here We Come Again

Today's Wall Street Journal stated the following:

"Another myth is that exports to the rest of the world would somehow rescue the U.S. economy. This was the idea behind the devaluationists -- in Washington and at Harvard -- who pushed a weak dollar to promote exports to counter the U.S. housing slump. So much for that one. Yesterday's selloff was worse in Europe and Latin America than it was on the U.S. Trying to steal "demand" from the rest of the world was short-sighted in the way that beggar-thy-neighbor tactics always are. And with Europe and Japan already in recession, and China slowing down, the export contribution to U.S. GDP is likely to fall sharply."

"A third mistaken idea is that Federal Reserve rate-cutting would save the day. This is the poor sister of the weak-dollar lobby, popular on Wall Street and at Chairman Ben Bernanke's Fed. Despite a year of falling rates, the financial panic is worse than ever and now the real economy is getting hit. The Fed's rate cutting led to dollar flight that produced a commodity spike and oil as high as $147 a barrel. That only made a recession more likely as it sapped consumer discretionary income around the U.S. and worried families and business alike."

"The good news is that some in the Fed now seem to realize this, and the Open Market Committee has stopped its pell-mell flight to a 0% fed funds rate. Instead, the Fed is using its discount window to provide liquidity to banks seeking safety, including yesterday's addition of $600 billion to its Term Auction Facility, growing to $900 billion by November. That's a striking amount of money, but it is the right way for a central bank to manage a panic."


If these comments sound familiar, they should. I have been addressing the weak dollar and the folly of excessive rate cuts since the beginning of this blog. Lowering the Fed Funds rate did not help the situation one iota. The problem as not that money was too expensive, but that it was being hoarded. Banks do not want to lend. Banks need all the capital they can get to recapitalize damaged balance sheets. The only loans it will make are those which are GSE-eligible. The allows banks to recoup the borrowed funds by selling the loans to the GSEs. Banks will not loan to other banks. If you are a bank CEO you know the garbage you have on your balance sheet therefore, you have a pretty good idea what garbage other banks have on their balance sheet. Knowing that, you are reluctant to lend your precious capital to banks who may or may not be able to repay their debt.

Compounding the problem are the inconsistencies of how various corporate crises were handled by the Treasury, the Fed and the FDIC. There is no coincidence in the market and understandably so.

I recall speaking with a colleague in 2004 about what will happen when the non-conforming, subprime, adjustable-rated mortgages adjust higher. We were concerned back in 2004, before the excesses and price spikes seen in the period from 2005 to 2007. The situation became worse than we feared. It is amazing that Wall Street fell into the trap of the unsinkable ship.

The Titanic was once considered unsinkable. Man thought it had found away to account for any and every eventuality. Engineers and others did not, could not, account for the unknown, unknowns. During the past several years, Wall Street put BLIND FAITH in quantitative formulas in the belief that they could account for every eventuality. They forgot about the unknown unknowns. The rocket scientists hubristically believed they were infallible. Their fall to earth was most shocking.