Why the Fed's Wall Street Bailouts Won't Work
So now the New York Fed is bailing out Bear Stearns. Earlier, Bernanke's Fed created an unprecedented $200 billion lending fund to Wall Street, offering Treasury securities in exchange for mortgage-backed securities. And there's talk of further Fed bailouts of Wall Street.
These bailouts won't work because the Street’s big banks are still sitting on what may be another three to four hundred billion dollars of bad debt. The rest of the world economy, through the magic of securitization, may be sitting on another few hundred billion. And because no one knows precisely how much or where this bad debt is, the risk premium is even higher. Which is why credit markets will remain more or less frozen.
We won’t be out of this mess until the speculative bubble that was created when the Fed cut slashed interest rates six years ago fully pops. For that to happen, Wall Street will have to face its real losses and write off another several hundred billion. And home owners across America will have to face their losses and watch the value of their houses drop another 10 percent, about to where they were before the bubble.
The Fed bailing out the big banks is like someone with an helium tank blowing more air into a leaky balloon. It only postpones the inevitable, which is that the balloon will lose its air and float back to earth. For markets to work again, speculative bubbles have to burst, one way or another.
The immediate practical question is how to manage the burst. A Wall Street bailout can help avoid runs on banks and runs on the dollar -- but only if conditioned on Wall Street pricing its assets close to their real market values.
The next question is how to cushion the blow for middle and lower-income people who might lose their homes or their jobs, cars, medical insurance, and large chunks of their pensions. This may require federally-subsidized insurance -- mortgage insurance so homeowners can meet payments, along with expanded unemployment insurance, health insurance, maybe even pension insurance. All hard to accomplish, but ultimately more important than bailing out the big banks.
These bailouts won't work because the Street’s big banks are still sitting on what may be another three to four hundred billion dollars of bad debt. The rest of the world economy, through the magic of securitization, may be sitting on another few hundred billion. And because no one knows precisely how much or where this bad debt is, the risk premium is even higher. Which is why credit markets will remain more or less frozen.
We won’t be out of this mess until the speculative bubble that was created when the Fed cut slashed interest rates six years ago fully pops. For that to happen, Wall Street will have to face its real losses and write off another several hundred billion. And home owners across America will have to face their losses and watch the value of their houses drop another 10 percent, about to where they were before the bubble.
The Fed bailing out the big banks is like someone with an helium tank blowing more air into a leaky balloon. It only postpones the inevitable, which is that the balloon will lose its air and float back to earth. For markets to work again, speculative bubbles have to burst, one way or another.
The immediate practical question is how to manage the burst. A Wall Street bailout can help avoid runs on banks and runs on the dollar -- but only if conditioned on Wall Street pricing its assets close to their real market values.
The next question is how to cushion the blow for middle and lower-income people who might lose their homes or their jobs, cars, medical insurance, and large chunks of their pensions. This may require federally-subsidized insurance -- mortgage insurance so homeowners can meet payments, along with expanded unemployment insurance, health insurance, maybe even pension insurance. All hard to accomplish, but ultimately more important than bailing out the big banks.
posted by Robert Reich | 11:27 AM
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