Money Sage (archive)

Well folks, the gurus are talking up a storm this morning. Why then, you might be inclined to ask, is this day different from any other day?

It is different because today, for a change, it is INTERESTING. Of particular interest are the pronunciamentos ex cathedra issued by three noted, if not notable figures: Treasury Secretary Paulson, President of the Philadelphia Federal Reserve Bank Plosser, and PIMCO bond fund chieftain Gross.

Paulson, for his part, stated that the housing decline will continue. He noted the forthcoming wave of adjustable mortgage rate resets, and the negative implications of same for the economy. For these "insights" -- which we, in our own humble way forecast last summer, we say: better late than never. In truth, what is significant about Paulson's declamation is his statement that what the government "...will consider is maybe expanding this (the Administration-brokered plan with mortgage lenders to freeze some adjustables before they reset) beyond subprime borrowers to other borrowers." Paulson has become sensitive to the fundamental reality -- which we have been focussing on since the inception of this blog in August -- that it is the BEAR MARKET in residential real estate which is at the root of the great distress in the banking system and of the developing credit contraction and the very serious economic implications this portends.

Paulson has travelled a far, far distance beyond the FED, which until very recently has clung to the illusion that things ain't that bad. We would note that the FED Chairman and his associates continue to refer to the house price bear market as a "correction." The FED's inability to relinquish its delusive and self-delusive euphemistic terminology has bespoken a severe analytical breakdown at our central bank. Things have changed though: we think that the FED's prissy language now is being deliberately crafted to contain publlic and market "panic." Paulson, clearly, recognizes the gravity of the situation and, as we suggested yesterday, is trying to move the Administration forward on what we have in an earlier post termed: "Bailout by Bits and Pieces."

Mr. Plosser's words of wisdom were banal enough. He said that the economy may need more rate cuts. While we would hardly regard this as some profound, cutting edge insight, the point is that coming from Mr. Plosser it has a lot of significance. Our perception is that Mr. Plosser is one of the most dedicated of the inflation-phobe party at the FED. He has repeatedly downplayed the need for rate cuts and additional liquidity (Of which the FED has actually supplied next to NONE). He has emphasized the seriousness of the imaginary "inflation threat." We take today's pronouncement as an important sign of the capitulation of the inflation-phobes at the central bank, in the face of an increasingly ominous contraction of lendable bank capital, an intensification of the real estate bear market, its spread to commercial real estate, and the gloomy prospects for the economy in the absence of MAJOR BAILOUT ASSISTANCE from the Congress and the FED. We have said all of this many times before, but it is obviously a heck of a lot more important coming from Mr. Plosser.

Finally, we come to the warnings of the legendary bond fund guru, Mr. Gross. Amplifying and clarifying prior warnings, Mr. Gross today said that credit-default swap losses will be in the neighborhood of $250 billion, approximately equal to the loss incurred in sub-prime mortgages.

In toto, the three commentators are pointing in the direction policy WILL INEVITABLY TAKE -- BAILOUT BY BITS AND PIECES. More rate cuts are a'comin, although the really important question is whether there will be any useful increase in the monetary base (inflation-adjusted, the base has actually CONTRACTED over the past year -- see our post "Federal Reserve Is Constricting Money Supply)." Other emergency actions to place the banking system deeper on life support will be forthcoming. In the realm of government action, Mr. Paulson and, hopefully, the full weight of the Administration will be placed behind measures to reduce the financial pressure of mortgage resets and the weakening of aggregate demand via some combination of federal subsidies, pressure on and financial or guarantee assistance to the lenders, government guarantees of mortgage loans, or whatever other specific mechanisms can be dreamed up.

It is unfortunate that the FED's tardiness in recognizing the seriousness of the subprime crisis, coming on top of its regulatory failure vis-a-vis the creation of this junk and the flood of bank loans to home purchasers unqualified to take down these loans, has assured that things will get a lot worse, and stay that way a lot longer, than was necessary. While FED errors and refusal to admit same will eventuate in substantially lower interest rates that anyone has envisioned, we presume that the inflation-phobes will be satisfied: the economy will be much weaker, and the lagging inflation numbers far more tame, than they could have hoped for.