Financial Meltdown

The editorial board at WaPo this a.m. is tossing Fed. Chairman Bernanke bouquets for pouncing on the financial community because of Bernanke's remarks at Aspen saying, essentially, that the U.S. will not bail out speculators. While there is some virtue in making this assurance to the public - after their watching the bailouts of savings and loans, airlines, etc. - this stance does not necessarily inform the public of what is happening. Instead, as the financial page of our major papers usually do, it conceals the real threats, in this event long-term.

The term 'pumping in liquidity' has been used to characterize the billions that the Fed has loosened up for lenders so they would not fail to meet their obligations when their credit was lost.

Providing liquidity is just another way of saying 'printing money'. Acknowledging that value is not there, the Fed acts as if it were and temporarily extends credit to the uncreditworthy.

The Fed by this action allows the policy of giving undue valuation to securities that are not of a quality to deserve that valuation - making our money worth less, especially internationally.

Investors and home buyers with poor credit histories have been allowed to undermine our economy because of greedy lenders who wanted to make the rising values of homes the basis of our values, while knowing it would not continue indefinitely. As long as it was not understood by the public, 'confidence' continued and buying continued unstinted. That has ended, and confident buying, with credit, has ended with it.

A good warning is given by op-ed writer Ignatius that also views the Fed's action as just putting off needed solutions. He also gives an excellent description of the flimsiness of the basis for the Fed's credit extensions.

People looking at this crisis in isolation expressed relief that the Fed bailout seemed to have worked. But I find greater cause for worry. What we are seeing is a financial addiction -- to ever-more exotic classes of high-yielding assets to tempt global investors and then to the Fed's infusion of liquidity to keep the system from self-destruction. The financial world, you might say, is addicted both to the heroin of high yields and the methadone of the Fed's rehab program.

Investment guru Warren Buffett has been warning for years about the dangers of derivatives -- the complex financial instruments that undergird modern capital markets. The problem is that derivatives, with their interlocking contracts that are often little understood even by financiers, bind the elements of the global system together while obscuring the weakness of the individual pieces. What happened in August's panic was partly that nobody in the markets could be sure how bad the subprime fallout would be, because it was obscured by all the swaps and hedge contracts. The French bank BNP Paribas sent the panic into overdrive when it suspended trading in three of its funds because it couldn't value their losses.

The Fed can keep rescuing the financial markets by providing emergency liquidity to rebuild the flimsy trailer parks. But it's time to look at the tornado itself -- the immense unregulated flows of capital and the new financial instruments that give them such devastating velocity.

It's rather like the administration's running up huge debts instead of taxing the public - to spend trillions on its war. These policies push an economic disaster off onto a future generation or two.

Sarbanes/Oxley propped up our investment sector by making it attractive to foreign investors, because it was under supervision. That supervision was undermined by false asset valuations. What is needed is a new standard for asset appraisals, embodied in law. That law needs to be administered by trustworthy officials, which will not happen until this administration is replaced by one with integrity.

Also, thanks WaPo commenter DEFJAX for pointing out that I got it right, it is the longterm consequences being covered up that are going to bite us after this 'bump' is past.