HYPOCRISY, PROFLIGACY, AND THE (NEW) AMERICAN WAY

9/19/07

The Fed has ridden to the rescue again, surprising most observers by cutting both the fed funds rate and the discount rate 50 basis points. In less enthusiastically disseminated news, Congress is working on a scheme that would allow people facing the out of nowhere, who could see this one coming reality of adjustment of their adjustable rate mortgages to refinance via the FHA, even if their homes are so high priced that existing FHA restrictions do not allow for refinancing.

The message is loud and clear: So what if you paid premium prices for poorly structured securities backed by shaky loans secured by grossly overinflated homes? So what if you’re long the debt of a company that was just one foot out of rehab before the debt you bought was heaped on it? So what if you bought far more house than you could afford? (After all, you wanted it, and in America wanting something is the only relevant qualification for any purchase.) No problem: Look! Up in the sky! It’s a meddling Fed! It’s a meretricious Congress! It’s SUPERGOVERNMENT!!!

No wonder risk remains grossly underpriced in our financial markets. No wonder the average American displays the financial savvy of a four year old. (Perhaps I shouldn’t limit this discussion to the United States; the UK government is using the same approach in the cases of Northern Rock, et. al..) The government stands ready to save, protect, and comfort the wealthy, the foolish, and the overextended. Ironically, it is those same recipients of government beneficence and their mouthpieces in the media who so obstreperously decry the evils of “big government.”

The redeeming news for those of us who believe in small government, even when it inconveniences its supposed champions, is that this can’t go on forever. While the markets initially loved the Fed’s actions (Why not? Declining risk premia lead to higher prices for risky assets—Finance 101.), such outwardly anodyne actions by the Fed have had, and will continue to have, a debilitating effect on the dollar. For a country as much in hock as this one, this could be devastating. Further, despite the “Move along, nothing to see here” attitude of the federal government, its statisticians, and the disconnected among the financial community, inflation is a problem and will only be made worse by this latest bout of Fed’s debasement of our currency in an effort to help the far from helpless.

In the longer run, the policy, manifested by both the Fed moves and this latest FHA scheme coming out of Congress with the support, tacit and not so tacit, of the Administration, of having the financial ants bail out the financial grasshoppers will fail. The economics simply don’t work; a society that punishes financial good sense and rewards profligacy cannot stand. I would like to say that the politics don’t work, but given that the financially fatuous compose the vast majority of the American electorate, the politics do work. That is why such idiocy is continually being proposed by the professional politicians who toil away in the District of Columbia at their appointed task of making our lives difficult, complicated, and more expensive.