The Fed bails out The Bear

The financial market disruption has reached a new level of mayhem. Margin calls abound and Bear Stearns is being bailed out by the Fed via J P Morgan. Like Willem Buiter, I puzzle over the wisdom of the Fed's action. Inflationary expectations are rising and gold, the ultimate inflation hedge, is touching $1000 per troy ounce. It seems to me that inflation targeting is dead. Central banks have tacitly decided to inflate their way out of a prolonged recession. Consumers and companies have caught on. Problem is, we're not fundamentally in a liquidity crisis but a market for lemons. The problems are lack of transparency, information and the inability to assess default risk. Pumping in liquidity doesn't solve these problems. Indeed, it may exacerbate them by propping up unsound institutions that would otherwise go bust - finally providing the market with some information. Seems to me we are headed toward a classiic liquidity trap.

At any rate, back to Bear Stearns and Willem Buiter's list of questions:

"Why hasn’t the Fed declared “unusual and exigent circumstances” yet, so non-deposit-taking financial and other institutions in need of liquidity (like Bear Stearns) and blessed with eligible collateral can go directly to the discount window?

Why was Bear Stearns offered the Fed lifeline rather than being left to sink or swim on its own? What were the systemic stability concerns that prompted this intervention to assist a non-deposit-taking institution?

If Bear Stearns was deemed too systemically important to fail, why was it not taken into public ownership, preferably at a zero price?

What are the securities the Fed is, directly or indirectly, accepting as collateral from Bear Stearns?

What is the interest rate charged on the loan?

How are these securities valued?

What is the haircut applied to this valuation"

Willem Buiter on the rising NAIRU in the US

Some extracts from consistently the most provocative and sentient economics blog. For those of you interested in the way we live now, I strongly recommend you sign up for RSS feeds from Willem Buiter's blog.

"The Fed...is not the party designed to orchestrate an insolvency-preventing bail out. That’s what the Sovereign Wealth Funds are for. If there is no private solution, a fiscal bailout financed, directly or indirectly, by the US Treasury, perhaps through the FDIC, is required if and only if systemic risks are deemed to be present. Personally, I don’t believe that, with effective deposit insurance in place, any US bank is too large to fail. But fortunately that is a judgment I will not be asked to act upon.

"The Fed should do no more than act as MMLR, however. US interest rates are already too low to maintain the credibility of the price stability objective of the Fed, and of its medium term implicit inflation target. The Fed should certainly not cut the target for the Federal Funds rate simply to prevent or delay the insolvency of US banks or other financial institutions, unless this action is also warranted by the need to meet its triple mandate: maximum employment, stable prices and moderate long-term interest rates.

"A falling actual unemployment rate and a rising natural unemployment rate call for higher rates

"The latest labour market figures show a large fall in employment and an even larger fall in labour supply, resulting in an actual decline in the unemployment rate to 4.8%. There is also evidence to support the view that the natural (equilibrium) rate of unemployment in the US is increasing. The combination of a declining actual unemployment rate and a rising natural unemployment rate means that there are now higher domestic inflationary pressures associated with any observed level of employment and unemployment than before.

"It makes economic sense that the US natural rate of unemployment is increasing, if only because of compositional changes in the labour force that are reducing, on average, its quality and employability. The post-9/11 imposition of additional obstacles to the immigration of skilled labour are one factor reducing labour force flexibility. So is the long-standing decline in the numeracy and literacy standards of the high-school graduates.

"The US needs to restore external balance through an increase of (at least) six percentage point of GDP in the saving - investment balance. This should be achieved through an increase in the national saving rate rather than a reduction in domestic capital formation. The slowdown/recession the country is experiencing now is the (almost) inevitable by-product of this necessary rebalancing. It is in principle possible to have the ex-ante trade surplus rise instantaneously and by the same amount as the increase in ex-ante saving over ex-ante investment. In practice, the world is stubbornly Keynesian in the short run, and a decline in economic activity will tend to accompany an increase the the planned national saving rate. This is why the Fed, the White House and the Congress are so misguided about wanting to prevent a significant weakening of consumption at all cost.

"The other side of the required rebalancing of the US external account is a large shift of resources from the non-traded sectors (e.g residential construction) into the traded sectors. At least a six percentage points of GDP increase in the production of exportable and import-competing goods and services and reduction in the production of non-traded goods and services is required, matching the increase in the saving-investment balance."

Provocative statements from Michael Burleigh's Blood and Rage

The readiness of the British government to treat with individuals (Sinn Fein) it had recently dismissed as murderers was noteworthy, with the lengthy talks themselves generating all manner of human sympathies among the negotiating parties. Just in case they failed, Lloyd George threatened to wage all-out war with the entire resources of the British Empire within three days....Ironically, the provisional government resorted to measures indistinguishable from the British to win what had become a civil war - although unlike the British it had the support of the Catholic Church, which eagerly excommunicated the IRA.

It was Alexander's tragedy that, having failed to institute thoroughgoing liberal reforms, he proved incapable of re-establishing his father's austere police regime too....The intelligentsia were a sub-set of the educated classes, encompassing those who talked about books they hadn't read....They were kept afloat like some speculative fraud, on a bubble of liberal good taste, for among an older generation corrupted by liberalism it was not done to challenge youth or its progressive causes until the example of renegade Dostoyevsky gave birth to a right-wing intelligentsia late in the day....Middle-aged and elderly dupes saw in Nechaev the wayward idealism of youth rather than a psychopathic conman.....Many people with liberal views irresponsibly sympathised with the terrorists up to the point of aiding and abetting them....

The British Labour Party and the German Social Democrats acting as ignorant cheerleaders....Indeed, fear of foreign liberal opinion inhibited a tsarist regime sensitive to the charge of being Asiatic from adopting effective measures to repress terrorism.

This was the first in a spate of assassinations that made the years 1894-1901 more lethal for rulers than at any other time in history.....The multfarious acts of anarchist violence achieved nothing beyond the individual tragedies of the people killed and maimed. [US] immigrants who "converted" to anarchism in their first three years in the country could be deported, an interesting example of conditional citizenship....the British persisted in maintaining liberal asylum law that anarchists were manifestly abusing.

Mrs Thatcher on the Fenian hunger strikers: "There is no such thing as political murder, political bombing or political violence. There is only criminal murder, criminal bombing and criminal violence. We shall not compromise on this. There will be no political status." The fact that special category status had been conceded in 1972 rather militated against that degree of certainty, as did the wording of The Prevention of Terrorism Act itself, under which these men had been imprisoned, since it spoke of "the use of violence for political ends".

Books on German left-wing terrorism never include chapters on the working class, a revealing omission that distinguishes Germany from Italy. There was no significant radicalism in working-class Germany unless you count young neo-Nazis., chiefly because workers were generally represented, as of right, on the managing boards of most companies.... But, as in Italy, the West German higher education system had been massified...."The Vietnam War is not what interests me, but difficulties with my orgasm do," as one Communard put it.

The group's preference was for powerful BMWs, so much so hat colloquially they were known as Baader Meinhof Wagen.

Insofar as the RAF prisoners had a strategy, it was to dramatise their predicament, making it seem as if the German state had finally let slip its mask to receal a Fascist inner heart...The detainees claimed they were being held in conditions resembling Auschwitz...The remand prisoners were permitted radios and record players...They received any reading matter they wished, which enable Baader to study theories he had spouted as slogans for years. In this fashion they built up extensive libraries (Baader some 974 books, Raspe a further 550)....Left-liberal defence lawyers, whose cynical occuupation of the high ground spared them from close press scrutiny, played a major role in facilitating communication between their imprisoned clients and the next generation of RAF terrorists.


There is something narcissistic about this assumption that the West is obsessed with Islam and seeks to destroy it. It is not. It is obsessed with itself, followed by China, India, and Russia, which jostle for Westerners' short attention span. It is drawn, wearily, into so many Middle Eastern crises because this region, with a manufacturing capacity only equal to that of...Nokia...is the primary source of instability in the modern world and sits on top of two thirds of the world's known oil reserves. If huge oil deposits were discovered beneath Canada, the West would disengage from the Middle East tomorrow, leaving it to implode amid its multiple conflicts.

Multiculturism means that each diverse group adopted a story of victimhood so as to put itself beyond close scrutiny, enveloping itself in the myth of moral purity that comes with being the historically oppressed. These diverse communities spoke to the government through their so-called community leaders, a liberal version of an imperial power dealking through nabobs and tribes with the natives....

Multiculturalism is likewise negligent of the shared moral values that make civilised living possible.

By sharing a common password, it was possible to access messages left in the Draft box, which technically, therefore, were read but never sent, thereby preventing the NSA from intercepting them.

Within weeks of 9/11 Bush became the first US President to ackowledge the desirability of the two state solution in Israel-Palestine, in an attempt to cauterise the issue that so antagonises the Muslim world. He then spent six years doing nothing about it.