Criticism of the U.S. Bailout Plan, Part 5

“The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are ‘upside down,’ as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.” – James Grant.

An October 5th Washington Post editorial entitled Bad Medicine by James Grant, the editor of Grant’s Interest Rate Observer, criticizes the Government’s bailout plan. He blames our current problems on the bursting of the housing bubble exacerbated by the Federal Reserve’s low interest policy.

Grant’s main points are:

• The bubble was brought on by too low interest rates and too much optimism.
• Wall Street investment banks were quick to cash in on the boom, but were slow to recognize the turn in the market and the attendant losses in their portfolios.
• The answer is to let prices reflect their market values, not to mask those reduced values by artificial government intervention.

Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes.

The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are “upside down,” as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.

But inflation and debasement are the very policies being put in place. The Federal Reserve, not waiting for Congress, embarked last month on a radical program of money-printing. Reserve Bank credit — the raw material of bank lending — is growing at the year-over-year rate of 61 percent.

After the stock market broke in 2000, then-Fed Chairman Alan Greenspan set about easing policy. In company with Fed Governor Ben S. Bernanke, the man who wound up succeeding him, Greenspan warned against “deflation.”

So it pushed the “federal funds rate” — the interest rate that the Fed directly controls — to 1 percent in mid-2003 and kept it there for a full 12 months.

American consumers pinched themselves. Could they really borrow more than 100 percent of the price of a house at an unimaginably low teaser rate without so much as presenting proof of employment? Indeed, they could. House prices went up and up.

When, in 2006, the roof began to fall in, Wall Street was in a quandary. It held outsize volumes of triple-A-rated mortgage-backed securities (MBSs). That they were not, in fact, triple-A, had become painfully obvious.

Prices can be unwelcome pieces of information. When an especially unwelcome batch wells up after a financial collapse, governments try to quash it. So it is today. The SEC has suppressed short selling. The bailout bill will open the door to the suspension of market-value accounting. The Fed is moving heaven and earth to cheapen the value of the dollar.

Long after the crisis burst into the open, the Fed and Treasury downplayed it. It was, they insisted, “contained.” Last week they asserted that, unless the House voted “yea,” the wheels would come off this $14 trillion economy. President Bush himself has broadly hinted that the nation is on the cusp of disaster.

How can they be so sure? And how can they know that the unintended consequences of the radical policies they are pushing through won’t be worse than the panic that they themselves are helping to foment? When the Fed insists it has no choice but to print up hundreds of billions of new dollars and when the keepers of accounting standards bend in the face of criticism that market prices hurt, what they are really saying is the that financial truth is too awful to bear. Heaven help us all if they’re right.

photo credit: Matti Mattila