Solving Debt and Moral Hazard With More Debt and Bailouts
The Fed’s response has been adolescent in the sense that it has permitted major damage by allowing the credit boom to happen. Right under its nose, the broad money supply (M3) doubled in the last eight years, from $7 trillion to $14 trillion, but it is trying to fool the market into thinking this statistic is irrelevant because it was vigilant and never allowed inflation to surface.
Can one really double the money supply, produce a few percentage points of inflation and GDP growth, and not have this prodigious sum of cash not produce some tremendous effect? If the answer is truly “no,” then why not double it again? In reality, this ballooning quantity of reserve currency dollars was a base upon which other countries could pyramid loans, repeating the pattern seen when the classical gold standard was liberalized under the tutelage of Kemmerer and Conant, morphing into the gold exchange standard.
Then and now this caused prices of equities and real estate to surge globally. In 2008 it also triggered a spike in commodities, sending oil to $140 per barrel, but strangely it evoked tame inflation for most commonplace items monitored in the United States’ CPI gauge, including importantly, wages.
Suppose that we were using the same yardsticks to evaluate the hyperinflation of late 18th century France. In that period, the real wages of the peasantry did not rise at all, but there was sudden spontaneous wealth in all of Paris and some in medium and small urban centers, where more than a few astute individuals abandoned farming for finance.
Yes, there was great inflation for items like bread, but all in all the lowest rungs of society stood still while wealth was transferred to speculators. By using newly issued U.S. government debt to print dollars to be swapped out for bad credit, the Treasury and the Fed wished to reset the clock back eight years by undoing much of the damage done to the system from real estate. However, M3 is not reset back to $7 trillion; it remains at today’s greatly expanded $14 trillion figure.
Individuals in the upper-middle class have high incomes but experience difficulty in accumulating assets due to confiscatory tax rates. Savings are also penalized by the constant erosion of purchasing power of the dollar.
Until the current crisis, economists used to explain away the chronically low savings rate by reminding us there was substantial unrealized value locked in residential real estate. The Fed’s suppression of interest rates at artificial, Japanese-style lows combined with the heightened availability of home equity loans and exotic mortgages provided upper-middle class homeowners an opportunity to assemble — and spend or invest — a mountain of cash.
Normally remittance of such income would be shackled by a requirement to simultaneously mail back to the federal and state governments a check for 50 percent of the proceeds, which would be the case had such individuals instead worked longer hours or taken a new risk to grow sales in a small business, if they owned one.
Can we blame today’s peasantry for wanting in on the action, pressuring their congressmen to make it possible through pressuring banks to lend without documentation or down payment via coercive programs such as the Community Reinvestment Act (CRA), and then borrowing to the hilt? Is the Fed beyond reproach for this mess, as its pathetic struggle to posture as a stalwart inflation fighter beholds?
With our culture not having changed as a result of the crisis (yet), the attitude across the board has been that deleveraging might happen to others, or be done later. Nowhere is this more evident than in government policy.
The Fed, the Treasury, and the Congress have decided to address the two monetary problems of our age, excessive debt, and moral hazard, by increasing debt and bailing out large, risky banks to the detriment of their better managed but smaller competitors.
Even the solution for Freddie Mac and Fannie Mae followed the pattern: They will be deleveraged in 18 months, but to get through this rough period, their balance sheets will temporarily grow now that they are owned by the federal government.
Certainly the bold action to prevent Armageddon was welcomed by most observers close to the scene. But Main Street saw this, and more especially the injection of money to troubled entities under Congress’s TARP facility, as something that it would be expected to pay for eventually through higher taxes.
Since these guarantees could pay off nearly the total mortgage principal of all U.S. citizens, the public rightly asked why it should help bail out Wall Street when repairing finances closer to home would solve the problem. The nub is that either option requires taxpayer funds, which at best is like paying oneself and at worst robs Paul to pay Peter, which could be good or bad depending upon one’s end of the bargain.
A consensus developed by mid-2009 that the vast amount of credit the Fed has injected into the banking system might produce inflation, and perhaps even hyperinflation. However, without massive, direct injection of cash into the hands of borrowers, pressure on asset and securities prices would remain. Financial institutions may have been temporarily saved, but individuals have not.