The Fed is to the rescue again of supposedly the economy in general but some would argue Fed Chairman Bernanke and company are rescuing the Greedy-Guts-Itself US Financial Industry. And there is strong evidence from the Federal Reserve Board itself that is actually what is going on. The Chicago FRB in its February 2008 Outlook Paper is saying that the US economy is doing fine – and likely to do as well as the last two years. The one problem is the financial turmoil originating from the Wall Street Banks having over-indulged in bad paper(aka Subprime Fiasco). So the Fed, instead of insisting on banking self regulation and joint funded “risk insurance”, is going to lower interest rates despite the possible stagflation, US dollar, and other trade risks. Avoiding a “recession in the Financial markets… oops in US economy” is now its number one priority.
Now to be fair there is a strong debate at the Fed, among US economists and even in the public on the question of Moral Hazard – i.e. the Fed continually bailing out US Banks and financial in the past 20-25 years. In fact it appears the Fed comes to the Rolaids Relief whenever financial markets and players have committed great risk improprieties – think Dot.com Bubble, Savings and Loans swoon, and Junk Bond episodes of the past 20 years. And to this observer the size and frequency of the US Bank’s improprieties are becoming – well risky.
And that is the point. The Stock, Financial and Banking Markets are undoubtedly becoming more volatile – one only has to follow recent changes in commodity, stock, and currency markets to see temendous swings and greater variability. So one would consider it just prudence for the Fed to move beyond its interest rate and Money Supply levers to help control variability. But it has been glacially slow to do so – in no small part because the banks and institutions in the Financial markets are against such added cost burdens
Now to put a Economic Populist point on this – it is particularly galling that financial capitalists are able to shirk and freeload their responsibilities given that a)capital is taxed at 10% while labor income averages 32%(and note that executive financial compensation has swung strongly to stock options and other capital gains pay instruments for just this reason). So the capital markets simply are not paying their fair share of regulatory costs and b)despite the arguments for high executive compensation only for high performance, the financial markets are rewarding themselves despite the huge turbulence, losses, and variability with record setting bonuses at 2007 year end once again. Talk about capitalists being impervious to the discipline of capitalist markets – isn’t that what Moral Hazard is all about ?
I only ask for a 5th of reasons why US Capital Markets and players should be allowed to be so dysfunctional.