John Hussman is always a good read. A week after it came out, I am catching up on reading reading “Should Come as No Shock to Anyone”.
Hussman is about as level-headed as they come, so it was interesting to see him accuse the Fed and Geithner of “Unconstitutional Abuse of Power”. Here is the pertinent snip:
There is most probably a second wave of mortgage defaults in the immediate future as a result of Alt-A and Option-ARM resets. Yet our capacity to deal with these losses has already been strained by the first round that largely ended in March. The Federal Reserve has taken a massive amount of mortgage-backed securities onto a balance sheet that used to be restricted to Treasury securities. The purchase of these securities is reflected by a surge in cash reserves held by banks. Not only are the banks not lending these funds, they are contracting their loan portfolios rapidly. Ultimately, in order to unwind the Fed’s position in these securities, it will have to sell them back to the public and absorb those excess reserves, so to some extent, the banking system can count on losing the deposits created by the Fed’s actions, and can’t make long-term loans with these funds anyway.
Increasingly, the Fed has decided to forgo the idea of repurchase agreements (which require the seller to repurchase the security at a later date), and is instead making outright purchases of the debt of government sponsored enterprises (GSEs such as Fannie Mae and Freddie Mac). Again, the Fed used to purchase only Treasuries outright, but it is purchasing agency securities with the excuse that these securities are implicitly backed by the U.S. government.
This strikes me as a huge mistake, because it effectively impairs the Fed’s ability to get rid of the securities at the price it paid for them, should Congress change its approach toward the GSEs. It simultaneously complicates Congress’ ability to address the problem because Bernanke has tied the integrity of our monetary base to these assets. The policy of the Fed and Treasury amounts to little more than obligating the public to defend the bondholders of mismanaged financial companies, and to absorb losses that should have been borne by irresponsible lenders. From my perspective, this is nothing short of an unconstitutional abuse of power, as the actions of the Fed (not to mention some of Geithner’s actions at the Treasury) ultimately have the effect of diverting public funds to reimburse private losses, even though spending is the specifically enumerated power of the Congress alone.
Needless to say, I emphatically support recent Congressional proposals to vastly rein in the power (both statutory and newly usurped) of the Federal Reserve. Starting with the Bear Stearns deal, the Fed under Ben Bernanke has made a sharp and distinct departure from its historical role, in violation of its charter. As I noted when the bondholders of Bear Stearns were rescued, “The troubling aspect of the Fed’s action was not that it lent to a non-bank entity. That ability is clearly authorized by Section 13(3) of the Federal Reserve Act. The problem is that it made its “loans” as “non-recourse” funding – meaning that it would not stand to be repaid if the collateral itself was to fail.” This is still what the Fed seems determined to accomplish.
In my view, deeper loan losses are ahead, and if we deal with the next round the same way that we dealt with the last, we will ultimately succeed in debasing the U.S. dollar. There’s little inflationary pressure at present, and chances are that fresh credit concerns will create enough demand for government liabilities to forestall inflationary pressures for several years more. But we cannot reimburse the losses of irresponsible lenders with trillions freshly issued government liabilities without those liabilities ultimately eroding in value. The probable real, after inflation return on stocks and bonds over the coming decade is likely to be very unsatisfactory.
I certainly agree and that is why we need the Fed audited in Ron Paul fashion, not some watered down proposal that makes allowances for and covers up the Fed’s unconstitutional abuse of power.
Mike “Mish” Shedlock
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