By Peter D. Schiff
Those who were blindsided by the recent financial meltdown are now loudly blaming the "free market" for its failure to police its own excesses, and are calling for greater regulation to prevent future disasters. But for those who clearly observed the problems developing [no doubt in high definition slow motion], the blame can be directed squarely at the policies of the Greenspan/Bernanke Federal Reserve regimes. As has been the case countless times throughout history, the free market will now pay the price for government incompetence.
During Senate hearings last week, all parties involved completely ignored the Fed's own culpability in igniting the speculative fever that caused the current conflagration. It's as if a senior prom had turned into a wild bacchanalia, and angry parents are now asking why the chaperones failed to notice the disrobing or why the DJ played provocative music, even as they ignored the bearded gentleman pouring grain alcohol into the punch bowl.
The Inflationary Shuffle
A perfect illustration of the Fed's failure to take responsibility can be found in central bank Chairman Ben S. Bernanke's explanations regarding inflation, which he solely attributes to the effects of the rapid increase in global commodity prices. He failed to mention that commodity prices are rising as a direct consequence of his monetary policy, which is debasing not just the U.S. dollar, but currencies around the world.
Rather than accepting the blame for creating inflation, Bernanke is shifting the blame to the free market. Senators seemed happy to let him get away with the subterfuge, since it provides more evidence to support the "need " for more government to save the economy from the disastrous effects of unbridled capitalism.
When asked how we got into this mess, Bernanke replied that our problems resulted from an excessive credit bubble characterized by aggressive leverage, reckless lending, and extreme risk taking. Absent from his laundry list of catalysts was the Fed's role in irresponsibly setting interest rates below market levels, which mispriced risk, got the party started and kept it raging into the wee hours of the morning. After drinking that potent punch, it's little wonder that Wall Street investment banks were stripped financially.
For much of this decade, the objective of the Fed has been – and continues to be – to encourage and facilitate borrowing and lending.
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Defending a Bailout
During his testimony, Bernanke continued to claim that The Bear Steams Cos. (BSC) was not bailed out. His reasoning: Shareholders only received about $10 per share. Of course, $10 is better than zero, which is what they surely would have received if the Fed hadn't thrown taxpayer money around. What about Bear's creditors though?
Although the collapse of Bear Stearns would have cost bond holders dearly, the bailout essentially makes them whole. Here again, the Fed creates an even greater moral hazard by encouraging excessive risk taking. By bailing out lenders who extend excessive credit, the Fed simply invites more of that behavior. The free market must be allowed to properly price risk. Lenders need to know that when they lend money, whether to highly leveraged investment banks and hedge funds, or to over-stretched homebuyers or credit-card users, they run the risk of not getting paid back. By interfering with this process, the Fed simply guarantees more losses and even bigger bailouts in the future.
Also, leveraged speculators need to know that it is not "heads they win, tails the taxpayers lose." Wall Street executives amassed fortunes by making extremely risky bets. Now that those bets have soured, why is it that the taxpayers have to eat the losses? Wall Street billionaires earned their bucks on the backs of the middle class, who made little on the way up, but are now forced to foot the entire tab for this mess on the way down.
While Bernanke talked about the underlying strength of our economy, he cried "necessity" in deciding to save Bear Stearns from bankruptcy, claiming the failure would have brought down our entire financial system. How sound can our economy be if the failure of one investment bank can cause it to topple? Does this now mean that no more major banks or brokerage firms will be allowed to fail? Since we routinely accused Japan of practicing "crony capitalism," what do you suppose we should call our own version?
Not to be outdone in rewarding reckless behavior, Congress earlier last week passed $15 billion in tax breaks for homebuilders, who had made their fortunes overbuilding during the bubble and unloading their shares to a gullible public. By threatening to hold back on their political contributions, these same homebuilders are awarded still more billions. The last ones we should be subsidizing are homebuilders. After all, the last thing we need right now is more homes.
The legislation also contained a provision that offers generous tax credits to individuals who buy homes out of foreclosure. While this is billed as a benefit to homebuyers, it is just another handout to lenders, since the prospective buyers qualifying for the tax breaks will simply pay more at auctions as the tax breaks subsidize higher bids. The real winners are the creditors who will now get more in foreclosure than they would have had buyers not been counting on having their bids subsidized by the government.
Of course, for all the talk about taxpayer bailouts, none of the Senators bothered to mention that – for the moment – no tax increases actually are on the table. Instead, the bailouts are being financed by savers, pensioners, wage earners, investors and the elderly on fixed incomes, who all suffer staggering increases in their costs of living, as the Fed uses inflation to rob Main Street to pay off Wall Street.
[Editor's Note: Money Morning Guest Columnist Peter D. Schiff is the president of Euro Pacific Capital Inc., a Darien, Conn.-based broker/dealer known for its foreign-markets expertise. A well-known financial author and commentator, Schiff is a regular Money Morning contributor, and has most recently written about , the fiction of the Bush Administration's professed "strong dollar policy", the futility of "juicing" the economy and soaring gold prices. In mid-August, when analysts were touting beaten-down financial shares, Schiff said the stocks were "toxic," were destined "to get hit hard," and advised investors to "stay away." Investors who heeded that advice, and avoided such shares as Merrill Lynch, also avoided some stressful, subprime-induced losses. Check out Schiff's first book, " ," which was published by Wiley & Sons last February.]
News and Related Story Links:
Bernanke Defends Bear Stearns Rescue.
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Midday Market Update: Markets Swing on Bernanke's Testimony.