Earlier I guessed that the economy would muddle along for some time before hitting the big "inflationary patch." OK, so most of those ideas aren't really original to me. I have acquired them from the economists I read, especially Gary North, imbued with a bit of my own flavoring of course. I'm more or less just a filter, and maybe a little bit of a contaminator. Anyway, I said that at some point, Federal borrowing and deficit spending and other such whatnot would eventually start pushing the massive buildup of bank reserves into the circulating money supply and begin causing a serious bout of inflation. Until such time we would be muddling along, mostly going nowhere and replacing private debt with public debt in the process.
In getting on with this disaster, the finance reform bill could prove to be a catalyst that pushes us rapidly through the muddling stage and on to the "recovery" stage more quickly. Inflationary death by recovery, that is. It contains provisions in it that might just open up the floodgates of bank lending that so many of us have been watching for lo these many months.
It is difficult to find specific details about the bill, except for specific details that don't much matter, of course. The "controversial" points, like the piddling $50 billion insurance fund which would really just turn into another deficit financing pyramid scheme like FDIC and Social Security, are mostly just window dressing. So is the provision banning derivatives trading by commercial lenders, which has angered Wall Streeters. These measures may prolong the monetary goosing schemes of the FED and delay a day of reckoning, but they do not address the fundamental forces that cause the business cycle and the financial crises that go with it. Ironically, this is precisely how the bills are being promoted.
The most important provisions it seems to me are the ones that deal with liquidation of the too-big-to-fails that do, in fact, fail. These provisions are being billed as putting an end to the bailouts, but it sounds as if the accounting is almost exactly the same but by another name. The bill seems to basically legalize the actions taken by the government during the last crisis, allowing the executive branch to seize any business it deems a threat to the economy and use the FED and FDIC to buy bad assets and liquidate the firm's holdings. The only difference is that legally a seized firm will belong to the government as it is being bailed out rather than remaining ostensibly private. That may mean a little to you if you are a CEO or board member of a corporation being seized, probably a very little, but if you are lowly average Joe American, it won't change much. I suppose you can feel smugly vindicated as you watch the Feds clean up the flaming train wreck of the economy with your money that those nasty CEOs won't be receiving any bonuses this year, at least from that particular company. But you'll still be broke and jobless, the economy will still be in the toilet, and you'll still be asked to shoulder the load.
There is a far more sinister side to this "deal" as well, as one clever commenter who I have not yet been able to identify has pointed out. The main impetus behind the bailout of these firms is to ensure that their creditors get paid back, as these creditors in turn are likely to owe money to others and might themselves fail if they are not paid back, and so on. The failure of one very large firm therefore threatens to take down the entire system, hence too-big-to-fail.
But having a liquidation plan in place to ensure that creditors to very large firms always get paid back reduces the risk of lending to very large firms. Therefore, these firms will find that they can borrow money at much lower interest rates. The liquidation plan has the perverse effect of guaranteeing loans to these corporations, effectively converting any sufficiently large firm into a Fannie Mae or a Freddie Mac. Once again, the Federal government is subsidizing risk taking and encouraging financial institutions to become larger and larger at the expense of smaller firms.
Large firms will have incentives to go heavily into debt, while smaller businesses will have trouble competing with them for the available capital. Lenders will be encouraged to lend without regard to risk so long as the company is large enough to qualify for Federal seizure should it fail. The executive branch will have unchecked power to seize "risky" firms and their assets.
The FED will not have its power to expand the money supply checked, instead it will be encouraged to buy even more assets in the event of any future slump that manages to put a major corporation in jeopardy. In other words, this reform seeks to prevent future catastrophes by enacting more of exactly the same kinds of things that caused the present mess in the first place. Sadly, this is what passes for reform in Washington.
Might I also point out that the reform package appears to have more or less bipartisan support? Yes, yes, I am aware that the bill was successfully filibustered by the Republicans. This was only a temporary setback, as most of their objections were insubstantive wheedling over unimportant aspects of the plan and purely political sentimentalities. It appears that debate will now commence. The bill will pass sometime soon, I think. There is too much rancor against Wall Street, and too much “accepted wisdom” that the crisis was caused by credit markets going wild. Which it was, but nobody bothers to ask what exactly caused the credit markets to go wild (too freakin’ much money spewing out of the FED!), but yet all seem to agree that “there need to be rules against this kind of thing.”
This rule making is something akin to watching a balloon being inflated, disliking the size and shape, and attempting to get the balloon to stay in its "proper place" by squeezing on it in the places you’d like to stay smaller. Of course, the balloon merely bulges out somewhere else, and might just pop. The solution to getting rid of those dangerous bulges in an economy being inflated with money is not to squeeze the bulges one doesn’t like, it is to stop inflating the thing in the first place.
But that is not the way Washington operates. Washington operates on the principle of having one’s cake and eating it too. We will have a free market, and when things get out of control or become “unfair,” we will legislate them back into bounds that we like. We will also inflate the money supply, because that makes it easier for everybody to make a profit regardless of what they are doing, and that makes everybody happy. Few people seem to see much contradiction in any of this.
No amount of reform or legislation will ever put an end to the financial busts that does not put an end to the money supply manipulations of the FED and the banking system. This and every other financial reform of the last seventy years is nothing but politically motivated economic sentimentalism, a.k.a. pandering, and more of the same kinds of accounting fraud that favor corporate and large banking interests and fail to even nibble around the edges of the actual issue. In fact, they mostly exacerbate it by allowing the economic cycles to continue ever longer and longer which allows ever more resource misallocation to take place before a correction sets in.
One day we're going to find ourselves without a leg to stand on, having frittered away everything at the insane proddings of a monetary system that has become utterly disconnected from reality and is economically meaningless.
In the Meantime...
In the meantime, the finance reform bill looks as though it just may unstick the logjam that has kept price inflation at bay by releasing the built up bank reserves at the FED. By making lending to a big bank an essentially risk-free proposition, this policy threatens to flood markets with pent-up high-powered money. The FED had better be on its toes.
I would also note that there have been noises about the government unwinding its positions in debt markets and the banking system soon. In such an event, such guarantees would help boost the prices of assets the government holds, blunting the effect of so many assets coming on the market at once. That is probably the plan, anyway.
On the other hand, one of the arguments against the bailout plan was that the assets hald by the government were largely "unpriced" by markets, so that the government would never be able to unwind its positions at anything approaching present day price estimates. They were guilty of counting their chickens before they hatched by conducting economics without prices, so the argument went, and asset sales were supposed to reveal the error. But if this reform package pans out the way it looks like it might, there should be massive volumes of new money available to purchase these assets. Or maybe the Grecian black hole, which is an immensely "interesting" situation in and of itself, will drag global markets back into a tailspin and the FED will be forced to delay such a plan for some more time yet. We'll just have to see what happens.
Expect to see a lot of action in the coming few months. Markets could rally like nothing we've seen so far. But they could be headed back for the depths as well if the government hasn't hatched its plan just right. At the end of the day, it doesn’t really matter, because none of this much reflects reality anyway. Anybody who follows this stuff will know that’s by design.
Be warned -- if you find yourself rooting for these kinds of plans to work, and they very well might in the short run, be careful what you wish for. There will be consequences. There always are.