Two major developments in the US made me sit up over the weekend:
- the first was the terrible employment report for August, which showed that new job creation in the US is at a stand-still.
- the second is that the Fed is going to sue virtually every major US bank for selling mortgage and mortgage-related securities to the housing agencies Fannie Mae and Freddie Mac. These institutions are now custodians of the US Fed, by virtue of the massive infusion of capital that the Fed provided.
The first bit of news has obvious implications for the US economy: lower employment can set off a downward spiral of lower demand, and hence even lower employment. This cycle will adjust only when there enough of a recession in the US for producers to force prices down so as to become competitive in world markets, and begin increasingly producing for export. This will, however, tend to be accompanied by lower domestic prices, too, which is counter to the US government's desire to prevent deflation, which could cause nasty consequences for the huge debt overhang.
Aside from the conflict between the self-adjusting cycle of prices and demand on the one side, and the government's concerns regarding debt on the other, there is another problem, namely that economic uncertainty all over the globe is pushing many investors into the dollar, which is leading to dollar appreciation, rather than the other way around, preventing US economic adjustment through this route. We have seen this before - in 2008. It will reverse, sharply, and not without further turmoil on financial markets; only then will this price-demand adjustment take place to the benefit of the US economy. It is going to be a long, volatile journey.
The second bit of news has much deeper ramifications. By deciding to sue banks on behalf of the housing agencies, the Fed is essentially suggesting that Fannie Mae and Freddie Mac were innocent victims of conniving banks. This is the worst kind of political posturing. The fact is that these were government sponsored agencies supposed to specialise in housing finance; they were leaders in creating mortgages and pioneers in creating derivatives for mortgage re--finance. To now suggest they were exploited by the big bad wolves of Wall Street selling them instruments they could not independently assess is dissimulation of the worst kind.
The timing of the proposed legal action is uncanny - it comes at a time when the Fed is at a loss on monetary stimulus, and virtually everyone has given up on the jobs front. Oh, and the US presidential elections are barely a year away. When this administration came into power, it bailed out Wall Street, peddling the move as an instrumentality to rescue Main Street. The first rescue was spectacular; bank profits bounced back, as did multi-million dollar bonuses. This created political discomfort, which deepened when the second part of the rescue act failed to materialise. Obama's ratings are dropping, and something needs to be done. Step 1 - step away from the banks.
Suing the banks will achieve nothing except some optics; however, it will deepen the uncertainty regarding economic policy and regulation in the US. One economic commentator calls such uncertainty 'regime change'. It think this is rather an extreme term; however, it does convey the level of complexity large financial corporations have to deal with. Amping up this uncertainty is not good for investment and growth, and drives a wedge of distrust between government and business. Good though this may seem for popularity ratings, it can only be bad for what matters, which is jobs on the ground.
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