“The punishment has been meted out to those who have done misdeeds and made bad judgments,”' Poole told reporters in St. Louis after a speech on the market for mortgages to borrowers with sketchy or weak credit histories. “We are getting good evidence that the companies and hedge funds that are being hit are the ones who deserve it.”
The “Poole” quoted above by Bloomberg News is not a televangelist inveighing against the money changers in the Temple. He is the President of the Federal Reserve Bank of St Louis. Another of Mr Poole’s interesting beliefs is that the problems sparked by non-performing subprime mortgages are not spreading to the wider financial services industry.
Try telling that to the holders of bank stocks. Large, small and in-between bank stock indices hit 52-week lows today as did many individual names. Or try telling it to corporate bond managers who are experiencing sharply falling prices for all but the very best credits. Or try telling it to the wizards of private equity.
Just this month, Henry Kravis, one of the first and most famous practitioners of the leverage buyout, was quoted by Bloomberg Magazine, “The private equity world is in its golden era right now. The stars are aligned.” Not any more. JP Morgan Chase reported yesterday that the issuance of Collateralized Debt Obligations, into which the loans and bonds that finance buyouts are often securitized, declined from $42 billion in June to less than $4 billion this month. To put this in context, the two biggest buyout firms—Kohlberg, Kravis & Roberts and the Blackstone Group—must raise $300 billion in the next few months to pay for acquisitions that have already been announced. And that does not include the more than $30 billion that must be placed this week to finance two huge privatizations, Chrysler and Alliance Boots, the UK equivalent of Walgreen’s.
The markets thought the subprime mortgage problem was contained following the demise of the most egregious lenders early this year and the subsequent tightening of underwriting standards. Then the markets thought the problem was contained when the collapse of two large Bear Stearns hedge funds did not seriously harm the firm or its lenders. (The investors, of course, lost everything.) Today’s stock market plunge and accompanying “flight to quality” Treasury buying shows that the problem is still far from contained. And that brings us back to the Fed.
The Fed has painted itself in a corner by holding the fed funds rate at 5.25% for the last year. Its claim that core inflation—up just 2.2% year-over-year—remains our most pressing economic problem is becoming harder to justify every day. Liquidity is rapidly draining out of the system, and while the elimination of excesses is necessary, the long-term harm could be substantial. JP Morgan Chase warns that “with home prices dropping and credit tightening, most of the borrowers of the roughly $500 billion of ARMs scheduled to reset over the next 18 months will probably be unable to refinance.” The Fed should start thinking seriously about lowering the fed funds rate. Opinions like Mr Poole’s only make the process more difficult.
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