Australian politics watchers will remember the defiance the Australian Reserve Bank showed in not making political decisions when dealing with interest rates in an election year. The US Federal Reserve is not so stridently empirical or independent. From swoop:

White House officials have told us that President Bush intervened forcibly to convince an initially reluctant Federal Reserve to reduce interest rates. "There were some telephone calls from the White House to the Fed in which some very crude language was used."

Is the White House claiming ownership of what is bad monetary policy? I doubt it matters, as adam pointed out through Marc Faber, Bernanke is a money printer.

This article is correct, but it is also an inside window into the fall of American conservatism. It is written in populist terms with some mythical conspiratorial elite and supposedly non-elected policy makers:

That is the deal the Federal Reserve has made on behalf of the public. It's the latest chapter in the socialization of risk and its corollary, moral hazard.

Anyone who works long enough on Wall Street knows, at least subconsciously, that this is the way things work: if the going gets tough, a small coterie of unelected and mostly unaccountable officials in Washington will probably decide that your employer is too important to fail.

In an effort to keep that from happening, wages, savings, fixed-income streams, and Social Security checks will be inflated away to "ensure the stability of the financial system."

I agree that this risk shouldn't be socialised, and there was a time when US policy makers would let big companies fail without being bailed out, however this article serves more as insight into conservatism's lost nature. You can imagine a populist like Chavez railing against the government with the same language.

The supposedly unelected policy makers are not the apolitical hidden elite this article imagines. The US Federal Reserve is one of the more political reserve banks and is politically influenced. There was an article not so long ago of Bush himself persuading fed policy by sending a bunch of cuss-words down the telephone line.

It is populism at its worst, similar to Cheney's "deficits don't matter." They do, just not politically.

Populism from the current Administration and Congress is an easier cop out than enforcing an economic policy that punishes failed risk with economic failure. This darwinianism is how it is supposed to be. The Bush Administration and Congress are avoiding that by inflating their way out of economic difficulties.

The title of the article, "Papering over the problem" is absolutely correct. It is a bad policy. However it is not one from a hidden elite, or non-elected policy makers; the policy is inherently political.

Barry Ritholtz has an impassioned plea; give us capitalism or give us socialism, but not the half arsed mess of both that the US Federal Reserve is serving up in the name of politics, bad policy, poor governance and crony capitalism. The result will be to prolong the current mess of bad lending, keep the recession going and increase inflation. None of which are palatable in the long run.

Ritholtz points back to the governance of Greenspan at the US Fed who actively promoted bubbles and then bailed out losers of the bubbles by making credit cheaper so that there were no losers and speculation could continue. Capitalism works best when those that over speculate are punished for it by bankrupcy.

Without the correct signals and punishments for failure then risk simply does not exist. We saw this in the subprime markets where risk was assumed to be absent. As a consequence bad loans were made that can never be recovered. The bad governance aspect is that now the US Fed is asking for 300 billion of tax payer money to bail out private institutions - include Fannie Mae - to cover their risks made on the private markets. This is not how capitalism works. Ritholtz writes:

There is a choice to be made: Either we regulate the Banks, or leave it to the vagaries of the free markets to punish those who trade with, or place their assets in the wrong institutions. But for God's sake, do not give us the worst of both worlds -- do not allow banks the freedom to make horrific but preventable mistakes (i.e., only lending money to those who can pay it back), but then expect the taxpayers to foot the trillion dollar bill.

That's not capitalism, its not socialism, its not regulation, and its sure as hell isn't what free markets are. Our language is insufficient to describe this hodge-podge system, other than to call it a random patchwork of quasi-capitalism, quadrennial-socialism, and politics as usual. Ideological idiocy is the only phrase I can muster that has any resonance with the daily insanity.

Ritholtz makes the statement that our institutions have failed us and that this is misgovernance on a grand scale leading back twenty years. Economic policy has not been grounded in the principles of capitalism; but instead 'feelgood' politics and outright criminal behaviour. American capitalism is losing its foothold as the world's leaders in economic activity. This is being shown in the US dollar dropping in value. It is bad policy and criminal behaviour that has led to this. It is recoverable - and the US will recover - it is not dead in the water yet. But it will take a strong hand of governance and the democratic will to govern with economically sound policies.

Joshua Gans has argued for an Aussie Mac. Australia has not needed one this far, and as a country Australia has more regulation into capital markets than the US does. Australia has not been impacted greatly by the subprime mess - only Macquarie Bank and a couple of others IIRC were up to their necks in it - and while global capital will become more expensive with the turmoil from US markets, it is no excuse to subsidise home lending with taxpayer guarantees. Otherwise politics will trump economics and Aussie Mac will be used for all manner of bailouts and social engineering.

Kenneth Rogoff writes that central banks such as the US Federal Reserve, the Bank of England and the European Central Bank are over-exposed as they have tried to absorb the dodgy credit of the banks that should have been allowed to fail. Rogoff notes that central banks can fix their balance sheets courtesy of having the backing capital of taxpayers and the patience of governments that rarely fail:

But history suggests that fixing a central bank's balance sheet is never pleasant. Faced with credit losses, a central bank can either dig its way out through inflation or await recapitalisation by taxpayers. Both solutions are extremely traumatic.

Rogoff asks why taxpayers should foot the bill and save banks when the financial sector has become used to high profits and executive bonuses through what is fiscally irresponsible behaviour.

This argument is all the more forceful if central banks turn to the "inflation tax", which falls disproportionately on the poor, who have less means to protect themselves from price increases that undermine the value of their savings.

The policies of the central banks amount to public subsidy of the financial industry.

And:

"Why would anyone inject equity capital into a financial institution if a few weeks later the government comes in and renders it worthless?'' said Axel Merk, president of Merk Investments, a Palo Alto, California-based fund manager. "The slope of bailouts is slippery and expensive.''

Why indeed. You can make more money speculating on their bonds if they are getting bailed out than you can lending to them and keeping them solvent.

So incompetent it is scary, the US fed has allowed banks to fund their liabilities in subsidiaries with depositors funds. From naked capitalism:

"Note that many banking experts, post the S&L; crisis and now, recommend the reverse, "narrow banking", which requires banks to invest depositors' funds only in the very safest assets. This is the exact opposite of the sort of regulatory measures needed to improve the health of the banking system. Expediency trumps soundness.

What a horribly useless Administration and Federal Reserve. If this mess wasn't picked up during Greenspan's early tenure and the Clinton Administration, then it should have when the Bush Administration came into office. The political and fiscal incompetence is seeping into criminal - especially when it is other people's money such as taxpayers and depositors.

I am really having trouble understanding this. At the height of the subprime lending I did not use that form of mortgage. I payed the 20% down and then took a fixed rate mortgage. I am fiscally wary most of the time and the subprime mortgages seemed to good to be true. Turns out that was true, not for lenders, but for investors in those securities.

I can understand the wish to create a financial product that will enable those that cannot get into a fixed rate loan to have access to a higher risk mortgage; but that does not allow for the fraud that went on around it. Nor does it get policy makers off the hook for allowing dodgy financial practices to occur at these shadow lending institutions and banks such as Bears-Stearn and Lehman.

Most of the policy makers and overseers move back and forth between Wall Street and Federal Government. It should not have been a surprise for these bankers to see. We could argue conspiracy, self-interest, etc but the Federal Reserve is a permanent institution that should have institutional memory and public interest.

The avoidance of this issue must have been a deliberate policy choice. Given the use of public money to bail out the collapsing US financial sector it was a bad policy.

Further on this issue of bailouts, Paulson Doctrine?

Unwittingly or not, Treasury Secretary Paulson has effectively created the Paulson Doctrine. The doctrine states that firms that he deems too big to fail (but we're not exactly sure where the line is drawn: LEH? No. BSC? Kind of. MER? Maybe. AIG, FNM and FRE? Definitely.) get the U.S. Government (and the U.S. taxpayer) as new senior shareholders, while the others are either left to execute an orderly private markets Good Bank/Bad Bank restructuring (if they can, like Mellon in the late 1980s) or a hurried Chapter 11 Good Bank/Bad Bank restructuring (if they can't: see BCS/LEH circa 2008).

Interesting article. Gold has been increasing in price for quite a while. Ultimately it is because of a lack of faith in the US dollar that money has been going into gold. With the US printing money for AIG and the on-going inflationary policies there was a very sudden spike from bonds into gold. Investors believe their money is safer in gold than bonds.