Bank of the Fed Expands; Is Nationalization Imminent?

Yesterday the Fed announced, not one, but two major lending programs: 200 billion for consumer credit and 600 billion for mortgages. This is the Fed moving further into the "Bank of the Fed" approach I advocated during discussion of the TARP bailout. The Fed is effectively taking "deposits" in the form of Treasury bill purchases and using the money to make loans to private entities. The loans are currently being made indirectly, by supports to private bank lending, because the Fed lacks the infrastructure to evaluate individual loans.

This has engendered a lot of concern about wasting money and crowding out private lending/borrowing; of which some concerns have made it to the mainstream media. These concerns are legitimate; during the TARP controversy I was particularly concerned with the Fed crowding out essential lending to make wasteful loans. However, I think at the moment there's just no choice. For whatever reason, banks are unable to convert virtually free money from the Fed into consumer and commercial credit except at exorbitant rates. We need credit for our society to function and apparently nobody but the Fed can do it.

Lending by the Fed, though, may very well drive what's left of the banking system out of business. The Fed has access to unbelievably cheap money; at this writing it can borrow for 3 months at a rate 0.04% (free, essentially) and for 30 years at the astonishing rate of 3.52%. There's no way private banks can compete with that. If the Fed loans to some people but not others it is effectively providing an enormous subsidy to the favored and will create monster distortions in the economy. In addition, the Fed will face severe political pressure, as we've seen with the attempt to give away the farm to the banks while the auto industry gets crumbs. So I think the Fed will have to be relatively even-handed in its lending, and this is going to leave the Fed dominating most lending much as Fannie and Freddie now dominate mortgage lending.

So in the very near future we will likely have a de facto nationalized banking system, with governmental standards determining who does and who does not receive loans. Good or bad, it's now basically inevitable since the private banking system used the freedom provided by deregulation to go out and commit suicide. It is truly ironic that the mad drive to deregulate of the past 25 years will lead to socialism on a scale not even considered seriously in America before. But, that's the situation, and we now have to start thinking about how the government will run the bank.

What do we have to invest in?

Many pundits are proposing government-funded investments as a way out of the current recession. I wonder though, what is there to invest in? Certainly current infrastructure has deteriorated in the past few decades of neglect, but I haven't seen any indications that the deterioration is causing the enormous financial losses that would justify the kind of investment we need. Likewise we've seen in the past year that energy consumption can drop substantially in a relatively short time, with driving down 5.6% in one year. Green energy isn't needed so desperately if consumption declines.

Fundamentally investment is to increase production. But we really don't lack for goods, widgets, or entertainment. The real goal should be to improve lives, and I think at the moment that more time with family and fun is more worthwhile than fancier cars, bigger houses, or smoother roads for faster highway speeds. In an abstract sense, we might be better off with a smaller economy; happier, better connected, and more relaxed.

The problem, as with all major shifts, is that capital and human resources are misallocated for an American form of Dolce Vita. If we have that kind of shift in consumption many investors and workers will be left with no way to make a living. So perhaps the solution, rather than massive capital infrastructure investment, is investment in what we might call "home economics" training - teaching people how to live well and control spending, and how to help others do the same.

The Blogosphere and the Crisis

Obama recently released his list of economic transition advisors and it's a real disappointment. Everybody is extremely middle-of-the-road mainstream. There are few who recognized the housing bubble before it popped and none who protested Greenspan's ultra-loose money policy which helped set it up. Many are from banking or the Clinton adminstration and involved in the regulatory changes that helped set it up.

So, while it's a group of competent workmanlike team members, it lacks anybody with the foresight to see the current crisis in advance. The puzzlement is that there's a large group out in the blogosphere which was far ahead of the curve in foreseeing this crisis. The star of course is Nouriel Roubini, whose far-out 12-step collapse process, ridiculed when it came out, has been pretty spot-on as a set of predictions. But almost any of the big economic blogs - check out Calculated Risk's links - has been ahead of the curve on this. So why is this large reserve of foresight, including academic heavyweights like Roubini and Krugman, unrepresented on Obama's transition team?

I am leaning to the idea that at this point being right isn't going to be enough. A lot of the more intellectual types (which would include me) tend to think that if you're publically right people will eventually start listening to you and implementing your ideas. But the current situation is about as much of a push for the "no more bubbles" policies advocated in the blogosphere as you could have asked for, and we're not seeing a thing. So it seems we need to connect with some kind of political movement as well. I'm not really sure how, because the "reality-based" blogosphere ideas seem to cut across party lines, based on the fight against the TARP. But I think it's something to start working for.

Baltic Dry Index levels off

After an incredible plunge over the past year, the BDI appears to be leveling off in the low 800s. We had two days up followed by a leg down today. This is less bad than a continued plunge, but the numbers are, on an inflation-adjusted level, similar to the lows around 750 in the past recession, and in many cases below the operating costs of the ships. So the drop is halting because the BDI can't go any lower-at this point shipowners will just idle their ships.

So the financial and speculative crises are now starting to affect the real commodity market, reducing lading to the point that shipping capacity is being lost. The next question is how severe the destruction will be.