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December 12, 2007

A Real Bailout For The Banking Industry

by Brad Warbiany

Only a week ago, I was claiming that the Bush “plan” to streamline the mortgage-modification process wasn’t a bailout. A bailout is when the government actually spends money or drastically changes regulation in order to give an industry a helping hand. That plan wasn’t a bailout, for many reasons.

But the financial markets weren’t quite happy with this non-action. And today, the Federal Reserve and European central banks chose to cow to their demands, by injecting inflation liquidity into the system:

A day after the Federal Reserve disappointed investors with a modest cut in interest rates, central banks in North America and Europe on Wednesday announced the most aggressive infusion of capital into the banking system since the terrorist attacks of September 2001.

Economists and market specialists say policy makers are trying to reassure bankers that they will stand firm as the lenders of last resort. The coordinated action is being led by the Fed, which will lend $40 billion this month. The European Central Bank, the Bank of England, the Swiss National Bank and the Bank of Canada will lend $50.2 billion this month and next.

“This is basically a reinsurance policy,” said William H. Gross, chief investment officer of the bond management firm Pimco. Central bankers “are saying, ‘We will stand behind you.’ ”

The market is reeling because the rapid expansion of credit is starting to come to an end, and the [necessary] resulting credit crunch will be nearly as painful as the heady days of credit expansion were joyful. The problem is, pain takes the form of recession, and central banks don’t want to stand idly by and let recessions occur, even if necessary. So they’re going to throw money into the system until lenders realize that a contraction won’t occur.

The Fed created this credit bubble. Now when it’s in danger of popping, they’re going to try to patch it up. Like many government actions, it might achieve its goal in the short term, but the long-term consequences will be far more damaging than allowing the system to correct today. Stocks may have rebounded today, but so did gold, an indication that this is a sign of future inflation, adding another story to the house of cards built upon a foundation of sand.

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1 Comment

  1. Hmm, this is what central bankers do all the time. They ease when they should not do anything at all. The policy by the Fed is ridiculous. Now everybody’s going to inflate.

    Nobody’s talking about how inflation is already racking the Chinese economy. Headline inflation in the US is out of control on commodities and wholesale prices. We need more inflation??? Somebody hand me some hard assets I can buy so I can protect myself from all this inflation.

    Yuck.

    Comment by TanGeng — December 13, 2007 @ 5:50 pm

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