Tuesday, 11 March 2008

Struggling Not to Name Names

When it was announced a few days ago that Tony Blair was going to teach religion at Yale – he will teach “how religious values can be channeled toward reconciliation rather than polarization” – I thought we had hit the equivalent of Absolute Zero on the absurdity index. You could not possibly top that – or go lower.

Then came the announcement of the Fed's latest design to stabilize the markets. It said, in part:
The Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured ... by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS.
The Fed's normal lending mechanism is similar to the way a pawn shop operates. You pledge US Treasuries or other Fed eligible securities and receive cash in return. When you pay back the debt, you get back your securities. The operation injects money into the financial system. The Fed could also pledge securities for cash. This reversing drains money from the system. Both are well known tools of monetary policy.

Notice now what is missing from the new arrangement: MONEY. The dealers will get Treasuries as before, but instead of paying money for them, they will pledge, i.e., give to the Fed, “other securities” including “private label residential MBS.” That is the junk they cannot sell because securities prices, and especially mortgage-backed securities prices, are way below what they were a year ago. Any sale at the current prices will result in substantial loss. Banks and broker/dealers have already posted over $160 billion of losses and have little capital left to absorb further losses. It is this scenario that the Fed is hoping to avoid.

At one level, this new lending facility is a laundering operation in excelsis: swapping impaired, “dirty” securities for clean US Treasuries. But note what happens in consequence: an entity whose raison d’etre is regulating the quantity and movement of money is pushed into the position of promoting and carrying out a barter exchange, one specifically designed to exclude money. No dialectician has thought of a more pointed example of self negation!

What brings about this mix of shadiness and absurdity is the incomprehension of events that we saw turn a liberal New York sophisticate into a man of faith. (See “Finance as Discipline of Faith” below.)

Will the gimmickry work? The bankers at the helm of the Fed must think and hope so. But the world is a complicated place, especially to those who do not understand it!

A few years ago, a Bush aide made his now famous “reality-based” comment against the backdrop of Iraq War. “We’re an empire now, and when we act, we create our own reality,” he said. What the cretin did not understand was that “the reality” has its own logic that acts as an elemental force, frequently subjugating and overpowering the individual designs. The turn of events in Iraq provided the ample proof.

Finance, too, has its laws that operate independent of the will of individual market players, often frustrating their plans.

Price, Karl Marx noted, is the money name of commodities. Commodities have money names because they have value, so price is the money name of value as well. By means of its new lending facility, the Fed wants to avoid naming names, avoid assigning prices to values. But merely ignoring prices will not make them go away. Transformation of values to prices is a fundamental principle of economics. No one need be conscious of it for it to operate. It will not, in the like manner, go away by wishful bankers wishing it to go away.

What the Fed has succeeded in doing is correlating, however indirectly, US Treasuries with junk. Under the current market conditions, that could only lead to the degradation of the Treasuries, as we must see in coming weeks.