Bail out! by gimleteye

Beginning exactly a year ago, in a series of posts (read our archive: Federal Reserve) I outlined the origins of the housing boom in Florida politics, the inevitable crash, the ensuing budgetary crises afflicting municipal and state budgets, and the hope that the Federal Reserve would not attempt to bail out the big banks and financial institutions, whose recklessness allowed builders and developers to create both the biggest financial asset bubble in US history and, in states like Florida, ground common sense in land use planning and environmental protection into the dust.

Let the markets find their equilibrium.

But conservative economic principles have just been fed into the Bush White House wood chipper.

This morning the market bounded up 2.2 percent, drifting lower on news that the Federal Reserve would, in effect, absorb $200 billion of toxic derivative debt. It is unprecedented. Of course, the stock market reacted well--initially. A year ago, the question in my mind was if the recession we had entered--as a result of the implosion of financial derivatives that had already rained billions in fees and commissions for Wall Street and profits for bankers and builders and the Growth Machine--was going to be a soft or hard recession.

Today's news simply adds to the picture of wheels rocketing off the axles of the train. The Washington wrecking crew is heading us straight into the most threatening economic storm since World War II. NYU Economist Nouriel Roubini sums it up in this morning's post from his website:

"This is a bailout as the recent decision by the Fed to increase size of its liquidity injections (via TAF and other operations) to $200 billion will imply that financial institutions will be able to sell to the Fed agency debt (as well as other much more toxic ABS instruments) and get Fed liquidity in exchange for it.

So now the Fed has effectively entered into the business of propping up a market – and reckless investors – whose spreads are widening for good fundamental reasons (as such GSE are now experiencing mounting multi-billion dollar losses on their portfolios). No wonder that some observers are starting to talk about a covert partial nationalization of the US banking system. Then the explicit partial nationalization of this financial system may only become the next step of this financial meltdown.

Tuesday morning update: The just announced new Fed facility - the the Term Securities Lending Facility that will to lend up to $200 billion of Treasury securities in exchange for debt including agency and private mortgage-backed securities - confirms that the Fed has now entered into the business of artificially propping up the agency debt market and the residential MBS market. With credit risk for GSEs recently rising for fundamental reasons the manipulation of this market just increases moral hazard and saddles the Fed with meaningful credit risk."

The problem with the $200 billion, in addition to whatever billions the Fed has already injected into the system, is that the collateral is represented by such holdings as empty townhouses and condos and single-family production homes in Homestead and Florida City. Multiply that disaster of land use planning by 100,000 across the nation and you have an approximate sense of the scale of the unfolding economic disaster.

What the Federal Reserve and Wall Street must know, is that it is planning to shift all the costs of this massive clusterfuck onto the backs of US taxpayers, already facing wars costing (as recently estimated by Joseph Stieglitz) $3 trillion. How many more trillions of dollars do we have to spend, on unsustainable policies and bad plans for economic growth?

It is unbelievable.