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The Fed Muddles Through a Bailout

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               THE CONSERVATIVE REVIEW   
                   April 22, 2008
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The Fed Muddles Through a Bailout
By George Will

Some say the world will end in fire,
Some say in ice. ...

-- Robert Frost 

WASHINGTON -- And some say it will end because of subprime 
mortgages. But for those who cultivate fears of catas-
trophes as excuses for expanding government supervision 
of other people's lives, the bad news is that the world 
is not going to end -- not from global warming or economic 
cooling or anything else. Today's untethered Federal 
Reserve will, however, make the muddle-through interest-
ing.

The late Sen. William Proxmire, a populist Democrat who 
represented Wisconsin for 32 years, wanted all members 
of Congress to write on their bathroom mirrors, so it 
is the first thing they read each day, this: "The Fed 
is a creature of Congress." Congress created the Federal 
Reserve pursuant to its constitutional power "to coin 
money" and "regulate the value thereof." Fortunately, 
Congress has left the Fed free to go about its business.

But suddenly the Fed is undergoing radical "mission creep." 
The description of the Fed as the "lender of last resort" 
is accurate without being informative. Lender to whom? 
For what purposes? Last resort before what? Did the bank 
"lend" $29 billion to Bear Stearns, or did it, in effect, 
buy some of the most problematic securities owned by Bear? 
If so, was this faux "loan" actually to J.P. Morgan Chase? 
The purpose of the money was to give Morgan an incentive 
to buy Bear -- at a price so low that an incentive should 
have been superfluous.

In 1979, when the government undertook to rescue Chrysler, 
conservatives worried not that the bailout would fail but 
that it would work, thereby inflaming government's inter-
ventionist proclivities and lowering public resistance to 
future flights of Wall Street socialism. It "worked": 
Chrysler has survived to endure its current crisis. The 
fallacious argument in 1979 was that Chrysler was then 
"too big to be allowed to fail." 

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Today's argument is that Bear Stearns was so connected to 
the financial system in opaque ways that no one could guess 
the radiating consequences of its failure -- the financial 
consequences or, which sometimes is much the same thing, 
psychological.

But what is now the principle by which other distressed 
firms will elicit Fed interventions in future uncertainties? 
By what criteria does Washington henceforth determine 
whether a large entity is "too connected to fail"?

The Fed has no mandate to be the dealmaker for Wall Street 
socialism. The Fed's mission is to preserve the currency 
as a store of value by preventing inflation. Its duty is 
not to avoid a recession at all costs; the way to get a 
big recession is to engage in frenzied improvisations 
because a small recession, aka a correction, is deemed 
intolerable. The Fed should not try to produce this or that 
rate of economic growth or unemployment. 

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After the tech bubble burst in 2000, the Fed opened the 
money spigot to lower interest rates and keep the economy 
humming. And since the bursting of the housing bubble, 
which was partly caused by that opened spigot, the Fed has 
again lowered interest rates, which for now are negative 
-- lower than the inflation rate, which the open spigot 
will aggravate.

A surge of inflation might mean the end of the world as 
we have known it. Twenty-six percent of the $9.4 trillion 
of U.S. debt is held by foreigners. Suppose they construe 
Fed policy as serving an unspoken (and unspeakable) U.S. 
interest in increasing inflation, which would amount to 
the slow devaluation -- partial repudiation -- of the 
nation's debts. If foreign holders of U.S. Treasury notes 
start to sell them, interest rates will have to spike to 
attract the foreign money that enables Americans to 
consume more than they produce. 

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Having maxed out many of their 1.4 billion credit cards, 
between 2001 and 2006 Americans tapped $1.2 trillion of 
their housing equity. Business Week reports that the middle-
class debt-to-income ratio is now 141 percent, double that 
of 1983. Because anxiety is epidemic, bipartisanship has 
reared its supposedly pretty head.

Republicans and Democrats promise cooperation, compromise 
and general niceness using other people's money. If Con-
gress cannot suppress its itch to "do something" while 
markets are correcting the prices of housing and money, 
Congress could pass a law saying: No company benefiting 
from a substantial federal subvention (which would now 
include Morgan) may pay any executive more than the high-
est pay of a federal civil servant ($124,010). That would 
dampen Wall Street's enthusiasm for measures that social-
ize losses while keeping profits private. 

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End of CONSERVATIVE REVIEW   
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