Saturday, March 22, 2008

The Fed vs the Market

In reading today's Mauldin letter (a follow-up on the Bear Stearns bailout/takeunder), I came across this typical and telling paragraph:
Now, if you were short going into Monday morning, you were not happy with the Fed, as they took money out of your pocket. But I can guarantee you that a forced sale that happened over 48 hours would not have come about unless the authorities were alarmed beyond what one can imagine. (emphasis added)
Ultimately, if the the market (i.e. the overall, and thereby best-informed, supply and demand of market participants) doesn't set prices, the only alternative is that it is someone's, or a group's, feelings that do. So if the Fed feels "fat, dumb and happy" they pour liquidity into the system at a breakneck pace; if they become "concerned" about inflation, they reduce liquidity; if they're "alarmed" they bailout companies who are making bets at 20:1 or 30:1 leverage. To the extent that these "policies" (if you can dignify emotional outbursts with such a term) deviate from market prices, it's all driven by feelings. And the (valid) lesson market participants take from this is that considered, rational judgment doesn't pay -- so instead of trying to forecast actual supply and demand, they're reduced to trying to guess (and then perhaps influence via lobbying) the emotional reactions of our economic czars.

This in itself is a tremendous tragedy and injustice, but it is compounded by the fact that these failures will be deemed "market failures" -- allegedly justifying yet more emotional input from our economic geniuses in Washington.

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