My Plan for What To Do with the So Called "Toxic Assets"

Here is the the problem as I see it.

RMBS can be sold for about 30 cents on the dollar now. But banks are unwilling to sell for less than 60 cents -- either because they really think the loans will experience only a 40 percent loss rate, or because they fear that acknowledging market value will put them into insolvency. Which it might very well.

In other words, If you sold these toxic mortgage bonds right now, the banks would be insolvent if they were sold at current market prices.(30 cents on the Dollar)In order to be solvent, these assets would need to be worth more like 60 cents on the Dollar. These banks are only in a position where they need to sell because they haveYet, banks actually now have plenty of cash. Of course they do, we just gave them $780 billion. In fact, the banks wouldn't even need to get rid of these RMBS if they could assign a value of 60 cents on the dollar.

In fact, the only reason that this is happening now is because of mark to market.

that investors think of the mark-to-market mess by using the following metaphor: A person buys a house for $250,000 and then takes out a $250,000 fixed-rate mortgage for 30 years. The person's income is adequate to make the monthly payments.


But under mark-to-market rules, the bank could call up and say that if your house is not sold immediately, it would fetch maybe $200,000 in such a distressed sale. The bank would then tell you that you owe $250,000 on a house worth $200 ,000 and to please fork over the $50,000 immediately or else lose the house

These banks are only a position where they need to sell because they have to give these illiquid asset a current market value. If you were to suspend that rule and implement the banks one where they are allowed to value these at 60 cents on the dollar however the banks can't move these assets for at least five years. Force the banks to hold onto these assets long term. You could even create an onerous penalty for early withdrawal.

This keeps them solvent. Meanwhile we force the toxic assets on those that deserve to hold onto them. This also keeps the banks solvent. It also requires absolutely no more cash outlays. It gives everyone a chance to take a deep breath because finally we could all assess the damage without the fear that things would only get worse and you'd have to write down even more. Furthermore, all of these bonds are backed by real estate. Because that real estate is currently falling, the current market value of the bonds has no bottom. No one is paying back the mortgage and the underlying value of the real estate is dropping. Giving these bonds five years allows the price of the real estate behind them to settle.

The banking system could thaw without the uncertainty that assets would tighten up again. It's really so simple that no one in the government would ever think of it.

Some Perspective on Marked to Market and the Current Crisis

There is a group of business folks and economists lead by Steve Forbes that believe that the magic bullet in stabilizing the economy starts with reversing the FASB rule of mark to market.

Mark-to-market is an accounting methodology of assigning a value to a position held
in a financial instrument based on the current market price for the instrument or similar instruments. For example, the final value of a futures contract that expires in 9 months will not be known until it expires. If it is marked to market, for accounting purposes it is assigned the value that it would currently fetch in the open market.

I have no opinion about whether or not reversing this rule would be the magic bullet, but mark to market has received little or no attention while its importance in the crisis cannot be understated.

First, in a perfect world, I would favor mark to market. Companies and financial institutions shouldn't be allowed to set an arbitrary value on assets, financial or otherwise. As such, setting their value at current market only makes sense. Yet, in the current market it has had a corrosive effect on our financial system.

Mark to market forces financial institutions to set their assets at current market value. So, how does this contribut to the current crisis? Well, many financial institutions are holding onto Mortgage Backed Securities. With the erosion of real estate, these MBS' have become 1) illiquid and 2)of significantly less value.

Because these assets can't be sold, financial instituions put them away and often have no choice but to use them as part of their asset value for minimum capital requirements. The problem is that these MBS' continue to fall in value. Furthermore, most of these financial institutions took on far too much risk and became far to leveraged. As such, meeting minimum capital requirements becomes a difficult task. With these MBS' continuing to fall in value banks have to constantly scramble just to meet minimum capital requirements.

This brings us to TARP, what banks did with it, and why the credit markets continue to be nearly frozen. Banks sit on Billions of Dollars worth of these MBS'. Their value continues to fall and none of these banks have any idea what they will be worth in the future. Since they can't sell them, their only worth is in contributing to minimum capital requirements. Since they aren't sure how much they will be worth, banks are afraid to lend any new capital they receive, for fear that if they do, they won't have enough capital remaining.

As such, if mark to market were rescinded and these financial institutions were allowed to place one value on these assets, then banks could hold them while the market recovered and they would be less afraid to lend. As this theory, championed by Forbes, goes, this would unfreeze the credit markets, and it would cost us nothing.

Government Intervention to Achieve Free Market Bliss?

That appears to be the logic peddled by a member of a Free Market think tank. What's really stunning about this piece is that its author, King Banaian, stipulates that it was government interference in the first place that caused this mess.

The “free market” did not get us into this mess, but we need the free market to get us out. For that to happen, the free market needs government as a partner, whether conservatives like that idea or not. …

[W]e suffer from more than a liquidity crisis at this time, and the most disconcerting for the free marketer is that many assets and derivatives on the banks’ balance sheets have an undetermined price. Mortgages on real properties are relatively easy to liquidate, but some other bank assets are relatively new securities innovations that turned out to be bad ideas. How these will be liquidated is unknown.

Ideally the government can act as a “market maker of last resort” in these securities, just as the Federal Reserve was envisioned as a lender of last resort for the liquidity crises of old. If the government can create a market where none exists, our system might recover without too much violence done to it.

Free markets do not mean always private markets. Free markets mean markets with an absence of coercion. It is possible for government to step forward for a missing market and not be coercive. A bailout that did not consume taxpayer dollars would be one example.

Well, with all due respect to King Banaian, free markets don't have partnerships with the government. Apparently Mr. Banaian is having a little trouble understanding the definition of the word free. A FREE market is FREE from government intervention, savior, or whatever euphimism some fair weather free market thinker wants to use. A free market is not free if it is bailed everytime the free market causes a crisis. I fact, a true FREE market is allowed to work out its own crises on its own without the steady hand of government intervention.

I have been stunned by the army of so called free market thinkers from Steve Forbes, Jack Welch, Dick Grasso, and Warren Buffet that have thrown their entire philosophy out the window because of this crisis. Now, frankly, what is clear is that they see this crisis as so severe that they believe that desperate times call for desperate action. That is a position I can respect. I will disagree with it but I respect it. What I don't respect is so called free market thinkers justifying and dressing up their government intervention pragmatism as some sort of back door free market approach.

It isn't. Let's call this what it is. There are really bad bonds and they have spread through the system like a cancer. Now, many believe that unless they are removed en masse from the system the entire system can't function. That maybe so. I don't know. I do, however, know that the government removing them from the system by force is nothing like a free market. Let's call a spade a spade. This is socialism and all so called free market thinkers that support it should at least have the courage of their convictions to admit that this crisis has shaken their belief in the free market.

Analyzing Forbes' Solutions to the Financial Crisis

According to Steve Forbes, there are three things that the Federal Government can do to end this financial crisis. In fact, Forbes goes so far as to call this crisis artificial.

1) Strengthen the Dollar.

If you have been following the work of Steve Forbes, then you know that his answer to every crisis financial and even national security is to strengthen the Dollar. He believes that the weak Dollar caused the spike in gas and food prices. What I don't see though is how a stronger Dollar would help in this crisis.

2) End Marked to Market

He is referring to FASB rule 157. Here is what the rule, instituted at end of 2007, said.

A Federal Accounting Standards Board (FASB) Statement that requires all publicly-traded companies in the U.S. to classify their assets based on the certainty with which fair values can be calculated. This statement created three asset categories: Level 1, Level 2 and Level 3. Level 1 assets are the easiest to value accurately based on standard market-based prices and Level 3 are the most difficult

Here is the net effect of this rule.

FASB 157 was passed to help investors and regulators understand how accurate a given company's asset estimates truly were. Many firms (including some of the largest in terms of assets) had to write down billions of dollars in hard-to-value Level 3 assets following the subprime meltdown and related credit crisis, which began in late 2006. By making companies report to investors the breakdown of assets, they allow investors to potentially see what percentage of the balance sheet could be open to revaluation or susceptible to sudden write-downs.

Here is how Forbes himself described the corrossive effect of FASB 157.

Think of the mark-to-market madness this way: You buy a house for $350,000 and take out a $250,000 30-year fixed-rate mortgage. Your income is more than adequate to make the monthly payments. But under mark-to-market rules the bank could call up and say that if your house had to be sold immediately, it would fetch maybe $200,000 in such a distressed sale. The bank would then tell you that you owe $250,000 on a house worth only $200,000 and to please fork over the $50,000 immediately or else lose the house.

Now many of these Mortgage Backed Securities and other financial vehicles derived from bad mortgages, would be classified into these level 3 assets. These assets had to be "marked to market" and thus market to some depressed price. Here is how one of my readers described the effect.

When portfolio managers discovered they were holding assets that would suffer from an unnecessarily harsh valuation according to this new rule, they all tried to sell them, and very quickly there was nobody to buy them. Thus, we began the Great Asset Contraction that helped to trigger the present crisis

As such, panicked selling happened at the worst time for no good reason besides a new accounting rule.

3) End so called naked short selling on financial services stocks.

Here is what naked short selling is.

Naked short selling, or naked shorting, is the practice of selling a stock short without first borrowing the shares or ensuring that the shares can be borrowed as is done in a conventional short sale. When the seller does not then obtain the shares within the required time frame, the result is known as a "fail to deliver."

A short sale is a speculator's tool used when you believe the value of a stock will go down. You sell the stock first and buy it back later. Normally in a short sale, the stock is borrowed, normally from the account of the broker you are using, before you sell it. With a naked short sale, even that doesn't happen. Because speculators have taken advantage of the financial mess to short sell every financial company in sight, this practice has perpetuated the problem. By ending this practice, even for a limited time as Forbes suggests, this would curb the practice of short selling. Limiting the ability of speculators to drive already beaten down stocks even further.

The Revolution of Fannie Mae and Freddie Mac

If you have any understanding of the dynamics of the mortgage market, and Fannie/Freddie's role in it, then you agree with me (no I am not trying to be arrogant in an annoying way) and these two need to be privatized and broken up. For instance, here is what Steve Forbes recently said.

Treasury Secretary Hank Paulson should finally do to these two corrupt,mismanaged monsters what he should have done months ago and unveil a plan to break them up into 12 new companies. They should be recapitalized, which will require an initial outlay of more than $300 billion. Current shareholders should be able to exchange their existing paper for shares in these new companies. They won’t likely recover what they lost on Fonie’s and Fraudie’s common stock, but they’ll end up with a lot more than what these shares were worth before the government takeover. Preferred shareholders should be able to exchange their paper for similar securities in these new entities, with warrants attached for conversion into common shares.

To help beleaguered regional banks, which owned much of this stuff, these preferred shares should be called in at par in, say, 20 years or so. That way banks and other financial institutions shouldn’t have to take a massive write-down. The federal government should also have warrants in these new outfits so that taxpayers can ultimately get a part or all of their money back. In this way you could have a dozen competitive companies with no ties to Washington.

It isn't that I am an oracle, however when you have dealt with them as long as I have, the answer is obvious. However, privatization and break up is one of those things that redefines easier said than done. First, there is the price tag. Here is how Forbes estimates it.

They should be recapitalized, which will require an initial outlay of more than $300 billion. Current shareholders should be able to exchange their existing paper for shares in these new companies.

Just because Forbes throws out $300 billion as though it is pocket change that doesn't actually mean that it is NOT an enormous sum. Because they are now nationalized companies, this capital outlay will have to be done by the government itself. The enormous sum the government would be required to fund is only the beginning of the massive undertaking.

First, while Forbes suggests 10-12 new companies, there is still a great deal of debate internally just how many new companies there should be. This debate is not merely existential. Because there are only two companies, each is too big to fail. That said, if you were to break them up into too many companies, there would no longer be economies of scale.

Economies of scale may be utilized by any size firm expanding its scale of operation. The common ones are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments), and marketing (spreading the cost of advertising over a greater range of output in media markets). Each of these factors reduces the long run average costs (LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to the right.

This concept of economies of scale as it relates to these two and the new companies they will form is also not merely theoretical. These two use their enormous size to drive interest rates lower. Keep in mind that any loan done by either has their core interest rate determined by them through the bonds they issue. If there are too many new companies each won't issue enough bonds to keep rates as low as they would be if there are fewer. If they aren't broken up into enough companies, then the new companies will continue to suffer from being too big to fail.

After the number of companies is determined, the real work begins. Keep in mind that these companies do everything: they securitize, they determine the rates, and they underwrite. They underwrite through three systems, Desktop Underwriter, Desktop Originator, and Loan Prospector. These are underwriting softwares that use very sophisticated formulas that essentially take the credit profile, income, property type, loan type, etc. and mix it up like a salad and then the software system determines if the loan is acceptable. Each of these new companies would have to develop their own systems based on what sorts of niches each would want to develop.

Furthermore, both Fannie and Freddie would then have to augment DO, DU, and LP because they are currently based their approval process is based on companies much larger than they will be. It is likely that each will have to make their requirements more stringent to deal with their new smaller size. Then, all of these new systems must be introduced to each and every bank. The underwriters at each bank must know how to use them.

Finally, there is the question of splitting up the employees and creating the right staff for all of these new companies. It is likely that each will have to hire all sorts of outside help. Still, the upper level management will have to come from Fannie and Freddie itself, or from folks that Treasury designates.

None of this is easy however it would be manageable if not for the big x factor. We are currently going through a mortgage crisis. Right now the mortgage market is going through chaos. If this is all done in a haphazard manner it will spin an already weak market out of control. With a slew of new companies, the entire industry will have to adjust to all new processes. Again, this would all be manageable if it wasn't done at such a trying time for the market itself.

Unfortunately, the alternative is even worse. These companies are in desperate need of reform. The longer they continue as two Government Sponsored Entities, the worse that is for the long term prospects of the real estate market. These two bohemoths have created a terrible deficiency in the mortgage market, and it is one we are now picking up the pieces of. If we don't reform them now, they will only continue to wreck havoc again. Unfortunately, there is no worse time for reform than now.

Next Stop Stagflation?

The economy is entering a very dangerous time, and what could be the result is something we haven't seen since the end of the 1970's, Stagflation.

Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time.[1] The portmanteau "stagflation" is generally attributed to British politician Iain Macleod, who coined the term in a speech to Parliament in 1965.[2][3][4] The concept is notable partly because, in postwar macroeconomic theory, inflation and recession were regarded as mutually exclusive, and also because stagflation has generally proven to be difficult and costly to eradicate once it gets started.

Throughout the year, the economy has shown very miniscule growth. Strong growth is about 3% growth in GDP. So far this year the economy has grown 1.4% and just over 0% in the first and second quarters respectively.

Now, in the last couple months, there has been troubling news on th inflation front. A recent wholesale price increase has further stoked fears of rising inflation.

Wholesale inflation surged in July, leaving prices for the past year rising at the fastest pace in 27 years, according to government data released Tuesday.

The Labor Department reported that wholesale prices shot up 1.2% in July, pushed higher by rising costs for energy, motor vehicles and other products. The increase was more than twice the 0.5% gain that economists expected.

Core prices, which exclude food and energy, rose 0.7%. That increase was the biggest since November 2006 and more than triple the 0.2% rise in core prices that had been expected. The bad news on wholesale prices followed a report last week that consumer prices shot up by 0.8% in July, leaving consumer inflation rising at the fastest pace in 27 years.

Now, if we face a period of significantly rising inflation at the same time we have a shrinking economy that is an unmitigated disaster. Here is how we got to this point.


Once the housing market tanked in August of 2007, that began the quick slide toward a recession. Since then, the housing market has only worsened. Initially, it looked as though the crisis would be limited only to sub prime. Quickly it spread into Alt A, and now more recently, Fannie and Freddie are also in deep trouble. The economy is NOT going to recover in any tangible way until the housing market recovers. That appears to be a long way off.


In September of last year, the Fed, clearly freaked about the impending real estate crisis, began a series of aggressive rate cuts. I said then that this appeared to be too aggressive. By the time it was all said and done, the Fed dropped the Fed Funds rate to 2%. It was clear that the Fed was making a very dangerous bet. The Fed was betting that their aggressive rate cuts would stabilize the housing market and eventually the economy without dropping them so quickly that it put the economy into a period of inflation.


Instead, the bet lost on both counts. The Fed clearly didn't take any stock of the housing market before they began their aggressive rate cut. The housing market was in a state of chaos far more significant than any rate cuts could resolve. On the other hand, the rate cuts weakened an already weak dollar. This lead directly to explosion in both commodities like wheat and more importantly gasoline. As the Fed was going through their reckless rate cuts, nearly no one, short of Steve Forbes, dared to criticize their actions. Even as their action weakened the dollar and ballooned food and gas prices, you heard nearly no criticism.


As such, the Fed has put the economy one step from unmitigated disaster. Fortunately, there are easy and tangible steps that can be taken to remove the economy from its ledge. First, the Fed needs to begin raising rates at a slow, but, steady pace. Second, the Congress needs to make the tax cuts permanent. By raising rates, the Fed will strengthen the dollar which will put downward pressure on both gas and food prices. This should relieve most of the inflationary pressure from the market. By making the tax cuts permanent, that will give the economy the necessary tax stability necessary to create investment spending and consumer spending.

From Boon to Crisis: Redux

When I analyzed the things that lead to the mortgage meltdown, I blamed it on five entities. I blamed it on the borrowers, the banks, the mortgage brokers, Wall Street, and Congress. In that particular piece I didn't mention it, but Alan Greenspan certainly also has plenty of blame. As I have examined the situation, most of the entities should be excused from any extraordinary responsibility. As I will attempt to prove, most of the entities were simply responding to market dynamics like any good capitalist, and thus the blame for this mess will be laid squarely in two hands.

First, let's review quickly how each of the entities were responsible.

Borrowers:

Many of them were simply irresponsible and bought more house than they could afford.

Banks:


They created the loans that put irresponsible borrowers into loans they had no business getting into.

Wall Street:

They made a market so that irresponsible borrowers were able to get loans en masse through irresponsible programs

Mortgage Brokers:

They were the middle men that put irresponsible banks together with irresponsible borrowers

Congress:

By making so many laws, it made the process terribly difficult for confused borrowers. It also made it that much easier, ironically enough, for unscrupulous banks and brokers to put borrowers in programs they had no business being in.

Finally, there is Alan Greenspan. By lowering the Federal Funds Rate to .75%, he created too much loose money. At the time, housing was one of the only sectors that was performing well. As such, banks had lots of money and only one place really to put it, mortgages. So, in effect, Greenspan started the chain of events that created the crisis.

So, now let's examine each group and see how much responsibility we should apply to each.

Borrowers:

Yes, they were irresponsible and so of course they should have ultimately bought property that was within their means. At the same time, these folks are irresponsible. That's what irresponsible people do...they act irresponsibly. By opening up programs to irresponsible people, the system opened itself so that irresponsible people could act irresponsibly. The trick is to make sure that irresponsible people don't qualify. That's why it takes up to a month for a loan to be approved. That's why banks examine such things as credit reports, income, assets, etc. They are making sure that someone is responsible and qualified to borrow. Once loans were opened up for stated income with no money down, the system was opened up to be exploited by those that are irresponsible. Anyone that is surprised or blames irresponsible folks for acting exactly as they are is simply blind to the nature of the beast.

Mortgage Brokers:

Did mortgage brokers know that they were putting folks into programs that they likely couldn't afford? Sometimes, and other times they simply didn't care. You want to blame the mortgage broker for this that is up to you. In the end, they were also creatures of the market. They had aggressive loan programs and they had borrowers willing to apply for these programs. What exactly did you expect these creatures of capitalism to do? Were brokers really supposed to say no to a borrower that could qualify because it might be too expensive for the borrower? Brokers work on commission not on salary. They are creatures of the market like everyone else. Banks created programs and they had lots of borrowers that were qualified for those programs. Those borrowers were perfectly willing to apply for these programs. It's that simple. If you want to blame a capitalistic creature for responding to the market then you just don't believe in capitalism.

Banks:

It was banks that after all opened up their programs to these irresponsible folks. Here is the inside story. It was Argent Mortgage, the wholesale division of Ameriquest, that wound up getting the ball rolling on all these aggressive mortgages. In a sense, we can all blame Ameriquest. That would be easy given their well earned terrible reputation. Yet, even Argent was only really responding to the market. How was Argent able to provide all these aggressive loans? They found folks on Wall Street willing to make a market in them. That brings me to the last group.

Wall Street:

This story starts in the mid 1980's with a man named Lew Ranieri.

The past quarter-century has seen a revolution in finance. It's felt every time a homeowner refinances a mortgage or signs up for a credit card. No one person can claim to have lit the fuse for this revolution -- but Lewis S. Ranieri was holding the match. Joining Salomon Brothers' new mortgage-trading desk in the late 1970s, the college dropout became the father of "securitization," a word he coined for converting home loans into bonds that could be sold anywhere in the world. What Ranieri calls "the alchemy" lifted financial constraints on the American dream, created a template for cutting costs on everything from credit cards to Third World debt -- and launched a multibillion-dollar industry.

The Wall Street traders that took loans and packaged them into bonds were all proteges of Lew Ranieri. Banks are totally helpless without the support of a Wall Street type to take their loan off the bank's hands and turn it into a bond. That is what provided liquidity in the market. A bank would never come out with an aggressive program unless there was someone on Wall Street willing to buy in bulk loans that qualified for that program. These so called no money down loans were created only because Wall Street was willing to buy them and package them into bonds.

So, it's all Wall Streets fault, right. Not exactly again. Why did Wall Street willingly package so many aggressive loans and turn them into bonds? This question is also answered through simple capitalism. These bond traders simply had too many buyers for their bonds when their programs were more conservative. What did anyone really expect a capitalist working in a trading pit to do when they were simply able to sell their product too easily.

This really came down to supply and demand. If there were more buyers than product then more product needed to be created. The reason they created more aggressive programs was because those could be sold. That's how markets work. Where was all this money coming from that was buying these bonds. Well, of course, much of its nexus comes from the very Fed Funds Rate Cut by Alan Greenspan I mentioned earlier. This leads me to the last two culprits.

So, we really only have two entities left: Congress and Alan Greenspan. Congress is to blame for creating a hyper regulated industry that still was totally impotent to obscene fraud and corruption despite the obscene regulation. In fact, all the regulations created so much paperwork that ironically enough it was easier to corrupt. Furthermore, all the politicians now speaking about a plethora of new mortgage regulation were strangely silent while the abuse was happening. Where was all the talk of regulations banning stated loans, no money down, etc. while the abuse was happening? The Congress stood by and ceded their Constitutional responsibility of regulating business while the market was hot. Only now, do they want to regulate. (though as my link points out even that can be explained by political market dynamics)

The main culprit is Alan Greenspan himself. By lowering the Fed Funds Rate so much he created the environment of irresponsibility that followed. Like I said in my earlier piece, he couldn't have possibly predicted the mortgage crisis itself but should have predicted the law of unintended consequences. By dropping the fed funds rate to an irresponsible level he created an environment of irresponsibility. In fact, all the other players were simply responding naturally to the unnatural stimulus created by his obscene rate cuts.

Greenspan wanted to create overwhelming borrowing and he did. Only, he obviously never thought about the consequences of such overwhelming borrowing. He should have because the mortgage crisis we face is that natural consequence. Every other player can be excused for acting naturally to the stimulus he created.

Thus, in conclusion, in my opinion, there is really one main culprit for this crisis and that is Alan Greenspan. (for a concurring opinion here is Steve Forbes)

Does the Fed Get It?

That answer would be a resounding no if you asked Steve Forbes.

The Fed must act immediately to strengthen the dollar, says Steve Forbes, publisher of Forbes magazine.

"You cannot have a strong economy with a weak dollar," Forbes observes. "That's what the Fed doesn't get."

"Instead, the Fed and Treasury are saying, 'We've got to fight malaria, and then we'll deal with the mosquitoes.'"

Forbes continues his one man debate on the nature and purpose of Fed policy. Much of what he said today is an extension of ideas laid out in this piece...

Since World War II most countries have regarded monetary policy as a critical instrument (the other biggies being government spending and taxation) in regulating the economy. If economic activity is slowing, so the thinking has gone, the central bank should rev up the printing presses: The extra money will stimulate growth. Conversely, if the economy is growing too quickly, the central bank should tighten up on money creation, slowing things down to avoid the economy's careening off the road in the equivalent of a car wreck. The longest-serving Federal Reserve Chairman, William McChesney Martin Jr., liked to say that it was the Fed's job to take away the punch bowl just when the party really gets going.This is a misbegotten view of what central banking's main mission should be. The Federal Reserve should have two key tasks--and only two: preserving the integrity of the dollar and dealing vigorously with financial panics to limit unnecessary damage.

...

Greenspan's woes came about precisely because he lost sight of the Fed's prime job: ensuring a stable dollar. In the late 1990s Greenspan inadvertently tightened up. The most sensitive barometer of market mistakes is gold. During that time the yellow metal plunged to a low of $250 an ounce. Other commodities crashed, with oil dropping to nearly $10 a barrel. For a time the dollar became too dear, which contributed to the 2000--01 recession. When it became clear--just before George W. Bush was sworn in as President on Jan. 20, 2001--that the economy was skidding, Greenspan realized his mistake and started to reverse gears. But he stayed too easy, even when the economy was back on track. In 2004 gold began to surge well above its 12-year average, and oil began its long, rapid ascent, as did all other commodities. The dollar weakened not only against gold but also against other currencies, such as the yen, the Swiss franc and the pound. With money easy, the already buoyant U.S. housing market began to go berserk as lending standards started to decline precipitously.

Not coincidentally, Forbes' comments come on the same day as this troubling new report on inflation.

Consumer prices shot up in June at the second fastest pace in 26 years with two-thirds of the surge blamed on soaring energy prices.

The Labor Department reported that consumer prices jumped 1.1 percent last month, much worse than had been expected. Energy prices rocketed upward by 6.6
percent, reflecting big gains for gasoline, home heating oil and natural gas.

The big rise in prices cut deeply into consumers' earning power with average weekly wages, after adjusting for inflation, falling by 0.9 percent. It was the biggest monthly decline since a 1.1 percent drop in weekly wages in September 2005.

The 1.1 percent June price increase was the second largest monthly advance in the past 26 years, surpassed only by a 1.3 percent gain in September 2005 from a jolt to energy costs after Hurricane Katrina.

Forbes continues to be a lonely voice in daring to criticize the Fed in any manner. Most so called capitalists look to the Fed to take control of the entire market each and every time there is even a hint of trouble. Keep in mind, lawmakers are on the brink of expanding the Fed's regulatory power from oversights over banks to "financial services" institutions.

Forbes goes onto pin much of the blame of our ailing economy on the weak dollar. He even goes so far as to say that 80% of the increase in gas prices is due to the weak dollar. Whether or not Fed policy should be focused on a stable dollar as Forbes wants is still a matter of debate. There are several things that are NOT a matter of debate. There is no doubt that Fed policy contributed to weakening an already weak dollar. There is no doubt that the Fed knew this would happen and didn't care. There is no doubt this contributed to exploding gas and food prices. Furthermore, there is no doubt that Fed policy has been an unmitigated disaster since 1999. (the ten years previous to that were a period of excellent fed policy which is why his point is open for debate)

Furthermore, the Fed carries a very troubling combination. It is both incredibly powerful and misunderstood. If Forbes does nothing else, he is at least raising questions about the Fed. The worst thing happening right now is that the Fed is going through an enormous power grab. Yet, no one is daring the question the wisdom of this.

The Fed is held in extremely high esteem even though they have been nothing short of an unmitigated disaster for the last ten years. They raised rates starting in late 1999, which popped the internet bubble and lead to a recession. Next, they dropped the Fed Funds Rate below 1% and that got the ball rolling on the mortgage crisis. Finally, over the last few months they have furiously reduced rates and with it weakened the dollar which has created all sorts of new inflationary pressure. This is not the sort of performance that warrants more power and yet that's what most want to grant the Federal Reserve.