classical economics
for analysis,  forecasting
and policy design

Red Lights Flashing
RED LIGHTS FLASHING AT FEDERAL RESERVE

    The nearly complete unhinging of credit relationships produced by relentless naked short selling attacks on equity share prices has come to roost at the Federal Reserve. On September 15, the overnight funds rate trebled to six per cent even as prepared to meet and hold its “target” rate at two per cent. The LIBOR rate more than doubled on September 16 from 3.11% to 6.44%, portending devastating effects on already troublesome adjustable rate mortgages in the U. S., not to mention other credit market afflictions.
    The Federal Reserve injected $70 billion in temporary liquidity in an effort to persuade banks to lend at lower rates, but the gross disruptions of credit markets by the demise of Lehman and, prospectively, AIG, were too unsettling to banks looking to their own survival in such a lawless environment. The emergency injection first succeeded only in lowering the real funds rate to four per cent. This led the FOMC to conclude lowering the target rate might not be doable unless it took action to remedy the impending AIG collapse. This resulted in no change in the target announced by FOMC on September 16. But leaks indicating Fed assistance for AIG combined with the liquidity injection had the real funds rate down to 1.25% by 3:45 pm EDT.
    The Federal Reserve’s refusal to fund Lehman’s survival or takeover and its initial reluctance to lend funds to AIG were based on a real concern (combined with political and pecuniary issues) that its balance sheet is no longer very strong. Bear Stearns alone put the Fed into a position that it could not do the same thing again. Now threatened collapses of AIG, WaMu, and an unending list of others threaten to put the financial calamity beyond rescue by combined federal efforts.
    Naked short sellers can create and sell more shares than the Federal Reserve and Treasury can buy or bail out. Those who are doing this to the markets must be stopped and required to buy back the non-existent shares they sold to others. They will probably try to avoid their obligations and abscond with the billions they have stolen, but far better to take the path towards recovery than the path traveled to this point.
    If you are not a naked short seller and wish a favorable outcome to these circumstances, you should seek to influence the SEC, Congress, Treasury, the White House and wherever else your views may be valued. ~