The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance. This disparate treatment, unappealing as it is, appears unavoidable. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt.
– Ben Bernanke, chairman of the Federal Reserve, Jan. 13, 2009
One of the more remarkable things about the expansion of the subprime financial crisis into a general economic contraction is the Federal Reserve System's narcissistic focus on itself. In his speeches, Ben Bernanke spends more time talking about the Federal Reserve's balance sheet and how stupendously fabulous it continues to be despite the vast quantities of loans it is making to shore up various aspects of the financial system than he does about the unemployment rate or the expected effects of economic contraction on the public.
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It's rather like a seeing a speeding school bus full of children smash into the school in front of the horrified eyes of the children's mothers. Then, after the crash and a subsequent explosion, the bus driver emerges from the cloud of smoke surrounding the wreckage and assures everyone he is all right, that, in fact, he has never felt better. But the health of the driver is no one's primary concern.
The Federal Reserve's myopic vision has been ironically harmful to the very member banks whose interests it is theoretically defending. In a 2008 speech entitled "Reducing Preventable Mortgage Foreclosures," Bernanke suggested a range of options to address the rising number of mortgage delinquencies and mentioned that despite the banking industry's distaste for loan writedowns, the combination of low equity rates and falling house prices meant that reducing the principle amount might increase the expected value of the loan by reducing the risk of default and foreclosure. However, neither the Fed nor the banks pursued this strategy of sacrificing reward to reduce risk, as the subsequent loan default statistics readily show.
Despite a government program that offers $1,000 to mortgage holders for each loan modification they make, the number of loan modifications has fallen by nearly one-quarter. In a recent study of subprime and Alt-A loans by Wells Fargo, it has been shown that banks continue to prefer foreclosures and liquidations to loan modifications involving writedowns despite the fact that: a) the average writedown amounts to only 6 percent of the loan value, and, b) the average loss per writedown is only $13,077 compared to $141,953 per liquidated foreclosure. The average loss per liquidated foreclosure was 64.7 percent of the original loan balance.
This has serious implications for the value of the large quantity of mortgage-backed securities that are still held by financial institutions around the world even as the huge injection of taxpayer money into the banks are creating massive short-term profits that have recently seen bank bonuses rocket to levels exceeding those of the housing or dot com booms. This huge transfer of wealth from the public to the very banks that created the problem is economically irrational, demonstrably anti-democratic and extraordinarily foolish. The banks stubbornly refuse to understand that they are not the public's masters, but that their favored position in society will exist only so long as they are tolerated by the public.
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As I pointed out last week, the American public can shut down the banking system in a matter of weeks by refusing to make their mortgage payments. And since state governments not only have the wherewithal to declare short-term moratoriums on foreclosures such as California recently imposed, but have the ability to make them permanent, the public can legally render the $14.6 trillion in outstanding mortgage debt essentially valueless by putting sufficient political pressure on the 50 state legislatures.
Such an action would be, as Cicero declared in "De Officiis," both a subversion of property rights as well as ruinous to the public welfare. But an increasingly impoverished American public may not really care about the long-term implications of radical action, not if they are forced to watch Wall Street bankers pay themselves $700,000 bonuses out of their taxes as they lose their jobs and homes. If the chairman of the Federal Reserve is wise, he will accept congressional demands for an audit of the central bank and abandon the outmoded Finance First theory of economic development, for if he does not, he may well find the Federal Reserve System being burned down by an angry and irrational American public.