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Markets are constantly in a state of uncertainty and flux and money is make by discounting the obvious and betting on the unexpected. - George Soros

It’s called PRICE FIXING, and it isn’t going to work.

Dec.01, 2008 in Market Outlook

From Global Research

Last Tuesday, Treasury Secretary Henry Paulson announced that the Fed would buy $600 billion of toxic mortgage-backed securities (MBS) from Fannie Mae and Freddie Mac, in effect, buying up its own debt. This is one of the unconventional strategies that Bernanke outlined in a speech he gave in 2002 on how to avoid deflation.

By moving the MBS from Fannie’s balance sheet to the Fed’s, Bernanke was able down interest rates by a full percentage point overnight, creating a powerful incentive for anyone thinking about buying a home. But Bernanke’s plan is not risk free; it increases the Fed’s long-term liabilities which, in turn, undermines the dollar. This calls into question the creditworthiness of the US Treasury which is becoming more and more uncertain every day.

The Fed also initiated a program to purchase $200 billion of triple A-rated loans from non bank financial institutions to try to revive the flagging securitization market. It’s another risky move that ignores the fact that investors are shunning “pools of loans” because no one really knows what they are worth. The appropriate way to establish a price for complex securities in a frozen market is to create a central clearinghouse where they can be auctioned off to the highest bidder. That establishes a baseline price, which is crucial for stimulating future sales. But the Fed wants to conceal the true value of these securities because there are nearly $3 trillion of them held by banks and other financial institutions.

If they were priced at their current market value ($.21 on the dollar) then many of the country’s biggest banks would have to declare bankruptcy. So the Fed is trying to maintain the illusion of solvency by overpaying for these securities and providing the financing companies more capital to loan to businesses and consumers. Once again, the Fed is stretching its balance sheet by trying to resuscitate a structured finance system which has already proved to be dysfunctional.

Bernanke would be better off letting the market decide what these debt-instruments are really worth. There are always buyers if the price is right. Just look at what happened in Southern California last month, where there was a shocking turnaround in the housing market. Home sales in Orange Country shot up 55 percent year over year in October. That’s because prices have dropped 36 percent from their peak in 2007. This proves that real estate—like complex securities–will recover when investors feel that prices are fair.

Does Bernanke really believe that his maneuvering will change the direction of the market or convince investors to pay full-price for dodgy securities?

Who knows; but we do know that the Fed has no mandate to prop up asset values which the market has already decided are worth considerably less. It’s the equivalent of price fixing.

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