Some argue that the European Central Bank (ECB), Federal Reserve Bank (Fed), and The Bank of England (BoE) are confronting the credit issues proactively and addressing them in an expedient fashion. Others hold that the central banks are encouraging the moral hazards that are currently gripping the markets.
Given recent central bank interventions, I am convinced that they are making the problem worse and creating opportunities for the wrong people. Instead of waiting to see how the market will correct itself, a state of panic has created commitments to fundamental departures from fundamental purposes, that is, maintain interest rates over containing inflation.
BoE Governor Mervyn King's U-turn decision to bail out Northern Rock provides valuable insight to this issue. Three days prior to unloading £10 billion of UK taxpayer money, Mr. King was a staunch opponent to market intervention. Rumor has it that he was influenced by Prime Minister Gordon Brown to provide the market with relief. Whether Mr. King was influenced politically or not, he did not stick to his guns and relieved the market. With that said, we have to ask to what consequences did his actions cause?
The answer is clear that Mr. King setup the taxpayers to lose their money. Those who ran on Northern Rock had the right idea - get in, get my deposit and get the "bloody hell" out. Northern Rock had no right to co-mingle depositors' funds with its subprime operations. That is flat out wrong. The taxpayers lose because they assumed Northern Rock's losses. With Northern Rock the subject of a potential buyout by Chris Flowers of JC Flowers, we can all expect two things: (i) the purchase price will be deeply discounted; and (ii) Northern Rock's portfolios will be liquidated in a fashion similar to St Joe's, Florida's largest private land owner. Mr. Flowers is going to do exactly what I cautioned everyone about in August, that is, the buying of valuable assets at undervalued prices.
This is good for Mr. Flowers (kudos to him), but bad for the taxpayers because how do they get their money back? My gut says that they don't. Similar situations have occurred in Germany and the US but attention has shifted to capitalists urging government to respond by priming the pumps - another fundamental departure from fundamental purpose. The ECB, Fed and BoE should guard against these intrusions by letting the system correct itself. Instead, they have come to rescue the villain and not the victim. Language such as "we must focus on growth" or "maintain interest rates" is a sham. The central banks of the world have adopted a "hot potato" policy to keep the markets propped up. The mentality of passing our credit problems along to the next bloke is dead wrong.
It is more than reasonable to expect continued intervention at this point in time. The unfortunate result will be more leverage for an already over-leveraged problem. We will see banks team up with buy out groups or hedge funds to create new vehicles to purchase certain loans at a deep discounts. For example, Citibank is in talks with Kohlberg Kravis Roberts (KKR) about receiving funding for the purchase of some of the leveraged loans on its balance sheet. These types of moves will permit banks to shift loans off its balance sheet, take a write-off for the loss while maintaining ownership of the loan portfolio. This is problematic because it gives rise to balance sheets of false appearances, again. On one hand the public will see a liquid and solvent portfolio but not see the risk involved in off-balance sheet activities. Banks aren't really offloading their troubled assets. They are disguising the fact and creating opportunities for those who know better, e.g. Mr. Flowers and KKR (whom is raising funds in an existing hedge fund to purchase leveraged loans and other impaired debt). As such, we can conclude that the more the central banks "maintain interest rates" or "focus on growth," the worse they make the market's credit problems.
Solution: Don't believe the hype - focus on the constants and comprehend the fine print.