Central Bankers Holding Back the Flood Waters

In response to my article Bank Earnings Reveal This Emperor Has No Clothes, Minyan Stephen Sherman offered, “The tide never goes out in this country, the government won’t let it.” And ever since I have to admit that I have not been able to get the image of Ben Bernanke in the role of Moses in the Ten Commandments holding back the Red Sea.

But in thinking about Minyan Sherman’s comment further, I have to admit there is more than a little truth to it, at least so far.

Among the many quotes I have collected from this crisis, one in particular stands out. In May of last year, following the rescue of Bear Stearns, now NY Federal Reserve President Bill Dudley offered:
 

“In essence, the Federal Reserve’s willingness to provide liquidity against less liquid collateral allows the re-intermediation and deleveraging process to proceed in an orderly way, which reduces the damage to weaker counterparties and funding structures. One can think of the Federal Reserve’s actions as smoothing and extending the adjustment process – not preventing it – so that the adjustment causes less damage to the financial system and less pernicious macroeconomic consequences.”

Clearly behind Mr. Dudley’s comment are lessons from the past: the psychological damage done by an orderly market decline is far less than the chaos created from a panic.

With Mr. Dudley’s comment in mind, I went back this week and looked at the equity market since the summer of 2007, and, low and behold, I found that every major bounce the market has seen has been a function of some kind of government intervention:
 

• August 2007 – The Federal Reserve lowered the discount rate, extended discount window borrowing terms from overnight out to thirty days and broadened the range of acceptable collateral.
  
  
• March 2008 – The Federal Reserve facilitated the purchase of Bear Stearns by JPMorgan (JPM) by purchasing billions in toxic assets.
  
  
• July 2008 – The US Treasury announced that the US Government would unambiguously support Freddie Mac (FRE) and Fannie Mae (FNM).
  
  
• November 2008 – In addition to the TARP program, the Government “insured” over $300 billion in troubled real estate assets from Citigroup (C).
  
  
• March 2009 – Congress announced its intention to mandate the suspension of key elements of mark-to-market accounting.

Five major “turning points”; each one a function of the Government. See them also in the chart below.

                                    
Click to enlarge