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More Mention of Intervention

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Tinkering Fed expected to buy mortgages, support dollar.

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Calls for a bottom in equity markets after repeated action by the Federal Reserve and Department of The Treasury have reinforced a reliance on the Bernanke put. Continually supporting the market leaves the Fed little room for disappointment.

Moral hazard has been shelved, at least for the moment, and investors are expecting two more pieces of government intervention to shore up capital markets.

First, speculation the Fed will start buying mortgages grew more intense this weekend, as the Financial Times reported central bankers are in talks to buy home loans from troubled banks. The Fed, for its part, denied the report.

It's unclear what will prevent further erosion of the mortgage assets piling up on banks' balance sheets. Home prices continue to fall and delinquencies continue to rise despite official denial of a recession. The Fed claimed last summer it wouldn't step in to support credit markets, as noted by Professor Sedacca, yet here we are several hundred billion dollars later.

The second form of intervention gaining favor among Wall Street analysts is direct central bank action to support the sagging dollar. Every dollar the Fed pumps into the financial system devalues those already in wallets and bank accounts. Earlier this month the greenback went into literal free-fall as the Fed announced back-to-back liquidity injections.

U.S. currency is at its weakest level since 1971. According to Bloomberg, analysts are now calling for the first coordinated currency intervention to support the dollar in 13 years. Although multinationals like McDonalds (MCD) and General Electric (GE) have benefited from cheap exports and strong overseas profits, American consumers are seeing their purchasing power erode alongside the dollar's worth.

A strong dollar makes for voter-friendly headlines and good rhetoric in Washington, but in the vein of asset class inflation versus dollar devaluation -- a theme often discussed in the 'Ville -- a dollar rally would hurt equity markets by dragging down commodities and other asset classes. Energy, mining and agricultural stocks have held the stock market together throughout the credit crisis and with debt problems yet unresolved, equity markets are likely to move in the opposite direction as the greenback.

In printing money to save the financial system from collapse, the Fed risks hyperinflation and total debasement of the currency.

Further dollar declines could set off massive sales of foreign-held U.S. Treasuries, pushing up interest rates right into the teeth of a recession. There are no easy answers, and central bankers continue to walk a very fine line.
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