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A Bear Stearns Market

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By James Grant
Sunday, March 16, 2008

Panic is old hat on Wall Street. Rarely before, however, has there been a crisis so comprehensive as this one. It first materialized last summer in the shape of a disturbance in the low-rated, or subprime, mortgage market. "Contained," the regulatory establishment hopefully pronounced. But it has blazed across markets and time zones, with central bankers, politicians and Treasury functionaries in hot and, to date, futile pursuit.

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What makes these proceedings so frightening is that not only is credit in crisis but so, too, is money. There are well-founded doubts about the promises to pay money and about the nature and integrity of the dollar itself. So it was on Friday that the Federal Reserve committed to lend undisclosed billions to bail out Bear Stearns, a top Wall Street purveyor of mortgage-backed securities and a leading lender to hedge funds. Where will the Fed find these dollars? Where it always, ultimately, does. It will have to print them, despite abundant evidence from the currency and gold markets that the world has just about all the dollar bills it cares to hold.

By the looks of things, America's surfeited creditors must make room for many billions more. The markets are in "uncharted waters," Robert Rubin, chairman of the Citigroup Executive Committee, said in a speech Friday. He urged the government to exert itself on behalf of the mortgage market and the American homeowner.

And who are these bankers who went sailing off the end of the Earth and thereby find it necessary to pass the cup to the government? The company of errant, if lavishly compensated, navigators includes none other than Rubin himself. Last fall, the former Treasury secretary confessed to Fortune magazine that until the mortgage storms broke over his head in the summer of 2007, he was unfamiliar with the kinds of complex mortgage structures with which Citi's own balance sheet was packed. Almost certainly, the gulf between competence and compensation on Wall Street has never been wider.

These lapses in mortgage underwriting are justly called "the biggest failure of ratings and risk management ever." But mortgages are far from the only blighted department of credit. The same carefree lending standards that led to record-high home foreclosures have brought deepening troubles in the market for loans to highly indebted companies. The "no-doc," interest-only, no-money-down mortgage turns out to have been a kind of universal American business model.

It wouldn't be so bad if the United States were not the issuer of the world's reserve currency. The dollar is not only America's scrip but also a store of value and a medium of exchange in Asia, South America and the Middle East. Yet -- and here is the rub -- the Federal Reserve makes monetary policy for one country only.

Back in 2002-03, Ben S. Bernanke, then a Fed governor serving under Alan Greenspan, got it into his head to scotch "deflation." Low, and lower, everyday prices were a clear and present danger, he claimed. Concurring, Greenspan led a campaign to reinstitute a decent rate of inflation by slashing the federal funds rate to 1 percent. Wall Street did not need to be told twice what glorious vistas for moneymaking such rock-bottom borrowing costs opened up, and it set to work creating junk bonds, mortgage-backed securities, leveraged bank loans and the rest. Naturally, real estate prices took flight.

Lenders and borrowers are forever prone to overdo it, then to underdo it. One day, anybody can get a loan. Next thing you know, the chairman of Countrywide Financial is explaining himself before a hostile congressional committee and the formerly carefree credit markets are in tears. The tears are all the more bitter today because the world is losing faith in the paper dollar.

Americans enjoy the inestimable privilege of consuming much more than they produce and financing the difference with the currency they alone can lawfully print. The reports about the record-high euro or the post-1995-high yen mean that we privileged ones will soon have to start spending less and working more.

The crux of the problem is that the Fed sets its interest rate for this economy and none other. Inflation is rampant in the countries that lash their currencies to ours. The last thing that China or Saudi Arabia or Qatar needs is a still easier, more inflationary, monetary policy. But the Fed -- its eye not on the worldwide inflation rate but on the Bear Stearns share price -- is about to turn still easier. It's a pickle for the ages but not one without its compensations. For one thing, the falling prices on Wall Street are at last beginning to restore a semblance of value to stocks and bonds. For another, the plunging dollar may prompt a serious reexamination of worldwide monetary arrangements. There must be a better way.

James Grant, the author of "Money of the Mind," is editor of Grant's Interest Rate Observer.


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