The Destroyer of Fake “Recoveries”: Unintended Consequences

Destroy the market’s ability to price assets, risk and credit, and you take away the essential information participants need to make rational, informed decisions.

A correspondent recently summarized why unintended consequences eventually destroy all politically expedient strategies that temporarily prop up a systemically unsustainable Status Quo:

“Unintended consequences almost always equal or exceed the benefits of whatever your temporary gains were in a complex system. We see this over and over again, in all sorts of different complex systems.”

In other words, all the “kick the can down the road” strategies being deployed across the globe by central states and banks will inevitably backfire because central planning fixes always trigger systemic consequences that were unintended by the planners, who are fixated on minimizing the political pain of powerful constituencies, not understanding or repairing the real problems.

Example #1: The Federal Reserve “saves the Status Quo” by lowering interest rates to zero, eliminating mark-to-market valuations of collateral and opening the credit spigot to banks and financiers.

Intended consequences: A) transfer wealth from savers who once earned substantial interest on their savings to the banks, which can borrow money for near-zero and loan it out to businesses and consumers at fat spreads, reaping billions of dollars that once flowed to savers.

B) By making cash into trash (i.e. it earns no interest, effectively losing value in a 2% inflation environment), the Fed intended to push everyone with cash and/or credit to put their money in risk assets such as stocks and real estate.

Unintended consequences: A) Now that everyone has been pushed into stocks and real estate, valuations are once again at bubble heights–and bubbles always pop, destroying every participant who has been lulled into believing this bubble will never pop because “the Fed has my back.”

B) By allowing mark-to-fantasy valuations of collateral, the Fed hasn’t cleared the credit system of impaired debt: it has enabled an expansion of bad debt and eroded the fundamental credibility of the system.

C) By enabling the wealthiest slice of America to borrow essentially limitless sums for free, the Fed has fueled wealth disparity, as the super-wealthy can buy rentier assets for nearly free with Fed-created credit, outbidding everyone in the 99.5%.

D) In becoming the buyer of last resort for Treasury bonds and home mortgages, the Fed has destabilized the bond and mortgage markets and undermined the U.S. dollar. As a result, the Fed has to taper its buying lest it end up owning the entire short-term Treasury market.

E) By buying $2 trillion in mortgage-backed securities, the Fed (in conjunction with Fannie Mae, Freddy Mac and the Federal housing agencies such as FHA) has essentially socialized the mortgage market in the U.S.– virtually all home mortgages are now backed or issued by the government. less than 5% of all mortgages are privately issued and not guaranteed or owned by the government.

Destroy the market’s ability to price assets, risk and credit, and you take away the essential information participants need to make rational, informed decisions. By crushing the market’s ability to generate accurate pricing information to save the Status Quo from necessary repricing and reforms, the Fed and the Federal government have generated enormously destructive unintended consequences that will not respond to additional politically expedient fixes.

All the other central planning fixes around the world share the same fatal flaw.


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