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Fed's Folly: Fooled by Flawed Futures?

Was it a misunderstanding of their mandate, inexperience, or just plain hubris?

Regardless, it took only 2 days to learn just how ill-considered the Fed's emergency market rescue plan was: To wit, a fraudulent series of losses led to a major European bank unwinding a huge trade:  Societe Generale Reports EU4.9 Billion Trading Loss.

SG's $7.1Billion dollar unwinding led to panicked futures selling on Monday and Tuesday.

Hence, we quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices. Their panicky rate cute were not to insure the smooth functioning of the markets, but rather, to guarantee prices.

As we have been saying for the past two days, this is not the Fed's charge. They are supposed to be maintaining price stability (fighting inflation) and maximizing employment (supporting growth) -- NOT guaranteeing stock prices.

I guess the European Central Bank has it easier: Their only charge is to fight inflation: "maintain price stability, safeguarding the value of the euro."

Tuesday's panicked 75 basis cut will prove to be an historical embarrassment, a blot on the Fed for all its days. Failing to understand what their responsibilities are is bad enough; allowing themselves to be bossed around by Futures traders is inexcusable.

And, having been rewarded for their past tantrums, the market will now be screaming for another 75 bps next week. As Rick Santelli appropriately observed, the Pavlonian training is now complete.

~~~

Too bad we didn't know this during yesterday's Fed debate . . .

Fed to the Rescue (11:20am )

~~~
One last point: I still think the Bernanke Fed inherited this mess from Greenspan, and are boxed in trying to resolve it...

>

Sources:

Societe Generale Reports EU4.9 Billion Trading Loss
Gregory Viscusi
Bloomberg, Jan. 24 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=a8GBEB7UuuXc&

Societe Generale Hit By Fraud, Write-Downs
NICOLAS PARASIE
WSJ, January 24, 2008 9:40 a.m.
http://online.wsj.com/article/SB120115814649013033.html

Related:

Equity Derivatives House of the Year - Société Générale   
RISK, January 2008 | Volume21/No1   
http://www.risk.net/public/showPage.html?page=685494

Juicing the economy will come at a cost
Jeanne Sahadi
CNNMoney.com, January 23 2008: 4:51 PM EST
http://money.cnn.com/2008/01/23/news/economy/cost_of_stimulus/?postversion=2008012316

Thursday, January 24, 2008 | 10:15 AM | Permalink | Comments (106) | TrackBack (2)
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Comments

SocGen told Bank of France. So the ECB knew and so did the Fed, in all probability. They went ahead anyway. What a bunch of sellouts. This is not the way monetary policy is supposed to be run. If they cut next week as well, it will confirm that we are a Zimbabwe style monetary policy regime.

Posted by: zao | Jan 24, 2008 10:23:39 AM

There is only one class of people being protected by our "Government of The People". While we are all taught that there is safety in numbers, we are never taught about the danger in those same numbers. The powers that be should be reading French history.

Posted by: Marcus Aurelius | Jan 24, 2008 10:25:39 AM

I will freely expose my ignorance by asking these questions for possible response from those more knowledgeable than I:

If the stock market is a leading economic indicator, is it not responsible for the Fed to seriously consider its apparent "warning" signs?

Is speculation so rampant that the stock market is no longer (or never was) a valuable economic indicator?

I tend to agree with BR's sentiment with regard to the disappointing moves by the Fed. It is certainly easier to gain "control" of things by letting them go their own way...

Thanks for any insight offered by comments...

Posted by: The Financial Philosopher | Jan 24, 2008 10:30:53 AM

Barry.

i disagree with you on this.

what if we would have had a stock market crash leading to corrections of 15%.

what if that would have led to meltdown in stock market all over the world.

i think FED did the right thing by removing panic, i would take inflation any day compared to being without job and in depression.

FED needs to let the market correct in a orderly fashion, which has been happening since the last 4-5 months, and will continue to happen. but they should make sure that we dont get a crash, which leads to consumers gettting spooked up, and almost a run on banks, putting the whole financial system in jeopardy.

yes whatever is happening in stock/financial market is total hogwash....its a shame on free market.

but we cant let 15-20 years of stuff to unwind in a week, and i am hoping FED plays smart and does only 25 pt rate cut next week.

Posted by: techy2468 | Jan 24, 2008 10:33:36 AM

I guess it all evened out then. The fraud took down the markets, the Fed leveled them off, then the monoline rescue chat brought the markets back to where they started! LOL. This is seriously hilarious.

Posted by: dukeb | Jan 24, 2008 10:34:15 AM

Barry the Fed had to do it. The market was almost certain to crash. All the baby boomer's retirement money would have went up in smoke and it almost certainly would have caused depression.

Posted by: John Borchers | Jan 24, 2008 10:35:55 AM

i would like to add that FED should have led the markets correct upto 6-7% before announcing the rate cut.

it was quite possible bleeding may have stopped at 6-7%, which would have saved the 75 pt rate cut for future.

now the market expects another 75 pt next week, i guess right now it sounds like a good time to put straddle-option play. stocks will either go up 10% or go down 15%.

Posted by: techy2468 | Jan 24, 2008 10:38:27 AM

that is quite a jump to concluded that the SoGen "rouge" trader is responsible for Monday's meltdown or you just want to make the fed look bad, they are doing a fine job by themselves.

Posted by: Sami | Jan 24, 2008 10:39:49 AM

"i would take inflation any day compared to being without job and in depression."

Let's talk again when inflation is 15% and see how you feel. Inflation only rewards those who are in debt. If you are smart and you've save, a recession doesn't hurt too much b/c you've got savings to hold you over. Inflation on the other hand, you can have a job and you can still end up living in a dumpster.

Inflation . . . the most insidious tax.

Posted by: Shane | Jan 24, 2008 10:40:23 AM

The futures are a joke in the first place. only in our market can you have the entire world selling off and our futures are up. Doesn't say much for the validity of using it as an excuse when the administration's is actively engaged in propping up said futures markets almost every night.

I am convinced that a nuclear bomb could go off (anywhere in the world) and our futures market would be up. Having said that you must be aware that if they can buy them up and present a rosy picture with just about any piece of news you can be assured that they can sell them off just as easily. I am positive that is what happened on Mon-Tues.

But creating it as a cause and effect make sit sound easier to digest......just like those rogue traders...

Ciao
MS

Posted by: michael schumacher | Jan 24, 2008 10:43:59 AM

AND the market is still expecting at least 50 bps next week???? So does this mean, the Fed, feeling duped, will say "Mr. market screw you" and give 25 bps or perhaps even nil... we'll see, but given what you wrote, there's more than a decent chance.

Posted by: Stuart | Jan 24, 2008 10:44:47 AM

Right you are, Barry. But why is there no mention of the fact that the Fed gov's are fully invested in the stock market. If that doesn't color their thinking, I don't know what else would. Are other world bankers allowed to be fully invested? I find it hard to believe, but I just don't know. I am not accusing them of deliberately manipulating their own portfolios, but they must certainly be subconsciously predisposed toward aiding themselves.

Any thoughts?

Posted by: fenner | Jan 24, 2008 10:46:31 AM

As someone said above, America is the next Zimbabwe. Hyper-inlfation is coming within 5 years. Buy gold, while you still can. But be prepared for when the government begins seizing all gold, which it will have to do when the dollar hits zero. I am truly ashamed to be an American.

Posted by: JTR | Jan 24, 2008 10:49:40 AM

I'll be giving out more candy next week.

You guys are so overthinking this. You are underestimating the stupidity of people...and the psychology of manipulation.

Posted by: Helicopter Ben | Jan 24, 2008 10:51:12 AM

If we are realists (rather than members of the bull or bear dogmatic religions), then we need to accept that the Fed is a put on the investment community. It matters not what their job description is in the public arena -- aren't we all believers in the maxim "actions speak louder than words"?

One of the underlying presuppositions that seems to cause faulty expectations is that the US exhibits either a free market system or is aspiring to do so. As a student of history, I do not believe either are true. The wealthy will always protect one another, and they will manipulate the system to maintain the orderly structure that has benefited them in the past. With all do respect, anyone who does not believe such behavior will continue is a bit naive (or waiting for a messiah).

The power elite will never support a true free market system because in practice it means chaos or at least letting go of the yoke they so tightly grasp. "Free market" is nothing more than the catch phrase of the day. Anyone who knows economic reality knows that all markets are manipulated by laws and power (including money). Kudlow is a perfect example of why "free market" is nothing more than double speak for "fiscal and legislative aid for investor capitalists."

Also note that although the Fed is bailing out speculators, they are ALSO providing a put for all the boomers who are currently or in the near future set to retire (or supplement income) on the worth of their two major assets: house AND EQUITIES. The value of equities play a very real role in consumer sentiment and per capita wealth. Thus, with all due respect, I think focusing on the Fed's effect on speculators over simplifies the issue.

Bottom line as a realist: the Fed cut rates and will continue to cut rates with no concern for "moral hazard." What do these objective facts mean for the market and the economy? The rest is philosophy and the religious faiths of capitalist existentialists ...

Posted by: D.H. | Jan 24, 2008 10:58:29 AM

Hi Barry, From the talking heads on CNBC to the president we have been told the stock market is the economy. President Bush and the congress need to be the first participants in our national effort on financial literacy. Stop spending, reduce the deficit, and strengthen the dollar.

Posted by: David Price | Jan 24, 2008 11:02:20 AM

Watching that video again today in light of the news out of SocGen, Liesman is even more of a joke. Criticizing you and Santelli for believing in a system of free markets? It's almost darkly hilarious.

Posted by: Florida | Jan 24, 2008 11:02:56 AM

Hate to reveal my old codger status but I was hired as a 'customer's man" when the wire houses were gearing up to handle 20 million share days on the NYSE.

From my perspective, the markets have become casinos. As we all know, it is good to be the house. If you are a serious investor, buy something denominated in Swiss Franks and wait for the Euro to come apart. Germans don't take kindly to using their good credit to bail out Spanish real estate speculators. Precious metals complex is ok also when inflation gets out of control, which it will. Foodsfuffs are a good place to hide when protectionism of food supplies becomes a national mandate.

I don't care what the Fed does. I have lived long enough to know the outcome and prepare accordingly.

My $2 worth...

Posted by: Ross | Jan 24, 2008 11:05:14 AM

BR wrote: "Their panicky rate cute were not too insure the smooth functioning of the markets, but rather, to guarantee prices"

BR, why do you see these as so different?

Is there a significant difference between "insure the smooth functioning of the markets" and "guarantee prices" in the market?

Posted by: winehouse fan | Jan 24, 2008 11:06:43 AM

next week rate cut depends on what else economic data we get.

if the data is a bit rosy, there may be just 25 pt rate cut or nil.

if data is bad 50 pt or even 75 pt, administration does not care about future inflation, only the next 12 months.

both ways it is good for equities.

but i guess after next week, it may be a good time to enter short positions, specially if market goes up wildly if ther is a 50-75 pt rate cut.

Posted by: techy2468 | Jan 24, 2008 11:10:18 AM

Don't worry shorts - the consumer is dead! Who can buy without money? The FED can cut all they want to, it isn't going to help.

Posted by: Justin | Jan 24, 2008 11:14:47 AM

Shane..

you keep forgetting that america is a nation of debtors....and as always majority rules in a democracy.

sorry dude, but i still prefer inflation, which can be controlled later, rather than go without job for 12-24 months, it will be too depressing.

inflation is the only way out of this mess, please do not go to the extreme chanting of "zimbabwe hyper-inflation", this is USA not zimbabwe.

if we can inflate, raise wages, debt will shrink.....but how to do it in a orderly fashion is the big issue.

if we deflate dollar, our debt holders who benefitted so far (china, india etc) will pay the price for keeping america as their markets.

in other words we will be sharing the pain, just as we have shared the prosperity because of our consumption supported by debt.

Posted by: techy2468 | Jan 24, 2008 11:15:39 AM

The fault is chronic overspending by congress...we need a balanced budget amendment....20 years ago..

Posted by: Bruce | Jan 24, 2008 11:18:22 AM

The great Physician's Rate Cut

(from Part 3, Chapter 5 of Gulliver's Travels, visit to Balnibarbi)

I was complaining of a small fit of the Cholick; upon which my Conductor led me into a Room, where a great Physician resided, who was famous for curing that Disease by contrary Operations from the same Instrument. He had a large Pair of Bellows with a long slender Muzzle of Ivory. This he conveyed eight Inches up the Anus, and drawing in the Wind, he affirmed he could make the Guts as lank as a dried Bladder. But when the Disease was more stubborn and violent, he let in the Muzzle while the Bellows were full of Wind, which he discharged into the Body of the Patient, then withdrew the Instrument to replenish it, clapping his Thumb strongly against the Orifice of the Fundament; and this being repeated three or four Times, the adventitious Wind would rush out, bringing the noxious along with it (like Water put into a Pump), and the Patient recover. I saw him try both Experiments upon a Dog, but could not discern any Effect from the former. After the latter, the Animal was ready to burst, and made so violent a Discharge, as was very offensive to me and my Companions. The Dog died on the Spot, and we left the Doctor endeavouring to recover him by the same Operation.

Posted by: John | Jan 24, 2008 11:19:23 AM

C'mon Barry -- here's your logic: "The Fed's move is bad bad bad! Look at this SoGen trader!"

Really, you need to think better.

One rogue trader. Now if there's are hundred rogue traders...

Look, the Fed made its move in accordance with its mission -- STABILITY. We were headed to a credit market meltdown. We can't have that, despite the desire of the shorts to make huge killings quick.

Let's wring out the excesses methodically, calmly.

Posted by: Karl K | Jan 24, 2008 11:22:26 AM

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