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Tuesday, July 17, 2012

The Weasel and the Fox

Suppose we sent the fox to investigate the weasel digging a hole under the fence to the chicken coop.  It's probably pretty clear to most people that the fox would be hard put to understand the problem and condemn the action.

Substitute the NY Fed (including former NY Fed president Geithner) for the fox, Barclays et al. for the weasel, and the Libor rate for the hen house, and you've got the gist of the Libor rate-fixing scandal and the failure of many to grasp the need to respond to the manipulation.

Here's the news:  the Federal Reserve manipulates the rate at which banks lend reserves in the U.S.  The target rate is determined by the Federal Open Market Committee, chaired by Bernanke, and detailed instructions are forwarded to the trading desk at the New York Fed. The New York Fed then buys and sells securities in the open market to manipulate the rate at the target level.  Push this rate to 1%, like they did in 2003, and you get a parabolic rise in house prices and all kinds of exotic mortgages offering low adjustable rate teaser rates, no doc loans, etc., coming out of the wood work.

The only difference here is that private banks have encroached on what central banks do on an ongoing basis.

This, of course, is likely to keep the Wall Street lawyer community pretty busy- as if they needed further work.  Hopefully it will also focus more attention on how central bank rate manipulation distorts resource allocation as well.

Bernanke starts his two-day Congressional testimony today.  Hopefully some senator will inquire as to when the Fed will start doing its job.

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