WSJ Blog: Hakin Has it Right!

Posted by urbandigs

Wed Oct 31st, 2007 08:32 AM

A: On Monday I posted one of my more emotional posts in a long time titled, "To Mr. Bernanke: BE STRONG", with the clear message to NOT CUT RATES and to BRING ON THE RECESSION! With stocks near record highs, oil just off record highs, commodities surging, and the dollar at record lows, aggressive fed rate cuts is the last thing we need! The problem lies in housing and the credit markets. Housing woes were brought on by ultra stimulative fed policy and ultra cheap money, while credit woes were brought on by bad bets / loans by lenders and the securitization of these loans into mortgage backed securities that went sour as the secondary mortgage markets seized up. Fed rate cuts is not the answer; a recession is the better option to flush out the bad bets, let housing work itself out without encouraging more bad bets by cheaper money, and let everyone learn their lessons so we can move on.

Yesterday, the WSJ Blog Real Time Economics had a post discussing, "Recession the Best Way To Deflate The Housing Bubble", deriving the idea from the American Enterprise Institute's John Makin. I think its spot on and is exactly what I talked about on Tuesday:

The American Enterprise Institute’s John H. Makin says that a recession "is the most desirable outcome" for deflating the U.S. housing bubble. "Avoiding it would involve so much government intervention and so much reinflation by the Fed that risk-taking would be encouraged even further, resulting in an even larger bubble and a larger subsequent recession..."

"I am suggesting here that the cost of avoiding recession after the biggest housing bubble in American history has burst is too high. It will involve rewards to those who took excessive risks that will only result in more underpricing of risk in the future, and therefore larger bubbles and, ultimately, a more unstable economy that underperforms expectations…"

"At the end of the day, the problem facing the U.S. economy - a collapse of a housing bubble with attendant damage to overall growth - is acute but not chronic. The way to avoid a recession - having the Fed print money and push house prices back up - is not a viable option. "
SPOT ON Mr. Makin! Spot on!

In my post on Tuesday I displayed my version of agreement with John Makin, and asked why we fear recessions so much. I got a bit emotional calling on Big Ben Bernanke to reach deep within himself, find his cahones, stand up to wall street, and take no action at all later today! Cut the discount window if you want to pump more liquidity into the system, but leave the fed funds rate alone.

WHY ARE WE SO SCARED OF A RECESSION! What has become of us! Why must we bail out those that made the bad bets? As I said on Tuesday:
We have become a society that fears recessions rather than understand them for what they are; healthy and normal disruptions in economic growth necessary to ensure longer term sustainable growth. We need to shake out the bad bets and weak players, let the markets fix themselves, and move on with the lesson learned.
The problems out there lie in:

a) credit markets
b) housing markets
c) threat to consumer spending
d) threat to economic growth

...all of which may combine to put us into a recession. Possible a harsh one. So what! We'll get through it. What we need is to be more forward thinking and consider just for a moment the problems that may arise if the fed continues this easing policy! Oil at $120/barrel? The US dollar continuing to fall? Re-inflation of asset classes? Failure to let the housing bubble correct itself by easing policy? Moral hazard issues of future risk taking? Volatile growth? Uncontrollable Inflation?


A recession will:

a) penalize those with bad asset holdings by not injecting more umph into our economic systems
b) allow housing PRICES to fall to correct inventories rather than RATES to fall to stimulate buyers
c) weed out the weak players who made problematic / risky bets
d) help to moderate commodities and energy prices without re-inflating them by easing policy
e) help prevent future buildup of pipeline inflation that easing policy creates

Recessions are normal disruptions in economic growth, necessary to penalize those that made problematic risky bets, to flush them out of the system so that we can continue on a path of longer term sustainable economic growth with the lessons learned! That is what the definition of a recession should be! There is nothing wrong with it, yet this new fed is hell bent on avoiding a recession at all costs; even if those costs put us in a worse situation down the road. There needs to be a stand, and tomorrow Ben Bernanke & Co. will have a choice.

Will they take the red pill and cut rates aggressively so that we don't enter a recession at the expense of bailing out those in need, the weakening US dollar, and a future buildup of inflation pressure?

Or, will they take the blue pill and stand strong, leave rates alone, announce that they are ready to act if things get real hairy, and support our currency and help prevent the buildup of future inflation pressure?

The choice is yours Ben. NO CUT!