Kass: Fed Is No Savior in Subprime Slide

Even if the Fed tried to help out, it might be shooting blanks.
Author:
Publish date:

This column by Doug Kass was originally published on March 15 at 8:17 a.m. EDT on Street Insight. It's being republished as a bonus for TheStreet.com and RealMoney.com readers. For more information about subscribing to Street Insight, please click here .

Bullish observers have increasingly been making the case that the growing fungus of subprime credit problems will force the

Federal Reserve

into a loosening of monetary conditions sooner rather than later.

These days, the private-equity put doesn't seem to be working, so it appears that the struggling bulls now must hold on to the notion of a Bernanke put to counter the currently troubling and tenuous stock market conditions.

After all, lower interest rates

always

reverse investor sentiment and adverse financial conditions, right?

My view is that with the level of inflation remaining stubbornly high, coming to the aid of a bunch of reckless and overly aggressive mortgage bankers is not necessarily seen by Chairman Ben Bernanke & Co. as an immediate responsibility of the Federal Reserve.

They might deem it too early in the crisis, or think there is no crisis at all.

In fact, consider the cheerleading of Treasury Secretary Henry Paulson in Tokyo last week and remarks made recently by Federal Reserve Governor Susan Bies, both of whom have downplayed the subprime problems:

"Credit issues are there, but they are contained. I don't think it (subprime) has, at this point, implications for the aggregate economy in terms of the ongoing expansion."
-- U.S. Treasury Secretary Henry Paulson"Based on some recent observations, mortgage lending certainly is an area in which we believe financial institutions and supervisors have learned some key lessons about risk management."
-- Federal Reserve Governor Susan Schmidt Bies

Also, consider this quote from another Fed official on what he sees as the Fed's true role.

Ultimately, though, ex ante judgments about leverage, concentrations and liquidity risk will continue to prove elusive. Our principal focus should therefore be not in the search for the capacity to preemptively diffuse conditions of excess leverage or liquidity, but in improving the capacity of the core of the financial system to withstand shocks and on mitigating the impact of those shocks. And, as always, central banks need to stand prepared to make appropriate monetary policy adjustments if changes in financial conditions would otherwise threaten the achievement of the goals of price stability and sustainable economic growth. - Timothy Geithner, president of the New York Federal Reserve Bank, Feb. 28, 2007.

Now even if the Federal Reserve did lower interest rates in March or April, the markets could interpret the move more negatively than the bulls realize by calling attention to the magnitude of the mortgage crisis and by fueling inflationary fears, serving to pull the capital markets into a tailspin.

As we move into the summer or fall (at the latest), there will be better visibility of the subprime problems. By that time, it will be abundantly clear to even the bulls that an inventory-swollen housing market is back on the sick bed as the two most important marginal buyers -- the first time and trade-up buyers -- have lost access to home-financing. And, by then, the multiplier effect of the housing downturn should be in full force, causing the economy to sputter and for corporate profit expectations to fall to more realistic levels.

The upheaval in the subprime mortgage industry is in its middle stages, but the broad impact on the U.S. economy is in its infancy. To paraphrase,

Frankenstein's

Dr. Waldman

, the

credit markets and Wall Street have created a monster

-- subprime -- and it will destroy the economy.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."

Kass appreciates your feedback;

click here

to send him an email.