The Next Unsustainable Asset Bubble

To some extent, Federal Reserve Chairman Ben Bernanke inherited a tough hand from predecessor Alan Greenspan. In the wake of the Nasdaq implosion and the September 11 attacks, Greenspan turned on the cheap money taps to soothe the markets. Cheap money contributed to increased mortgage lending (often at lax standards) and escalating housing prices -- the real estate and subprime bubble that's currently bursting.

Unfortunately, however, Bernanke's fix for this current crisis seems to be more of the same bad medicine -- cheap money and lax standards. On top of

• panicked rate cuts,
• bailing out failing institutions, and
• guaranteeing multibillion-dollar private loan packages,

the Bernanke Fed recently announced that it has gotten into the financial equivalent of the business of handing out crack cocaine to addicts. The new Primary Dealer Credit Facility opens the Fed window to securities dealers like Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), and Lehman Brothers (NYSE: LEH).

Out of the frying pan, into the fire
So let's get this straight: Bear Stearns nearly goes belly up because it overleveraged with cheap money. And the way to prevent other leveraged financial institutions from suffering the same fate is to offer them cheap, federally backed money?

At least we know why so many banks and financial stocks were up so strongly the week of March 17 when that window first opened. They had just gotten their hands on a virtually unlimited supply of cheap money from a benefactor that is more concerned with limiting short-term fallout than finding real fixes for the bad practices in a flawed financial sector.

That abrupt change in Fed policy, more than anything else, explains why these banks and investment houses suddenly rose out of their doldrums:

Yeah -- we've all heard how bad it is in the financial sector. That still doesn't make it a good idea to throw more cash at companies and hope that this time they'll be responsible enough to handle it.

Blowing bubbles
There is absolutely no way this will end well. The Central Bank's rates are far below what any sane private lender would require. As a result, these companies may get addicted to the Fed's funding and thus be unable to go it alone again. As a result, this "temporary emergency measure" could easily become a "standard part of doing business," with taxpayers shouldering the costs of failure.

In other words, these quick fixes are both delaying the inevitable and risking public money.

Stop the madness
We don't know exactly when that next bubble will fully inflate or when it will collapse. As long as the first response to any financial stress is a quick infusion of cheap money, the formation of the next bubble is a virtual certainty.

The recession that the Federal Reserve is trying to prevent may be painful to live through. Unfortunately, the other alternatives at this point appear to be either a largely worthless currency or a Japan-style decade of economic stagnation. With options like that, the short-term dislocations from a recession don't seem nearly as bad, especially given the welcome benefits that come in their wake.

Pick your poison. We're at a critical crossroads, and history has shown that too much cheap money can quickly become very expensive.