A Buyer For 14th Amendment Bonds

There has been speculation that, if the federal debt ceiling isn't raised by August 2, 2011, the President might order the Treasury Department to issue more U.S. Treasury securities anyway, relying on supposed authority from the 14th Amendment to the Constitution. The President has said he won't do this. But if push comes to shove, and the ship is about to hit the iceberg, who knows? Desperate times call for desperate measures.

Legal talking heads have yammered busily about the correct interpretation of the 14th Amendment. Market talking heads have speculated that buyers would be hard to find because the uncertain legality of 14th Amendment debt would make it a pig in a poke that investors would shun.

The legality of such debt is open to vigorous debate. But in terms of finding buyers, that's easy. No sweat. There's a buyer out there who will snarf up all 14th Amendment debt, if necessary, and not worry a bit about its legality. That buyer would be the Federal Reserve.

Fed Chairman Ben Bernanke hasn't said a word publicly about the Fed buying 14th Amendment debt. The thought may not have even occurred to him. But if push comes to shove, and the Sword of Damocles is about to drop on the federal government, the Fed will undoubtedly ride to the rescue with regimental colors flying and Garry Owen playing. A central bank buying its government's debt is said to monetize that debt, a serious no no in the view of many economists because it could trigger inflation. But the Fed hasn't, in recent years, seen any inflation it didn't like. And with the economy slowing again, Chairman Bernanke may well be pondering how to slip a little more quantitative easing into the financial system. Buying up 14th Amendment debt may be the least controversial way to do it, since the Fed could claim it's monetizing debt for the sake of Old Glory.

The Fed need not send a check directly over to the Treasury for the 14th Amendment debt. That might be a tad indiscreet. Instead, it could quietly signal to its primary dealers that they wouldn't take any losses on the stuff. The dealers would likely do the patriotic thing and choke down these latter day Liberty Bonds even if they taste an awful lot like broccoli. The Fed could then buy the stuff up from primary dealers or accept it as collateral for their borrowings from the Fed.

What if the 14th Amendment bonds turn out to be unlawful? The Fed would surely protect its primary dealers and take the losses itself. The uncollectable bonds would simply relieve the Fed of the necessity of withdrawing some liquidity from its quantitative easing program. Nothing would make the Fed happier. Of course, the Fed would have a paper loss. But the loss would consist of money it printed, not real money from member banks or taxpayers. Easy come, easy go.

Maybe Not Bailing Out Lehman Was the Right Decision

Former Secretary of the Treasury Henry Paulson and the current Chairman of the Federal Reserve, Ben Bernanke, have been well-excoriated for their 2008 decision to let Lehman Brothers fail, rather than bailing it out like Fannie Mae, Freddie Mac and, subsequently, AIG. The charges leveled against them are to the effect that the financial markets expected a bailout, and Lehman's failure led to a massive credit lockup that turned a mild recession into the worst economic crisis since the times of Charlie Chaplin. Paulson and Bernanke are, at least implicitly, held responsible for the layoffs of millions of Americans, the near collapse of the financial services industry and the 50% drop in the stock market.

Now we have a bankruptcy examiner's report on Lehman's demise, which depicts a recklessly managed (or mismanaged, to be precise) firm on a hedge fund-like leverage rampage that artfully (in the Dickensian sense of the term) presented itself as an investment bank. Prominent among Lehman's shenanigans was the sly use of British repo transactions to sweep some of its leverage under the carpet at the ends of quarterly financial reporting periods in order reduce the firm's apparent leverage. Now that this stink bomb has exploded, a lot of former high ranking Lehman executives are denying knowledge of these British repos (called "Repo 105s") or not commenting. The auditors insist they did an acceptable job, although it appears they knew of the allegations of a whistleblower. And one can only wonder if, at its meetings, the board was focused on what would be served for lunch instead of the financial condition of the firm.

The press and blogosphere are now swarming the potential culprits like packs of ravenous wolves with litters to feed. Blame is being avidly and abundantly cast. Very possibly, it is well-deserved.

Perhaps, though, along with the zestful mud-slingarama, we should consider whether anyone comes out looking a little better. Maybe Hank Paulson and Ben Bernanke weren't so far off the mark. With what we now know about Lehman's true financial condition, we can see that a bailout would have been much more expensive than it seemed at the time Lehman collapsed. Outrage over bailing out undeserving Wall Street executives would have been all the more magnified if the shameless gamblers at Lehman had received the munificence of taxpayers. The chattering classes would have fulminated about immoral levels of moral hazard and the witlessness of the government allowing potential wrongdoers (top executives, board members and auditors) to live to fail another day.

It doesn't necessarily follow that a Lehman bailout would have precluded the need to bail out AIG. Perhaps, a bailout would have encouraged AIG to extend its leverage even more in the hope of trading its way out of trouble, like the losing gambler who goes in for a dollar after losing a dime. That strategy could have easily led to mega-disaster in the volatile markets of 2008. Then the taxpayers would have been taken to the cleaners even more than they were.

Did Hank Paulson have an inkling of what Lehman was up to? After all, he would have had access to the top levels of Wall Street, and it's quite possible that others on the Street sensed, if not knew, what was going on at Lehman. Did Chairman Bernanke field enough phone calls from Wall Street execs to get the picture? We may never know for sure everything that Paulson and Bernanke knew, heard, sniffed out or suspected. But, in the interest of Monday morning quarterbacking government officials fairly, let us consider that their decision not to extend the generosity of taxpayers to a bunch of rascals really wasn't all that bad. Indeed, had Lehman not gone into bankruptcy, we wouldn't have the comprehensive examiner's report to provide a better picture of how inept risk management in the financial system has been, and why financial regulatory reform, still stalled in Congress, remains desperately needed.