It's time to rein in the Fed

By Bill Fleckenstein

Last week, those who believe in perpetually higher stock prices continued to play their favorite game -- "This is bullish because . . ." -- in which they slap that label on any and all news.

Thus they ignored the weakest reading on consumer confidence since 1973, when a particularly brutal recession was in its early days. After all, when more than a handful of people react by uttering the word "recession," you have to get ready for the recovery -- because we all know that recessions don't last for more than the blink of an eye. (Or so their logic goes.)

Of course, we saw another incarnation of the game Wednesday. That's when the crowd sent Bear Stearns (BSC, news, msgs) spiking 8% in 10 minutes on the news that Sen. Christopher Dodd would hold hearings this week to probe the role of the Federal Reserve, the Treasury Department and the Securities and Exchange Commission in Bear's sale. What that implied to the bullish community: the potential for an ever-higher stock price for BSC.

It apparently never occurred to them that if the Fed were to drop its financial guarantee (and though it's now willing to lend money to brokers), Bear Stearns could still be headed for the trash heap. In the bailout nation, every financial problem must always resolve itself positively, right?

System collapsing? Buy stocks, of course

Taking a step back, we recently witnessed the same response to the near demise of Bear Stearns and the financial system. That was deemed to be bullish because financial crises always mean you should buy stocks.

However, the important yet subtle point in the current saga is that the "system" has devolved to the point where Bear Stearns, teetering on the edge of bankruptcy, was in effect able to tell the Fed: You can't hurt us anymore, but we can hurt you if the deal collapses, so we demand more money. (Which Bear got a week ago, when JPMorgan Chase (JPM, news, msgs) raised its takeover bid.) Meanwhile, the bondholders (lenders) were made whole -- as the Fed, through its assumption of debt, coughed up roughly $250 per BSC share.

Obviously, folks are depending on a continuation of the Greenspan put. During the roughly two decades of former Fed Chairman Alan Greenspan's watch, bailouts became bigger and bigger -- as the Fed tried to solve the problems created by too much easy money with more easy money. All of these "lessons" have been absorbed by current Fed chief Ben Bernanke. Perhaps he is even more outrageous, given his apparent intent on taking to the nth-degree a policy "perfected" by his predecessor: trying to target the right interest rate to run the world and then bailing out whatever trouble ensues.

Fed LLC

Under the current Fed chairman, the central bank's modus operandi has changed. Not only has the Bernanke Fed strayed far from its long history of supplying liquidity to just AAA government credits, but, via JPMorgan, it is basically setting up an LLC (a limited-liability corporation, similar to a special-purpose investment vehicle) to hold the dreck that almost ruined Bear Stearns.

It's a structure similar to the off-balance-sheet financial instruments that caused so much pain for so many other financial institutions in the first place.

• Video: Is the Fed getting a bad rap?

All of this proves the old saw that fact is stranger than fiction. Or, said differently, you can't make this stuff up.

Sadly, as my friend Jim Grant put it to me recently, the speculators have gained control at the expense of the savers. It's a variation of what I said last week: that the prudent are bailing out the reckless. The Fed seems under the impression that its role is to act as enabler-in-chief. As such, the Fed is an abomination.

Continued: Time to defenestrate 'em out

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