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Can the Federal Reserve Prevent another Meltdown?

Can the Federal Reserve Prevent another Meltdown?  
By Ron DeLegge
May 7, 2010

SAN DIEGO ( – In some quarters, the Federal Reserve is being lauded for stopping the 2007-09 financial crisis from escalating into full-fledged pandemonium. 

In his just published memoir, former U.S. Treasury Secretary Henry Paulson argues the government had no choice but to bailout major Wall Street banks. He declares the financial system was “on the brink.” While the government may have succeeded in calming financial markets, at least for now, how ready is it for the next crisis? Can it prevent another financial meltdown from occurring?

Before we answer these questions, let’s look at what they’ve been up to.

Tackling the Great Recession
As an extension of the U.S. government, the Federal Reserve Bank has thrown a few kitchen sinks and tables and chairs and household blenders at the ailing economy. It’s also ordered interest rates to stay artificially low, it’s increased the money supply and it’s acquired radioactive assets that nobody else wants.

Yet, the housing market (NYSEArca: XHB) and the job market – two vital elements of a sound economy - still remain in shambles. Personally, I’ve never believed in a “jobless recovery” any more than I believe in “healthy cigarettes,” “harmless explosives,” or “tame lions.”

Regarding unemployment, even though the federal government reported that 290,000 jobs were added in April, there’s actually less people employed today than last year. Furthermore, today’s unemployment rate is not really 9.9%. Rather, it’s 17.1% if we include discouraged workers and forced part-timers. Excluding them would be unfair discrimination, not to mention misleading. And because the Bureau of Labor Statistics doesn’t included another category of the workforce known as “self-employed unemployed workers,” adding them to the mix would bring nationwide unemployment above 20%. Forget about what the stock market is doing, does that sound like economic recovery to you?

Lessons in Fuzzy Math
The recently passed “Health Care and Education Affordability Reconciliation Act of 2010” offers an excellent case study in fuzzy math. According to the government, the bill will cost $940 billion over the first 10 years and reduce the deficit by $130 billion during that period. Put another way, the government plans to save $130 billion by spending $940 billion. How is such great financial acumen accomplished?

According to the Wall Street Journal, the U.S. government will “borrow one of every three dollars it spends” in 2010. In other words, the general game plan is for the government to borrow its way out of debt. And over the next ten years, budget deficits are projected to be $8.5 trillion. While this number is big, it’s not nearly as frightening as the unfunded liabilities of Medicare and Social Security.

If you still don’t understand what any of this means, you’re not alone. Try this: Tell your family that you’re going to spend $50,000 to save $5,000 and see how they react. If they throw you out of the house, you can blame this article.

Running Low on Ammo
The financial crisis in Europe (NYSEArca: VGK) offers strong lessons for all. The EU (NYSEArca: FXE) along with Greece gave too many excuses and waited too long to address over-borrowing, over-spending and financial shenanigans. Could any of this been prevented? And what do you do with an inoperable patient? The EU says, “You call in the undertaker to dress up the corpse with a multi-billion dollar bailout.”

Europe’s financial problems are a likely precursor of domestic trouble just ahead.

Going into the 2007 downturn, the Fed and government had plenty of ammunition to fight an economic collapse. The budget deficit was a mere $160 billion and the federal funds rate was at 5.5%. Today the Fed’s $2.3 trillion balance sheet and the government’s $1.4 trillion deficit leave both with very little financial flexibility. And lowering interest rates again is out of the picture too.

In short, the Fed’s potency for tackling another meltdown has been severely weakened. Liberal monetary policies have certainly delayed the inevitable, but can it eliminate the inevitable?   

Re-thinking Your Safety Net
Those that rely on the government or Fed statements to protect and defend their financial interests are likely to be badly disappointed. Wasn't it Bernanke that said the sub-prime mortgage mess was contained when it wasn't? Now more than ever, it’s important to have the right mix of investments within your portfolio. Is your portfolio ready for another major meltdown?

Where can you go for help? ETFguide’s six ETF Portfolios each offer a different mix of ETFs to help you during these turbulent times. Which asset classes are best positioned for the storm ahead? The ingredients are readily available, now it’s up to you to execute the recipe.   

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