Hard-Money Week

Hard money from the Treasury and hard money from the Fed seem to be the policy watchwords this week.

Treasury man Paulson refused to bail out Lehman Brothers and talked about the need to respect moral hazard. In other words, no more government goodies to reward bad corporate behavior. Of course, stocks got killed yesterday. But interestingly, today they are up about 100 points.

Meanwhile, despite pressures from Wall Street,the Ben Bernanke Fed elected not to ease money at their FOMC meeting today, and instead kept their fed funds target rate at 2 percent. They mentioned that “the downside risks to growth and the upsides risks to inflation are both of significant concern to the committee.” And I take them at their word that they are worried about stagflation.

Even though inflation indicators have been falling and today’s CPI dropped one-tenth of a percent, 12-month growth is still 5.4 percent for headline inflation and the core rate is 2.5 percent. The CPI less energy is up 3.1 percent, and non-energy prices in fact kicked up by three-tenths of 1 percent. So it would appear that the Fed wants to defend King Dollar and hold down prices. This is good.

Meanwhile, there are rumors that a $100 billion Fed loan to AIG will be completed tonight. Otherwise the global giant insurance company probably will be forced into bankruptcy tomorrow. Helping to turn the Fed around is a lot of pressure from New York’s Mayor Bloomberg and Governor Paterson.

Given AIG’s global connectedness in all the derivatives markets, a failure is almost unfathomable. The question is how the Fed might structure the loan in order to avoid taxpayer liabilities. They could conceivably provide funding through a conduit like JPMorgan Chase or some other high-quality dealer. Hence they would take high-quality collateral — a normal transaction. But it looks like some form of assistance is coming.

This may compromise Paulson’s no-bailout policy a bit. But Paulson is really saying that not every Tom, Dick, and Harry is gonna get bailed out. AIG may be an exception. Let’s wait and see.

    • Barclays to Buy Lehman's Broker Unit for $2 Billion