McCulley Speaks at Inaugural ISI Macro Conference

Investment Strategy and Investment Group atracted many of Wall Street's best and brightest to their inaugural Macro conference, and while a coveted invitation might not have shown up in your inbox, the transcript of Paul McCulley's speech might be the next best thing to being there.

And while Vince Reinhart has been critical of the Fed, McCulley is taking a more pragmatic route, particularly in regard to the events of last March:

I think it was the right thing to do at the time; in fact, I think it was the only thing to do at the time. To be sure, I wish, as surely the Fed wishes, that circumstances had not reached such an “unusual and exigent” state. But the fact of the matter is that the weekend of March 14-16 unambiguously fit that description.... That’s a bail out, my friends. Plain and simple. To be sure, Bear Stearns shareholders got only ten dollars a share; but Bear Stearns debt holders and counterparties were made completely whole by the transaction. That is a fiscal policy action in no less a way than when Congress facilitated the bailout of Chrysler many moons ago, by guaranteeing that company’s debt. Pimco

But McCulley recognizes that the world has changed, and the Fed's independence has changed since it stepped into the abyss. And while they might be losing some control over their balance sheet, The door is now open for regulatory reform.

I’m sure that the Fed hopes I’m wrong in this forecast, that its balance sheet genie can be put back into the no-credit-risk bottle. I doubt it, because Congress has now had a dramatic example of just how powerful that genie is. In a democracy, this is not all bad, in my opinion. And as a practical matter, I don’t think its all bad for the Fed, as an institution, either.

Post opening the discount window to the investment banks, regulatory arrangements will ineluctably change – it is simply untenable for the Fed to lend to someone that it doesn’t regulate. The Fed knows this and Congress knows it, too. Thus, while the Fed may have less independence over the composition and size of its balance sheet, the Fed will have greater leverage at this watershed moment to demand and get sensible regulatory reform, aimed at counter-cyclical, rather than pro-cyclical, constraints on leverage in the financial system.

Yes, the freewheeling days of the shadow banking system are over. A counter-cyclical constraint on leverage will not likely afford John Paulson an opportunity to makes billions of dollars in 12-month, and his trade likely mark the end of the madness.

Wall Street shot itself in the head once again, and a more buttoned down culture is likely to emerge as the smoke clears, and the cowboys holster their guns.

And for better, or worse, there is a new Sheriff in town.

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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

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