"The Fed listens to Wall Street and believes what it hears," Willem Buiter wrote in a paper. "This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous."

Other economists piled on too, saying that the Fed's various auction facilities that allow banks to warehouse poor collateral with the Fed and get liquid Treasuries in return doesn't help solve the fundamental problem: asset quality.

In fact, it simply prolongs the reckoning the financial system badly needs, where assets are marked down to market value, bad loans are written off, losses are taken, and the misallocated capital from the credit boom is liquidated.

You can't move on if you design a system that prevents mistakes from being realised, or punished. But as much as we all seek to avoid discipline, life (and markets) have a way of meting it out, whether we like it or not.

Dan Denning
The Daily Reckoning Australia

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