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Fed Policy ‘Turned Financial Markets Into a Casino’: David Stockman Says ‘No’ to QE3

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Hours from now the Fed will issue its long awaited decision on monetary policy. The big question for the financial markets: Will Fed officials decide in favor of a third round of quantitative easing, buying long-term government securities in order to reduce long-term rates to boost growth? Or will the Fed do something else entirely, or nothing at all?

Stocks rose moderately Tuesday in anticipation of Fed action and on Wednesday U.S. markets did just the same. If the Fed decides instead to stand pat, stocks are expected to retreat.

Fed Chairman Ben Bernanke's speech at the annual monetary meeting in Jackson Hole, Wyoming in late August is fueling the speculation of more QE.

"As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation," Bernanke said. "The stagnation of the labor market in particular is a grave concern."

[Related: Bernanke Will Likely Take More Action But the Effects Won't Last: Glenn Hubbard]

A week later the latest jobs report provided more evidence of a continued weak labor market. The Labor Department reported that payrolls grew by only 96,000 in August, well below expectations, and that 368,000 Americans had left the labor force. That last bit of data reduced the unemployment rate to 8.1%, but not for any good reason.

In another sign of a slowing economy, the Institute for Supply Management last week reported the third straight month of declining manufacturing activity, and Fedex, operator of the world's largest cargo airline, cut its earnings forecast for the quarter ended August 31.

These continued signs of a sluggish recovery have led many Wall Street economists to expect the Fed will announce another round of quantitative easing at the conclusion of its two-day meeting today.

But David Stockman, former budget director for President Ronald Reagan, says more QE would be a big mistake.

"The economy is saturated with debt. Lower interest rates are irrelevant to recovery but they're doing enormous damage to the financial markets," Stockman tells The Daily Ticker. "We need an economy that saves more and consumes less," Stockman says, adding that the Fed is doing just the opposite.

The Fed's policy "encourages consuming and…trashes savings. We're going in the wrong direction," says Stockman. What's needed instead, he says, is "a period of austerity" which shrinks the economy and reduces the "massive debt held by businesses and households."

[Related: U.S. Debt Downgrades Are a Foregone Conclusion: David Stockman]

He blames the low rate policy of the Fed before 2008 for the financial crisis that struck that year, and says maintaining even lower rates now is like trying to "resuscitate a crippled system."

The Fed cut short-term rates to near zero in December 2008—where they've remained ever since--and followed that with two rounds of quantitative easing and Operation Twist, replacing short-term government securities and with long-term securities. As a result of these initiatives, the Fed's balance sheet swelled to $2.8 trillion.

The Fed has pledged to keep rates near zero at least through late 2014 if the economy stays sluggish and the inflation outlook "subdued," but some economists expect it will extend that date into 2015, at today's meeting.

Bernanke and other Fed officials maintain that the central bank's multi-pronged approach helped prevent the Great Recession slipping into another depression.

But David Stockman says Fed policies have "turned the financial market into a casino" and helped save financial firms that should have failed.

"Morgan Stanley should not have been saved and Goldman probably should have been badly impaired," says Stockman. "If that would have happened, it would have changed behavior of a whole generation. It would have stopped the speculation. It would have shown that there are penalties for being so aggressive and using so much leverage…"

Eventually the Fed will change policy and start raising rates, and when it does there will be "total panic on Wall Street," says Stockman. "The Fed is at a dead end. It's only a matter of time before its policy blows up."

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