The U.S. Economy: Remembering the Past Could Help Fix the Future

Federal Reserve Chairman Bernanke responded appropriately when he lowered the Federal Fund and Discount rates again on Thursday in an effort to thwart bank failures—creating generous loan spread to boost bank profitability. By lowering rates again, the Fed made a clear and dramatic statement that banks required help to remain solvent, and he came to their aid. This is not a bad thing. We do have an emergency, and surely having the U.S. financial system implode serves nobody.

Undoubtedly, the next step will be the Fed, in collaboration with Treasury, engineering a bailout of private insurers, MBIA (MBI) and AMBAC (AKF). This is required because absent a bailout, money market funds, banks, broker dealers, pension funds, etc. will lose capital and/or capital reserves resulting from the reclassification of securities that no longer qualify to be held, or used, as dollar for dollar collateral. The resulting downgrades would set off a domino sell-off both here, and around the world.

Moody’s and Standard & Poor's realize this is the case, and without a doubt are being asked to hold off. One must rethink what this means for financial rating objectivity, especially if you’re being defrauded as an investor. Just like New York Insurance Superintendent Dinallo’s plan to inject token capital into the monocline insurers, there now seems to be a consensus among regulators that labels matter more than fact.

What’s unsettling is that the image of two Americas is clearly coming into focus: one for those making the rules and their beneficiaries who pay (lobby) for access, and a different one for everyone else. (The picture will be complete when GNMA reports the extent that its pocket was picked, and taxpayers are given the tab.) Somehow, akin to Socialism, there is a fundamental, underlying tenant that the masses shall pay the tab. You’ve witnessed it before as “too big to fail;” Capitalism just dresses it up, walks it backwards, and lets the chosen benefit. Remember Resolution Trust? Remember the accounting fraud on Wall Street where the solution was to fine the shareholders. Incredulous, but true!

But this author can hear it now: Capitalism is the greatest economic system known to man - yeah, yeah, and yeah. This great system impoverishes people as well. It seems to me that there’s something systemically wrong with a system wherein a company like MasterCard (MA), for example, can report a seven-fold increase in profits mainly by gouging the public. Not only does it charge late fees for delinquent borrowers, but it hikes the consumer’s rate to 24-30 percent on outstanding balances because legally, it can. Meanwhile the Fed, Treasury, and the Congress singing in concert pledge help for homeowners, and plan to mail out loan checks. It sounds a bit reminiscent of turning on street hydrants to cool off kids who live in homes without air conditioning on hot summer days. (It’s a well thought out move whose goal is to diffuse the torrent of rage building like a powder keg all across America.)

And what solutions would I propose, let it all crash? No, obviously not. But ‘too big to fail and bailouts for bad economic decisions are certainly not Capitalism. Instead, I would access the solvency of each regulated entity, large and small, and put it into receivership, and let the profits go to pay back the Treasury. Why should the taxpayer, and not the management and shareholders who support management pay the costs? Granted this might eliminate competition, and possibly result in greater foreign ownership of U.S. financial institutions, but I submit that this is preferable to rewarding bad business decisions, and proliferating more of the same.

The other part of my solution is to reform the Fed. It should be obvious, even to Congress, that this independent monetary arm of the Government is not independent. Much like Members of Congress voting for their own pay raises, can continue to permit the Fed, the FDIC, and the Comptroller to fix their own failures? No. Capitalism is a system of profit and reward. This author argues that our system is a hybrid of Socialism, advertised as Free Market Capitalism. A system that creates monopolies, rewards inefficiencies, and redistributes income to appease, not to reward capitalistic values.

The fact is that America is indeed a great country with a remarkable history of overcoming adversity, founded on the principle of government ‘by the people, for the people, and of the people.’ But what has evolved is a redefinition of “people” as business owners. Until we correct this error, and respect and reward all people, we will continue to have the errant efficiency, large scale dislocation, and rampant systemic, greed-driven failures we are experiencing today.

And yes I say ‘loan check,’ because the Treasury doesn’t have the money to hand out, so in the end, we will pay it back in the form of higher taxes as soon as the economic condition stabilizes.

Comments

[Mark N]

Where are the criminal charges. The bankers are taking the world's economy down and they are sitting on their yachts blaming the fed.

[ebi2505]

Even if the Fed managed to bail out private insurers, what would prevent the next bail out to occur again. Since the Fed would step in and save the day again. Let's continue the binge lending.

[DeaverB]

The problem as Pearl Bailey said is, "When the rich get a cold, the poor get pneumonia." As a serial entrepreneur, my companies' need related to cash loans and cash investments. Scare off the rich and the source dries up. Makes for good politics--and lousy business. Yeah, yeah the rich are on yachts. As Paul Tsongas said to Ted Kennedy (the former from working class Lowell; the latter a spoiled heir--who never worked so thinks punishment works), when Chyrsler was going down, "Ted, the rich won't be hurt; it's those union jobs that will be lost that will hurt." Ted, to his credit, got with it and supported the bailout. Same here; than bankers/investors may be this that or the other thing--but the last thing we need is to close their wallets and thinking defensively.
As the Eagles said, "Get over it," in one of their best songs.....

[the finalhorseman]

lets throw the politicians and the bankers, etc. in prison for, say 20 years and one day...unless they deregulated the meaning of the sentence. somehow i dont feel strong enough to carry these bloated giants on my back.

[kkin365]

A few columns back, Newsweek columnist Samuelson said: The problems of capitalism are the capitalists -- CEOs reaping "bonuses" while putting their companies close to bankruptcy. More interestingly, these captains of industry pooh-poohed Chinese citizens for not using credit cards or regulatory agencies in China for disallowing buying stocks on margin or engaging in short sales. These captains of industry also show disdain for Chinese government's involvement in financial matters but see nothing wrong in demanding rate cuts from the Fed. Is this another example of American exceptionalism in action?

[Easy E]

The credit card companies are not forcing anyone to take on debt. I don't make much money and I have no debt. It is a personal choice that everyone has to make. You cannot blame a system that is voluntary to participate in. The blame lies with the volunteers. And if you don't like CEO's making hundreds of millions then don't invest in their companies, don't buy their products, don't work for them. Capitalism is a system of choice and consequence, if you make the wrong choices you must suffer the consequences. Today, plenty of Americans have made terrible choices and they must suffer the consequences. It is from the consequences that they will learn. If you try to remove the consequences then you just create more bad choices. The only other alternative is to have no choice, and that system would involve even more suffering.

[User 5997]

That's the point; a bailout is tantamount to removing the consequences. If Easy E's premise is correct then we are just creating "more bad choices".

[Ratch2002ca]

So you are smart, Easy E., and so am I. I use my credit cards responsibly and pay little if any interest. The banks get a transaction fee from the vendors. But that is not where the credit card companies are making their money. They do so by sending credit card applications to everyone, offering very low balance transfer intest rates, leading those who are having credit problems to refinance at a lower rate. Sounds wonderful, but then these poor people buy more and then the short term reduce rates go away and they cannot pay the bill. Even paying a good portion of the bill will not stop the bank from charging interest on the whole thing. If they cannot make the minimum payment the interest rate goes up even more. The latest wrinkle is that if you pay your bill in full once they still charge you interest on all your purchases until you've paid in full a second consecutive month.
The suck the fools in an bleed them dry. The banks should pay consequences for their actions. Not all banks behave this way. You can tell by your mail who the big abusers are. Balance transfers don't mean much for you or I.

[ponchovilla]

So many of these problems can be traced back to the lobbyists who have written the legislation and bought both Republicans and Democrats through obscene contributions. In the not too distant past a Republican had fiscal discipline, favored deregulation to ease burdensome government regulation and even had a moral/ethical compass based on core principles. When George Bush and his ideological team took over all of the old rules changed. Watch C-Span and witness (in disgust) the incredible stonewalling of the Agency Administrators at the oversight hearings FDA, EPA. GAO, Justice and on and on. Don't even include the War in Iraq. It's an embarrasment to American democracy and our system of checks and balances. Enron all over. Mark to market accounting, off balance sheet transactions, creative accounting, CDO's, structured finance. "A house of cards built over a gallon of gasoline."
MBIA, for all practical purposes wrote the bankruptcy laws that Congress enacted. All credit card companies prey on the uneducated the weak and the desperate. The interest rates and fees are pure usery. Testimony before the Senate finance committee from the executivesof the credit card companies revealed nothing but Cheshire Cats grinning. They knew every loophole so everything they do is according to law. Just like the tobacco company CEO's stating under oath there is no link (indisputable scientific evidence... a legal term meaning we need to study it for 100 more years) between smoking and cancer. BIG MONEY. It's now known that Merrill Lynch and others are refunding money to small school districts (Bloomberg, Erie Pa and more) who had little ability to understand the complexity of the contracts. What ML knew is that their fees were huge allowing incredible profits and year end bonuses. BIG MONEY.
GREED, FRAUD, WASTE and ABUSE. Are these the principles of our elected officials and BIG MONEY? We have too many politicians and not enough Statesmen.
As for MBIA and AMBAC; the social cost to let them fail is a very high price to pay.
What were seeing is capitalism run amuck or maybe the beginnings of financial terrorism.

[Buddy]

This is the best article I have read describing what "Joe Public" is not aware. It is this simple. People over bought. Losses and write downs are far larger than one can imagine. When I traded no one bailed me out of my bad positions and I had to take my loses. The holders of CDO, SIV, ABC and the like know the market is much lower than their write downs. This was evident when there was no secondary market. The UST yield curve will continue to steepen and seek a level where the Fed has no room to bail this economy out. They are going to run out of options. This is going to be 1928 all over again. Sorry for the mistakes of others and I hate to see a financial collapse, but let happen. Go to cash, UST silver and gold. If we bail out MBIA, AMAC, FGIC, ACA, SCA and the rest of the insurers it will just delay the inevitable because it well happen anyway. Let them find their on capital/resources to keep them in business. It's not up to us to give them or any financial institution a second chance. We tried Rap accounting for the S&L's in the 1980's and they went under anyway. There is a price for everything: let the market work and seek its level.