Getridofthemnow

3 Things America Needs to Do to Get the Economy Back on Track

Great article

Buffett Warned Us in 2003

Excellent article/post. Thanks for sharing. Now, let us not socialize the whole system. Wait. Reverse that. It's already happened. Time to go drink some vodka comrads.

Federal Reserve Buys AIG

The entire U.S. (and global) banking system is a fiat system that relies on confidence. Many seem to have forgotten this fundamental axiom. Like integrity, confidence is not something you "gain" overnight, but it is something that can be lost quite quickly.

What we have called a "liquidity" crisis is not completely accurate. Liquidity is available if there is confidence in the counterparty. Money waits on the sidelines, but when faced with a system and leadership gone amok, it must surely wait for a stabilizing force, or forces; forces yet to arrive. For many, there is simply no longer any confidence; not only in counterparties, but in the "system" itself (read: "How Washington Failed to Rein In Fannie, Freddie" at the Washington Post). Can you hear me now? The SYSTEM is broken.

For those that think FRB and Bernanke are heros, you need to go back and study economics 101. Markets react to incentives. In fact EVERYONE acts on incentives. This is as old as Adam Smith and the Wealth of Nations. The TBTF "incentive" is a very poor one to give teeth to. I am afraid both Ben and Hank have a "savior" complex that needs checking.

This particular crisis was created, regardless of the arguments to the contrary, through a woeful lack of understanding about market incentives, a failure of leadership in the private and public sectors (large commercial banks, GSEs, Congress, and market watchdogs), and a complete lack of understanding for what constitutes the credit and leverage creating process in modern markets. This lack of understanding permitted a "super-bubble" to form that, ultimately, couldn't be anything but confidence eroding. Under former "leadership" massive incentives were created to take spread income into GAAP earnings - particularly over the period of Dec-00 through June-04.

When the curve intermediation (i.e., borrow short and lend long) became more difficult (once the "slow" and measured rate increases began), the intermediation moved en masse off-balance sheet through SIVs and other funding vehicles, an effort to mask the real economic and financial leverage. Commissions were paid, of course, up front, as well as CEO bonuses tied to aforesaid GAAP earnings, not true value creation (and of course, Wall Street mistakes accrual earnings for value creation every day, which explains Warren Buffett's success).

Bernanke, unfortunate for him, inherited this mess, has little real-world experience to handle it (which explains the abdication of FRB financial leadership to Paulson), and has taken steps that, in hindsight, has allowed the TBTF doctrine to become a very tangible reality. I agree with a former post that a study of the Austrian economic school of thought would be helpful (Human Action, by VonMises), and Minsky's text (Stabilizing an Unstable Economy) wouldn't hurt either.

In order to correct the problems, we need less government intervention, not more. We seem to forget this fundamental truth, and instead look to financial market uber-"re-regulators” to "save us". Thank GOD that we have FINALLY (with the Lehman action) decided to let the market start to understand that TBTF isn't a clear-cut proposition, and have begun to unwind the moral hazard problem.

We need to permit failures, and more rapidly, and we need an orderly system for unwinding the bad bets and de-leveraging; however, equity holders (and even hybrid debt holders) may need to suffer, and so it should be. This will require a federal bridge bank organization to be established, a la RTC.

The prescription to for resolving this crisis - more long-term - includes (but is not limited to):

• Smaller, not larger, financial intermediaries. No single firm should imperil the "system"
• Privatized deposit insurance, or a much more risk sensitive public system (I refer reader to "A Mandate for Change", written by FDIC economists many years ago)
• A less aggressive FRB and UST. Non-trivial restraints need to be added, as should now be evident
• A less "fractured" regulatory system, but quite a bit different from Paulson's "blueprint"
• Eradication of the GSE model
• Massively increased transparency and data collection/distributio... could be tied to a "systemic risk" score. More systemically important and potentially risky firms have much more aggressive disclosure requirements
• A totally reformed SEC. Historically, all they care about is compliance, not risk management. This has been a disaster.
• Rapid moves toward international harmonization of accounting rules. FASB/IASB need to come together.
• Debate/reconsideration of GLBA
• Private sector governance of a central OTC clearinghouse. Non-exchange markets HEAVILY regulated and "taxed" via massively increased reg capital. Force business flow to exchanges, daily MTM and settlement, and standard contracts