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 (NYSE: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 (NYSE: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.