Friday, December 12, 2008

Capitalism 101

A few weeks ago Treasury secretary Paulson told the congress that if he didn't have 750 billion dollars that weekend catastrophes would occur. The implication was if he got it, the economic ship could be righted. He got it, and then a couple of weeks later completely trashed the plan he was going to implement, and decided on an entirely new one. Think about it. We were "on the precipice," but had a plan to save the world. Congress appropriated an astronomical amount of money for it, and then Treasury rethought things and decided the first plan wouldn't work, but a new one they dreamed of would....sure..

The economic insanity has reached record levels. Nearly every state, municipality, industry and home owner is looking for a bailout, and every politician, pundit and economist has an idea how to save us from the pain of the recession. None of them have a clue.

There is a history of government action, and it isn't pretty. See Freddie Mac and Fannie Mae for details. They were arguably the start of the cancer that grew into the present crisis.

Do you remember the stimulus package a couple of months ago? I do. I just can't see where it helped.

Although Roosevelt is given credit for bringing us out of the depression, the fact is he and his predecessor, Hoover, caused the severity and length of the depression. Obama's public works initiative is modeled on Roosevelt public works policies, and although suggesting that such policies brought us out of the depression makes for romantic liberal storytelling, the reality is that a stock market crash partly due to a bubble created by 10 to 1 leverage began a recession, but failed monetary policy, trade barriers, and increased taxed got us into the depression. The reversal of at least some of these got us out, not Roosevelt's huge public spending.

No one today knows the effect of the policies they are proposing. The forces in the economy are so complex that we can only make educated guesses. History fails us as a guide for the future because new forces constantly enter the equation, and since we don't understand things very well to begin with, we certainly can't understand things with a constant flow of new variables. If we could get it right, we would all be rich. The attempts to influence the economy through government action can never be proved to have failed either. There is no control group to measure it against, so no matter how bad things go, it can be argued it would have been worse without the action.

In Washington perception is reality. If the auto bailout fantasy is to be believed, it will save millions of jobs, it will create a viable healthy industry that will wean the country off fossil fuels, repay bondholders in full, and possible even profit shareholders. I'd laugh out loud except it is so tragic.

This bailout shows that once congress is involved, political considerations trump everything else. The auto executives told congress what they wanted to hear, not what the industry needed to be profitable. The auto companies were going to concentrate on green cars. Right.. they will sell a lot of them with $1.50 or $2.00 gas.

The congressmen said the unions (their consistent supporters and contributors) have already given up a lot, and shouldn't bear the entire burden. This is code meaning the industry must keep the union wages at twice what foreign manufactures pay for their US labor. That will sure help a lot..Not only can't this approach actually will make a bad business model worse.

Fannie and Freddie are a recent example of government involvement in business. Congress created these monsters under the guise of expanding home ownership. They gave them implicit government guarantees on the money they borrowed. This created a squeeze on other lenders because without a similar guarantee they couldn't borrow as cheaply. Congress then used Fannie and Freddie as a depository for their political cronies. In order to beef up bonuses for the cronies (among others), the companies borrowed far too much, were too leveraged, (it couldn't have happened without that government guarantee.. no one would have loaned them the money), and committed accounting fraud. Franklin Raines, a Democratic political operative (Carter and Clinton administrations), was appointed the CEO of Fannie Mae. During his term earnings were overstated by 2.7 billion dollars, and he earned over 90 million dollars for himself. He settled the civil suit filed against him for a couple of million dollars and gave up his then worthless options. It pays to have friends in high places. But I digress. Congress later passed the Community Reinvestment Act. It said that Fannie and Freddie should make every effort to lend to non creditworthy borrowers, with insufficient equity (down payment). They also said that other banks would have to lend in poor neighborhoods (spell that non creditworthy borrowers with insufficient equity) or they would be prohibited from getting federal approval for mergers. As to profits..well really, what does congress care.

It is laughable that now that the entire thing has blown up, congress accepts no responsibility, and instead invents "predatory lending" as the culprit. This fantasy says that lenders who lost huge sums of money, were guilty of conning poor unassuming honest middle class families into borrowing more than they could afford to repay. The lenders may have been stupid, but predatory? No no..The borrowers may have foolish as well.. but victims? I don't think so.

We don't know where our attempts to solve this will lead, but we do know government action always enlarges the problems and creates new ones rather than solving anything. Let us first do no harm. Get the government out. Nationalizing industries has consistently been disastrous. We may not know what allowing these failures to occur would do, but we do know that although the market place is often painful, it corrects bad behavior as quickly and painlessly as possible. I don't know on what course the market will take us, or how bad it will be. I just know that it is the best choice from an obviously bad menu.

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