September 22, 2008

Financial Crises

It seems like every day or two there's another aspect of a tremendous financial disaster looming. Now Treasury Secretary Hank Paulson is looking to get Congress to approve a $700 Billion bailout (that would include foreign banks), and Congressmen and Senators on both sides of the aisle are willing to oblige him. Indeed, it seems the only points of contention are how many additional bailouts will be added to the bill so that Wall Street stockholders won't be the only recipients of this largess. No Foolish Risk-Taker Left Behind would be an appropriate title for it. This is all in the name of financial stability. If we don't do something then the stock market could cease to function. Credit would completely freeze-up and the economy would come to a standstill.

Is this likely? Or more importantly, will the bailout really stop it if it is? Remember that $700 Billion is a lot of money for the government to borrow (and us to pay back with higher taxes), but is really a drop in the bucket compared what is traded in worldwide financial markets. The bailouts of Bear Sterns, Fannie Mae, and Freddie Mac didn't thwart this crisis, so can we really be sure that this additional $700 Billion will actually do the trick?

Additionally, do we want to further the rampant moral hazard that has significantly contributed to this problem to begin with? Are we so concerned with assuaging the guilt and fears of the self-proclaimed Masters of the Universe, as well as the stupid folks who mortgaged themselves to the hilt, that we'll pat them on the head and say, "that's alright. You made a boo-boo, but we'll help you," regardless of the fact that these people are in a position they put themselves in? Especially since the lesson for all investors is: American capitalism means you get to keep the money you make (after taxes, of course), but if you are sufficiently connected to the right folks in Washington, you don't bear the full brunt of your mistakes. The more poor decisions are rewarded, or bailed out if you will, the poorer we will be in the long run for it. This is true on the micro scale when it comes to family interactions, and on the macro scale as we are seeing.

The main counter to this is that there wasn't enough oversight. If we had good regulations in place and good regulators enforcing the rules, then this would all have been avoided. So we pay through the nose now, but we'll have stricter rules going forward. I call BS. We could have regulations up the wazoo and it wouldn't stop people from making dumb investment decisions. What we have to do is make it clear that the consequences of bad decisions are borne by the decision-makers, and turning Goldman Sachs and Morgan Stanley into holding banks so they can get quicker access to federal money does the exact opposite. Similarly, instituting bans on short-selling does nothing more than shoot the canary in the mine before he can suffocate and warn the rest of us.

The laws of economics, like the laws of physics, are immutable. You can't wish or legislate them away, no matter how much they vex you. We didn't start flying because we decided gravity was holding us down (pun intended) so let's pass a law, but because we figured out how to work within its confines and developed the airfoil. We can't solve this problem by throwing money at it and adding more onerous regulations. We have to suck it up and let these institutions fail. Yeah, the consequences would be terrible, but continuing to put band-aids on a gushing head wound won't do us any favors either.

Of course, the politicians will never let that happen. In order for the Democrats to win the White House and take more seats in the House and Senate they have to seem very concerned and pass the bailout, with plenty of goodies included for their core constituencies. It's not like Democrats understand how economics works anyway, or they wouldn't be Democrats in the first place, but that's a rant for another time. :-)

And don't think I'm giving a pass to the Republicans. If there is anything the last 8 years have taught us, it's that they are perfectly willing to forgo their stated principles of limited government and personal responsibility if it means increasing their power. This current bid by Paulson to control huge I-Banks is a perfect example.

So what do we average slobs do? Buy gold. Hedge the American dollar and start saving for that rainy day, since the forecast looks cloudy, to say the least.

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