The Latest Treasury Bailout and the Law of Unintended Consequences

I have to admit, my thoughts regarding the latest financial debacles waver from one extreme to the other.  My initial instinct is that the markets need to be stabilized, and anything that provides a floor for a stock market in apparent free fall is a good thing.

My next thought is that $700 billion is a huge chunk of change, and ultimately, the taxpayer, that is, you and me, is on the hook.  The current US budget is running a significant deficit, Congress and the current Administration have not proven themselves worthy of handling such a large sum of money.  On the other hand, the Treasury is acquiring these assets at a fire sale price, so as a taxpayer, we may be able to recoup our investment, and then some, and as an investor, that’s a good thing.

Then my mind turns to the fact that these companies have done a poor job managing their resources and risks and should by rights, be allowed to fail.  If their managers did stupid things, why should we bail them out?  I guarantee you that if I squandered my family’s capital, no one would bail me out, least of all the government.  My immediate family, maybe, but not the government.

Finally, I realize what the unintended consequences of allowing huge financial institutions to fail would be, whether quasi-governmental or otherwise, and the uncertainty it would create not only with the stock markets, but the currency markets, the bond markets, and the global repurcussions that would ensue and I realize that someone has to do something, and that someone is Chairman Bernanke and Secretary Paulson.

I remember in 2004 and 2005 Federal Reserve Chairman Alan Greenspan implored Congress to do something about the unchecked growth of FannieMae and FreddieMac.  Now we hear reports of how attempts to actually do something failed to make it out of committee because of Democratic efforts to kill any legislation that would curb them.  We hear that Senators Dodd and Obama were the main recipients of Fannie and Freddie generosity.  We hear Barney Frank dictate that any bailout package must include a provision that allows homeowners to stay in their houses even though they can’t afford to make their payments.  (Doesn’t that sound like government-sponsored Socialist policy to you?)  I remember that the root of the current crisis began with “mark to market” accounting rules established during the Clinton Administration.  These rules require that financial institutions mark down the value of certain assets (securities) to current market value and take a charge against earnings and capital even though the value of these assets may rise in the future and the institutions can then sell them for a gain.  I remember how Chairman Greenspan was “puzzled” by the lack of risk premium associated with certain assets as he tried to slow the real estate bubble by gradually and systematically raising rates, with no effect.  I hear calls for increased regulation and accountability by the same people who received contributions from Fannie and Freddie, the same people who are blaming the Federal Reserve for this mess, the same people that allowed Fannie and Freddie to grow unchecked.  I want to throw up.

We don’t need more regulation.  The markets self-regulate.  Poor decisions always end badly.  The chickens always come home to roost.  However, and this is the important part, we cannot allow the markets to free fall, with the ensuing panic that results.  This cannot be 1929 all over again and President Bush cannot be Hoover.  The problem is that I don’t trust the folks in Washington any more to promote whatever is in the taxpayers best interest.  They have squandered my trust and respect, and I have no confidence that they will do what it takes, that is, the right thing, to earn it back.

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