Lawson for Congress

It started last week with the Freddie and Fannie bailout, where our Treasury ignored our national interests and bailed out foreign central banks, PIMCO, and other sophisticated investors. What was wrong with this story? Most importantly, the Treasury offered public funds to guarantee debt that has never had any government guarantee, implicit or explicit:

Read the bold print on that prospectus. Should there be any confusion here? If homeowners start falling into default and not paying their mortgages, and the rate of default exceeds Fannie’s ability to make payments to its lenders, is there any reason to believe that the holders of those mortgages should expect our Treasury to make up the difference?

As Jim Rogers notes, in the wake of our Treasury volunteering our liability for Freddie and Fannie’s debt, we are perfecting the art of welfare for the rich:

While some well-meaning Americans attempt to rationalize this bailout as a “necessary evil,” the unintended consequences are beginning to reverberate. First, our government’s destruction of Freddie and Fannie’s preferred stockholders has closed the door on preferred stock for other at-risk organizations who might have wanted to use that route in attempts to raise capital. As Denninger noted:

If you’re a bank or other financial and need to issue (or have outstanding) preferred stock, you’ve got a problem - a serious problem.  The Federal Government just declared out loud that it will declare that stock essentially worthless any time they think there’s an accounting irregularity, and they will value things as they - not GAAP - sees fit.

Here’s what happened to you if you held just one of the many series of Fannie Mae preferred (the others are all essentially identical)

How about that - $13 to $2.50 in one fell swoop.

That’s an instantaneous 80% loss.

Now think about this from the perspective of, say, Lehman.  You have a capital problem.  You’d like to go out and issue some preferred stock - essentially a junior debt issue, where you pay interest in exchange for money, and perhaps its convertible into common stock at some point in the future.

However, you have a bunch of Level III assets, which might include mortgage bonds - not Agencies, but private-label stuff and commercial real-estate backed.

As a potential buyer of these securities, are you going to take this sort of risk?  Remember, Fannie and Freddie did not file bankruptcy; even in a bankruptcy, you’d likely get something as a preferred stockholder!

But in this case you got essentially nothing as a result of an (arguably) unlawful “taking” of your ownership interest in the firm!

My opinion?  This move just destroyed all preferred stock issues going forward for financials in the United States.

Paulson attempted to argue just the opposite in his press release:

Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly. By stabilizing the GSEs so they can better perform their mission, today’s action should accelerate stabilization in the housing market, ultimately benefiting financial institutions. The broader market for preferred stock issuance should continue to remain available for well-capitalized institutions.

Right. Well-capitalized institutions. That obviously doesn’t include Lehman, which is on the chopping block this weekend.

So now what?

Well, many observers believe that this unwinding of our banking and financial system is just getting started, with damaging consequences. Representatives from the New York Fed and major banks are working this weekend to orchestrate an orderly resolution for Lehman Brothers. Such meetings sound refined and sophisticated, although the situation is best described as a giant game of “chicken,” with our banking system hanging by a thread.

If Lehman fails suddenly, it is likely that its collapse would bring down its trading partners, as well. As Roubini notes:

If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

The potential for a widespread meltdown has brought banks to the table, each eager to avoid a similar fate. However, while banks are collectively motivated by self-preservation, no one individually wants to pay scarce money for Lehman’s questionable assets. So the “chicken” comes in when the banks look (again) to the Treasury and U.S. taxpayer to guarantee their purchase, thus bailing out the system and allow the status quo to continue:

But suitors like Bank of America, worried about the risk of buying an ailing financial institution like Lehman, want the government to step in with a package similar to what was offered to J.P. Morgan when it bought Bear. Then, the federal government agreed to absorb as much as $29 billion in losses. In seeking a Lehman deal, Bank of America Chairman and Chief Executive Kenneth D. Lewis is likely to face a tough sell to investors if he doesn’t secure some federal government backing.

As of this evening, no deal has been reached. Of course, the goal will be to reach a definitive plan by Sunday evening, before Asian markets open. We wouldn’t want to upset the new owners.

What can Americans do about our current predicament?

The first thing we need to do is educate ourselves about how we arrived at this precipice. It’s taken us a long time to get to this point, but the pressures have been gradually building since our current money and banking system were established in 1913.

One must first understand the system itself: a debt-based money system combined with fractional reserve banking. Once one understands how the system works, it becomes clear that our entire economy rests on an unstable foundation — and that the turmoil we’re experiencing is not unexpected. In fact, the system is working exactly as designed. As was noted by Robert Hemphill of the Atlanta Federal Reserve Bank in 1936:

“If all the bank loans were paid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture the tragic absurdity of our hopeless position is almost incredible, but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.”
- Robert Hemphill, Federal Reserve Bank of Atlanta.

Our money and banking system is the antithesis of a “free market” — it is a private monopoly managed for the benefit of the banking system itself. Are you surprised that inflation has been attacking American families, and that even two jobs are often insufficient to pay for gas, groceries, healthcare, and save for retirement? Are you surprised that our goverment, in attempting to “help,” has taken on a $9.6 trillion national debt with over $50 trillion in long-term liabilities that we cannot afford?

Based upon understanding the system, we shouldn’t be. Again, it’s working exactly as designed — although it’s been pushed past the limits of sustainability, and is nearing tragic absurdity.

It’s time to change the system. Congress unconstitutionally delegated control of our money to the Federal Reserve, a private central bank, in 1913. Congress can, and must, return control of our money to the people.

This entry was posted on Saturday, September 13th, 2008 at 9:55 pm and is filed under banking, corporate welfare, debt, eliminate the income tax, fractional reserve banking, monetary reform. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.