Pushing on a String

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Someone is
reading Lew Rockwell's mail.

In the internet
era, government actors, big banks and most importantly, the market
almost instantaneously respond to the truth that is now available
to all through LewRockwell.com, Mises.org and other brave truth-telling
websites. This is particularly evident in the stock market's rapid
assimilation of the truth regarding the bailout. The market has
immediately recognized that the $850 billion "emergency"
bailout was not necessary, essential or even helpful in "rescuing"
the US financial system. This comes as no surprise to those who
knew that this was not its intent. Like all Bush Administration
boondoggles, the bailout was a patent attempt to use a crisis to
consolidate power and line the pockets of Bush cronies. Just two
weeks ago, callow politicians promised that the bailout would somehow
miraculously save the economy and the market. Today, the stock market
has exposed these empty promises. The market is screaming to the
social planners that their actions can have no effect other than
to worsen what is clearly a bear market. While the planners continue
to plan, the market laughs. The truth is that the US economy is
in recession and has been for some time. Non-market-based government
interventions, in whatever form, are as ineffective as pushing on
a string. In just two weeks, the government has scuttled $850 billion
Bailout Plan A for $850 billion Bailout Plan B. Plan B, however,
is even more dangerous and systemically corrosive than Plan A because,
as intended by its advocates, the inflationary dollars injected
into the system under Plan B are not traceable to any particular
transaction but generally injected as capital into the nations largest
banks.

A SHORT
HISTORY

On October
2, the day before Congress passed the bailout, LewRockwell.com detailed
the bailout for what it was: inflationary crony capitalism designed
to consolidate banking power in JP Morgan and Citibank. A week before
the bailout, the Bush Administration used the regulatory power of
the federal government's FDIC to foreclose on Washington Mutual
and threaten foreclosure on Wachovia and tender their respective
assets to JP Morgan and Citibank at fire sale prices. The practical
effect of bailout bill was to place JP Morgan and Citi first in
line to receive $850 billion in new dollars in exchange for the
unmarketable securities they acquired in the Washington Mutual and
Wachovia muggings. On October 3, Wells Fargo, perhaps cynically
recognizing the Austrian economics principle that the first pigs
in line at the fiat money trough get the fattest, stated that it
wanted to be in on the Wachovia deal, which was not set to close
until December 31. Over the next six days, Citi, Wells and Wachovia
fought, with the FDIC clearly taking Citi's side.

On October
9, LewRockwell.com showed the piggish motivations behind the Citi-Wells-Wachovia
dispute and warned the participants to be careful what they wished
for. Although the "first pig" rule is generally true,
it has no application where the fiat currency retains no marketable
value. Moreover, the "right" to sell to the government
could quickly become a messy, inefficient and unprofitable "obligation."
Notwithstanding a
prearranged infusion of $11.5 billion of capital on September 26
,
the plummeting share price of JP Morgan (down 21 percent from October
2 to October 15) perhaps signaled that the future right to receive
$850 billion in newly printed dollars could be as worthless as the
securities sold in exchange. On October 10, Citi bowed out of the
Wachovia deal which the FDIC had orchestrated on Citi's behalf.
On October 11, LewRockwell.com sang Citi's praises for taking the
moral high road, at the same time preserving its legal strong claims
against Wells and Wachovia, and predicted that the Wisdom
of Crowds
that is the market would reward Citibank and further
noted that Wells was in the unenviable position of selling unmarketable
securities in exchange for potentially worthless dollars and at
the same time was exposed to Citi's lawsuit that would require Wells
to disgorge any profits it made from the bailout.

From October
10 to October 14, the market did look kindly on Citi, with its share
price rising from 12.93 to 18.62, a 43 percent increase. On October
14, however, the Treasury announced that it would not allow Citi
to escape the bailout. The Treasury would hide its inflationary
infusion by purchasing stock in all the big banks, including Citi.
Citi apparently relented and its stock promptly dropped 12 percent
on October 15. From the October 2 to October 15, the stock prices
of these three big banks are as follows: JPM (-10.44; down 21 percent);
Citi (-6.56; down 28 percent); Wells (-2.98; down 8.12 percent).
Even though these entities are first in line to receive as much
as $850 billion dollars in new dollars in capital in some form or
another, the market does not appear to care. Indeed, because the
new plan does a better job of hiding the inflationary infusion of
new dollars – there is no purchase price of subprime securities to
evaluate or audit – the market appears to like the Plan B even less
than Plan A.

Unfortunately,
if Wells, Citi or JP Morgan are in fact reading LewRockwell.com,
they are not reading closely enough. If they were they would recognize
that the market is telling them to reject government intervention
in the market and imploring them to use reason, the free market
and all available legal, tax and accounting tools to achieve an
expeditious liquidation of the non-performing real estate loans
on their books. History will remember the heroes who have the courage
to take such action. The market will also reward them.

PLAN B MORE
DANGEROUS AND CORROSIVE THAN PLAN A

The government's
first bailout strategy (cast aside after only one week) was to incorporate
a new "government sponsored entity" (GSE) that would use
newly printed US dollars to purchase $850 billion in non-performing
loans from JP Morgan, Citi, Wells and other banks. This was the
patently unsound entity in which taxpayers were "investing."
Now the government has changed course. It now says that it intends
to initially purchase $250 billion in equity in the nation's largest
banks. The idea is that the government will infuse "capital"
directly into these banks and receive some sort of non-voting, preferred
stock in exchange. How the bad loans will be liquidated has not
yet been disclosed.

So why is Plan
B worse than Plan A? First, the purchase of bank share still represents
a vast, inflationary expansion of the money supply – the Treasury
will fund the purchase by selling bonds which the Fed will dutifully
purchase using newly printed dollars – only this inflation is nearly
undetectable and untraceable. Because Plan A contemplated a sale
between the bank and new GSE, the taxpayer at least had the opportunity
to see how much he had been cheated. He could evaluate the sales
price of a non-performing $100,000 mortgage against the amount realized
(price received at foreclosure less transaction costs) from a similar,
actual, mortgage foreclosure. The difference between the two numbers
would represent the amount stolen from the taxpayer. Cynics would
claim that this is why the politicians have adopted Plan B. Plan
B, coincidentally proposed by Swedish Central Bank Honoree Paul
Krugman, purposefully hides the inflation by laundering the new
dollars through the big banks' capital accounts. The purpose of
this infusion is to compel these lenders to make more loans to a
public that it just starting to realize to folly of excess leverage.
In short, it is doubling down on a bad bet.

Second, the
new plan is unsound because the government is doing something that
the free market is unwilling to do. If the capital markets saw value
in investing in these entities, capital would naturally flow to
them. Wise capitalists like Warren Buffet and Jim Rogers are participating
in the capital markets, if at all, intelligently, as mezzanine financiers
or by short-selling the stocks of troubled banks. In his latest
investments, Warren Buffet has demanded a 10 percent preferred return
with a right to acquire a large controlling common-stock interest
if there is a default. If the best of our free market capitalists
are not doing it, then neither should the taxpayer. The banks are
not "too big" for this. If there is profit in the sale
of non-performing mortgages, which there is, then capital will find
a way to finance it. Furthermore, with an apparently unlimited federal
lifeline of capital, what incentive do the banks have to efficiently
liquidate their non-performing loans? Answer: none. The new plan
is an unequivocal moral
hazard
. Banks that participate in Plan B will be party to the
making ghost towns out of vast areas of urban America as over-encumbered
property sits vacant and underutilized for the next several years.

Third, the
strategy will in the short term harm the non-troubled community
banks, regional banks and credit unions that have benefited from
the flight of deposits from insolvent banks. Over the course of
the last year, many depositors have quietly and electronically withdrawn
their funds from troubled big banks and deposited
them with these well-run banks
. This is the free market telling
the failed big banks that they are not providing a valuable service – providing
a secure repository for money. The well-run banks are solvent and
have made good lending decisions. The natural infusion of deposits
and capital is their market reward for a job well done. With the
increased deposits, they have the capacity to make more sound loans.
In contrast, the infusion of artificial, non-market based new money
"capital" into JP Morgan, Wells et al. disrupts the natural
operation of the market. The newly created inflationary dollars
infused into these banks gives them an artificial capacity to make
additional loans. In short, they did not earn the capital infusion.
Flush with an infusion of this irrational capital, feeling federal
pressure to expand the credit-based economy and in bed with a government
led by the former
lawyer for ACORN
, one can expect these big banks to continue
along the same self-destructive road: making bad, inefficient and
unprofitable loans. As these banks inject irrational money into
the economy and make loans that the non-troubled banks would not,
this distorts the market by placing pressure on the non-troubled
banks. The loan officers of the non-troubled banks will compete
with the big boys only if they are willing to make similar irrational
loans.

Fourth and
finally, for the banks that agree to get in bed with the federal
gorilla, it very well could be their death knell. While all banks
are already quasi-government institutions (all banks must be federally
licensed, insured and therefore regulated), none have federal bureaucrats
on their boards, on their payroll or overseeing or directly influencing
lending decisions. The banks that accept federal "investment"
can expect all of these things. While these bank may see short-term
riches in government promises to be preferred lenders in federally
guaranteed programs to, for example, make low-income housing loans,
they will inevitably see a capital flight as the market recognizes
that they are no longer rational, capitalist institutions. Today's
Bailout Banks could very well be tomorrow's Fannie Maes and Freddie
Macs. All
Bailout Banks should note that the Plan B/ "Krugman" plan
copies the Swedish government takeover in 1991 and 1992.
It
is no surprise that the banks that best survived the Swedish intervention,
like the
Wallenberg family-owned SEB
, were the ones that most resisted
government interference.

JP MORGAN
AT CENTER OF FUTURE STORM

In a case of
with-friends-like-you-who-needs-enemies, JP Morgan may be questioning
its close relationship with the Bush Administration. Bush has been
so ham-handed in passing the nation's economic problems on to JP
Morgan, even
JP Morgan's CEO Jamie Dimon has intimated that in 2009 he would
rather be President Obama's Treasury Secretary than CEO of JP Morgan.
Although this would be a typical post-election Rockefeller-Morgan
alliance, it may also signal the lack of a future in Bailout Banks.
Plan B ties the hands of the Bailout Banks, limits executive pay
and places other, non-market restrictions like limiting the payment
of dividends. On September 15 the capital markets told the planners
and the Bailout Banks loud and clear that Plan B was not a good
way to attract real capital. Mr. Dimon, like the market, perhaps
recognizes that Plan B may be the beginning of the end of these
banks and wants to be the first rat off of the sinking ship. Rational
capital will necessarily flow to smaller, nimble, well-managed banks
that are not under political pressure to extend credit to particular
ethnic groups, congressional districts or "purple" (half
blue/half red and therefore politically in play) regions.

Because the
Bush Administration loathes trial lawyers, it is also a bit ironic
that the coercive and unjust means that the Bush Administration
employed to orchestrate the JP-Morgan Washington Mutual takeover
may give rise to the largest collectible judgment in history and
may end up costing the taxpayers and/or JP Morgan another $10 billion.
In the week before the FDIC took over Washington Mutual and paid
$1.9 billion for its assets, the Wall Street Journal deal
journal indicates that JP
Morgan had arranged $11.5 billion to finance the purchase of Washington
Mutual
. This is pretty good evidence that JP Morgan saw at least
$11.5 billion in value in Washington Mutual yet, with the help of
the FDIC paid 1/5th of this and got the FDIC's help in
wiping out the WaMu shareholders, including an investment group
that had invested $7 billion just six months earlier. Press reports
at the time indicate that W himself was involved in the transaction.
Bush's impulsive actions therefore may give rise to the biggest
government taking case of all time and may implicate W himself in
an action under 42
U.S.C. 1983
, which obligates the defendant to pay the prevailing
plaintiff's attorneys fees.

CONCLUSION

Like
other Bush Administration power grabs, the bailout, in whatever
form it ultimately takes, will necessarily fail and will cause much
needless pain and suffering. The Bush Administration appears to
believe that it can invent reality and repeal or suspend the laws
of gravity. It cannot. In an age before the internet, concealing
the truth and delaying the effect of government theft was perhaps
possible for a time. In an earlier age, the true motivations behind
the bailout and the predictable consequences would not be known
for months, years or perhaps even decades. When Hoover and FDR were
destroying the US economy with federal intervention following the
1929 stock market crash, only a few obscure
academics
knew the truth. Today, however, the truth travels fast. Today, websites
like LewRockwell.com and Mises.org have brought the truth to the
masses, so much so that principles of Austrian economics are regularly
discussed on public blogs like Google Finance and Yahoo Finance
pages. While the Bush Administration has taken drastic and unprecedented
steps to avoid or delay the impact of 8 years of irresponsible leadership,
the omniscient, eminently moral "invisible
hand"
of the market will not listen and will not obey.
As fiat dollars flow into the Bailout Banks, real capital will flow
out. The market is powerfully informing the Bush Administration
and its fellow travelers who in fact is the Decider.

October
18, 2008

Bill
Butler [send him
mail
] is a Minneapolis attorney and the owner of Butler
Liberty Law
.

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