Pushing on a String


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.


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.


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.


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.


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