This Week’s Biggest Loser? The Free Market

September 19, 2008 by  
Filed under Economics, Investing, Money and Behavior

The news coming out of Washington last night and this morning is stunning.  Inherent in the news is some hard truth about our free market economy. 

Fed Chairman Bernanke and Treasury Secretary Paulson are reported to have been briefing Congressional leaders on what else needs to be done to save their friends on Wall Street.  Can you picture the “deer in the headlights” look on the faces of our clueless political leaders?  

We don’t know what the politicians were saying in these briefings but Mr. ToughMoneyLove is reasonably confident their thought process went like this:  “I don’t know nothin’ about no economics.  Tell me what needs to be done to insure that money keeps flowing into my party’s re-election campaigns.” 

Why do I say that the free market is the biggest loser?  Let’s summarize what happened this morning and what is about to happen.

No Short Selling of Stock in Financial Institutions 

This “emergency” rule is actually a positive development because it punishes people who deserve punishment.  There are hedge funds and other market manipulators that have intentionally forced declines in some financial stocks through aggressive short selling, regardless of the actual financial health of the company being shorted. 

Thanks to the repeal of the uptick rule in 2007, this deliberate “manipulation by shorting” strategy was much more effective and destructive.  On top of that, the SEC has been lax in its enforcement of the rule against naked short selling(selling shares that you haven’t borrowed.)  Mr. ToughMoneyLove does not consider such activity (in which massive short positions are concealed from public or regulatory view) to be consistent with a free market. 

However, to our asleep at the switch SEC I say:  Six months late and billions short. 

Government Insurance of Money Market Funds 

You may recall my post of earlier this week about the “Uncle Sam All-Risk Insurance Company.  I confess that I did not realize then how true that statement was.  The new risk being insured is the inability of money market funds to maintain a $1.00 per share value of the fund.  Why?  Because some of those funds invested in short term obligations that themselves were too risky.  Now the managers of those poorly managed funds are upset that folks are pulling money from them.  True, the panic is spreading to all money market funds but the effect of the government guarantee will be to save the bacon of the worst fund managers, interfering with free market consequences. 

The Conception of a New Resolution Trust Corporation 

Mr. ToughMoneyLove has a few years under his belt and therefore clearly remembers the formation of the Resolution Trust Corporation, in which a governmental entity took over real estate assets of failed savings and loans so that they could be disposed of in an orderly fashion.    Some will say that it worked out OK then so why not now? 

No one is sure yet how this plan will be implemented but I predict that there will be three key differences that will distinguish “RTC – The Sequel” from the original.  

First, RTC II will take questionable assets off the books of financial institutions that have not failed.  (These are the old and new friends of Bernanke and Paulson).  In RTC I, the government took control of assets owned by S&L’s that failed. 

Second, RTC II will be taking control of derivatives and other complex financial instruments that have no market value.  They are so highly leveraged that it will be impossible to find any hard assets behind them.  They will just be written off.  RTC I had actual real estate to manage and sell. 

Third, Chuck Schumer and Barney Frank are going to load the bill creating RTC II with additional anti-free market provisions that Bernanke and Paulson don’t want but that are sure to get votes from broke Americans.  First and foremost, Schumer will demand a provision that allows bankruptcy courts to impose changes in the terms of mortgage loans.  You can’t afford that mortgage payment anymore?  No problem – Mr. Bankruptcy Judge and your friendly politician will get a better deal for you.  There will be others just like this and many of them will get Republican votes as well.

Update Post-Paulson Press Conference – 9:30 AM CDT

What Paulson said:  “We need to flush these illiquid assets from the system.”

What Paulson meant:  “These bad loans have been in Wall Street’s toilet for too long.”

What Paulson said:  “Our plan will require an investment of hundreds of billions of taxpayer dollars.”

What Paulson meant:  “The taxpayers have a bigger toilet so we’ll just dump the stuff over there.”

What Pauslon said:  “We need to get credit flowing back to consumers so they can secure mortages and borrow for college.”

What Paulson meant:  “We’ve given up trying to cure consumer debt addiction or to get spenders to save.  So let’s at least do something that will help the financial sector and business community.  The savers will pay for it.” 

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3 Responses to “This Week’s Biggest Loser? The Free Market”
  1. I am going to open a business selling bread on credit. I’m to give credit to absolutely everyone and never chase it up. When no-one pays me back I’ll be sending my bill straight to the government. A precedent has been set!

  2. Please put me on your bread delivery list. I will send you an IOU.

  3. Oooo. Bread that sounds really good. Sign me up!

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