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Wednesday, September 10, 2008 1:09 AM

Roubini Misses the Boat on Regulation

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Before we get to addressing Roubini's blaming of the mess we are in on "free-market laissez-faire" philosophy, let's take a look at calls for Paulson and Bernanke to resign, and one other post on "Socialism For The Rich".

Inquiring minds should consider Senator Bunning Says Paulson Acts Like Socialist, Should Resign.

Senator Jim Bunning said Treasury Secretary Henry Paulson, by rescuing Fannie Mae and Freddie Mac, is acting like China's finance minister and both Paulson and Federal Reserve Chairman Ben S. Bernanke should step down.

"I sincerely believe that Henry Paulson and Ben Bernanke should resign," said Bunning, a Republican from Kentucky on the Senate Banking Committee. "They have taken the free market out of the free market."

"We no longer have a free market in the United States, we have a government controlled free market," Bunning said in an interview. Paulson, a former chief executive officer of Goldman Sachs Group Inc., "is acting like the minister of finance in China."

"No company fails in communist China, because they're all partly owned by the government."
Socialism For The Rich

Nouriel Roubini launched a scathing and well deserved attack on Paulson today. Inquiring minds may wish to consider Comrades Bush, Paulson and Bernanke Welcome You to the USSRA (United Socialist State Republic of America).
The now inevitable nationalization of Fannie and Freddie is the most radical regime change in global economic and financial affairs in decades. For the last twenty years after the collapse of the USSR, the fall of the Iron Curtain and the economic reforms in China and other emerging market economies, the world economy has moved away from state ownership of the economy and towards privatization of previously stated owned enterprises. This trends was aggressively supported the United States that preached right and left the benefits of free markets and free private enterprise.

Today instead, the US has performed by far the largest nationalization in its history. By nationalizing Fannie and Freddie the US has increased its public assets by almost $6 trillion and has increased its public debt/liabilities by another $6 trillion. The US has also turned itself into the largest government-owned hedge fund in the world: by injecting a likely $200 billion of capital into Fannie and Freddie and taking on almost $6 trillion of liabilities of such GSEs the US has also undertaken the biggest and most leveraged LBO (“leveraged buy-out”) in human history that has a debt to equity ratio of 30 ($6,000 billion of debt against $200 billion of equity).

" Socialism" is indeed alive and well in America; but this is socialism for the rich, the well connected and Wall Street. A socialism where profits are privatized and losses are socialized with the US tax-payer being charged the bill of $300 billion.

This biggest bailout and nationalization in human history comes from the most fanatically and ideologically zealot free-market laissez-faire administration in US history. These are the folks who for years spewed the rhetoric of free markets and cutting down government intervention in economic affairs. But they were so fanatically ideological about free markets that they did not realize that financial and other markets without proper rules, supervision and regulation are like a jungle where greed – untempered by fear of loss or of punishment – leads to credit bubbles and asset bubbles and manias and eventual bust and panics.

The ideologue “regulators” who literally held a chain saw at a public event to smash “unnecessary regulations” are now communists nationalizing private firms and socializing their losses: the bailout of the Bear Stearns creditors, the bailout of Fannie and Freddie, the use of the Fed balance sheet (hundreds of billions of safe US Treasuries swapped for junk toxic illiquid private securities), the use of the other GSEs (the Federal Home Loan Bank system) to provide hundreds of billions of dollars of “liquidity” to distressed, illiquid and insolvent mortgage lenders, the use of the SEC to manipulate the stock market (restrictions on short sales), the use of the US Treasury to manipulate the mortgage market (Treasury will now for the first time outright buy agency MBS to manipulate and prop up this market), the creation of a whole host of new bailout facilities (TAF, TSLF, PDCF) to prop and rescue banks and, for the first time since the Great Depression,to bail out non-bank financial institutions ...
Only The Beginning

Minyanville's Mr. Practical weighs in with Death of Fannie, Freddie Only the Beginning. Following is a large snip but inquiring minds will want to read the entire piece.
As the world celebrates the US government's takeover of Fannie Mae (FNM) and Freddie Mac (FRE), a few thoughts from someone who told you 2 years ago that this would happen. For those few who dare to see past the market's immediate positive reactions, this is all a very long-term negative for the U.S. and the world in general.

The following 3 bullet points were written by Alex Barron of Agency Trading Group:

"1. From a philosophical economic standpoint, what the government has done is the biggest move yet in the direction of socialism, and has prevented the free market from working itself out.

What was needed was not a conservatorship, but a restructuring. This means allowing investors who took the risk of investing in Fannie and Freddie in exchange for a potential reward to absorb the losses - not the taxpayers.

This would basically consist of allowing the equity and preferred equity to get wiped out and convert every $1,000 of debt to some conservative combination of debt and equity such as $500 of debt and $500 of new equity. This would effectively allow Fannie and Freddie to become “well-capitalized,” and would also allow the previous debt-holders to absorb future losses in their new equity.

2. From a financial standpoint, what was needed was to completely privatize the economic functions of Fannie and Freddie, not have the government stepping in to buy securities in the open market and helping the GSEs provide more un-economic mortgages.

In order to get out of a hole, you first need to stop digging. So, to get Fannie and Freddie out, the first thing they need to do is to stop buying more un-economic mortgages. As long as home prices are dropping -- and they will continue to drop as long as REO (bank -owned) inventories are growing -- the risk of losing money by lending to someone buying a home exists.

The only way to minimize that risk is by demanding a higher down payment, higher interest rates, and lending only to highly qualified borrowers. A private entity would eventually do this, or else it would go bust. A public mortgage lender will simply continue to lend money at low rates in order to provide “affordable housing” and “expand homeownership” - and have the taxpayer absorb the losses down the road.

3. From a moral hazard standpoint, this sends the strong signal that the government won't require anyone deemed “too big to fail” to pay the piper. Instead, the government will bail them out by simply printing money. This will cause a long line of people to “position themselves,” as Pimco euphemistically put it this morning, for a handout. The amount of inflation that will follow shouldn't surprise anyone.

Now, if you assume that those with capital are logical, that they can discern between a good investment and bad (which is logical since they accumulated money in the first place), then it must be illogical for the government to step in and take their place. If you understand that then you understand how we got in such a mess: the government decided that everyone should have access to cheap loans when savers, savvier investors who have accumulated money, said no.

I also said the the government would, ironically, somehow garner even more power with their policy errors. So socialism is growing and socialism means no future growth....at best.

The next devaluation (after the deflation cycle which is just now going from the denial phase to the "get me out" phase) will be a doozy. This is when the Fed plays its last card (probably not for a year or two) when the deflation cycle reaches bottom and they must monetize all debt.

I wish I could stay around for Minyans to describe that situation. But my time has passed. As we go into this next stage of deflation I am hunkering down here in Japan.
Misguided Calls For More Regulation

Roubini is correct about what is happening. We are indeed rapidly becoming the United Socialist State Republic of America. Furthermore, Roubini has been in front of this mess for as long as anyone as to what will happen. I have high respect for Roubini and have learned from him.

However, as right as he is about what is happening, and as right as he is about what is coming, Roubini cannot possibly be more wrong about what went wrong and who is to blame. I do not believe he will take what I am about to say personally. It certainly is not meant to be taken personally. But ....

The problem is not the "fanatically and ideologically zealot free-market laissez-faire administration."

Nor is the problem "ideologue regulators who literally held a chain saw at a public event to smash unnecessary regulations”.

Roubini Is Dead Wrong

It is a simple truth that the solution and the problem cannot be one and the same. Ironically, Roubini rails against the lack of regulation when it was regulation that created this mess!

The fact of the matter is there does not need to be regulation of Fannie Mae or Freddie Mac because neither should have existed in the first place. It was government meddling in the free markets that created Fannie and Freddie.

Government meddling in the free market will always blow up. No matter how many government regulators one threw at Fannie or Freddie, both were going to blow up sooner or later.

Ownership Society Mentality

Ownership society mentality is to blame. The HUD, FHA, Fannie, Freddie, and hundreds of affordable housing programs all came out of "ownership society" type thinking. This culminated into what Roubini is now masterfully railing against.

Sponsorship of such entities creates a problem that regulators can never get right. The bureaucratic mission inevitably takes on a life of its own. It is foolish to expect otherwise.

Government promotion of housing put an artificial bid on housing that a free market never would have. That artificial bid had the exact opposite effect of what was intended. In other words, every government sponsored affordable housing program raised the price of housing. Regulation could not fix that basic flaw and eventually the model blew up with ever increasing efforts to keep the ponzi scheme operative. Ponzi schemes always blow up as soon as but not before the pool of greater fools runs out.

Insolvency At The FHA

Some blame the problems of the FHA on the fact that the FHA was forced to take seller financed down payments. NO! The problem was and remains the very existence of the FHA itself. No possible amount of regulation or regulators can circumvent every problem or distortion that may arise by the creation of programs that should never have existed in the first place.

The solution to all the above problems is simple: Eliminate government sponsorship of housing. In other words, abolish the FHA, the HUD, Fannie Mae, Freddie Mac, Ginnie Mae, and every silly program on the books to create affordable housing.

Government Sponsorship Of Rating Agencies

Many blame lack of regulation for the incredible fiasco at the rating agencies. The simple reason Moody's, Fitch, and the S&P do such a miserably poor job is government sponsorship.

I am stunned by the ridiculous solutions that some people I otherwise respect have come up with for this problem. The solution is easy: End government (SEC) sponsorship of the big three. It is far past Time To Break Up The Credit Rating Cartel.

If Moody's, Fitch, and the S&P had to survive based on how good their ratings were instead of a model where the SEC says they have to rate everything, the problem with rating agencies would be cleared up overnight. Once again, no amount of regulation can possibly cure flaws that arise out of government sponsorship.

The Fed Is The Problem

Senator Bunning is calling for the resignation of Paulson and Bernanke. This is easily understandable because Bernanke is nothing but a complete academic fool. However, Bernanke's resignation is the wrong solution. If Bernanke resigned he would be replaced by some other clown with some other bureaucratic mission that would cause a different set of problems down the road.

It is critical to realize that Bernanke, although a fool, is nothing but a scapegoat. The problem is the creation of the Fed itself, a blatant intrusion on the free market. We do not need to get rid of Bernanke directly. The correct solution is to abolish the Fed itself. Sadly, the only one in Congress that seems to understand this, and that person is Ron Paul. Even sadder is the fact that highly respected economists cannot or will not see this problem for what it is.


The Greenspan Fed, ever wanting to "help" banks make more profits, instituted a policy of sweeps. For a primer on sweeps please read Where's the Cash?. Inquiring minds should also read You Know The Banking System Is Unsound When....

In the above article I listed 25 reasons the banking system is unsound.

Here are points 1, 24, and 25.
1. Paulson appears on Face The Nation and says "Our banking system is a safe and a sound one." If the banking system was safe and sound, everyone would know it (or at least think it). There would be no need to say it.

24. There is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Indymac will eat up roughly $8 billion of that.

25. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.
Every penny has been swept out and lent out (10 times over) thanks to the Greenspan Fed and fractional reserve lending. What cannot be paid back will be defaulted on. If you did not know it before, you do now. The entire US banking system is insolvent.

Is the problem lack of regulation or is the problem fractional reserve lending and authorizing someone like Greenspan to allow something like sweeps?

Securitization Problems

The originate to securitize model has blown sky high. Are "free-market laissez-faire policies" to blame? The answer is no. In a free market with a sound currency, the originate to securitize model, aided and abetted by the rating agencies, would never have occurred in the first place.

The same holds true for Citigroup's $500 billion to $1 trillion it is hiding off balance sheet in SIVs. The same is true for absurd leverage that is going to send Lehman to bankruptcy or bailout.

None of the above can be blamed on "free-market laissez-faire policies". Every one of them can be blamed on fractional reserve lending and the ability to create money (credit really) at will by borrowing it into existence.

Roubini's Brilliant Rant

Nouriel Roubini made a brilliant rant. It was clever and catching. He is also correct on one major point: We are indeed becoming the United Socialist State Republic of America.

However, one of the reasons we are becoming the USSRA is that highly respected persons such as Roubini blame failures on the free market instead of where the blame lies: misguided regulation and manipulation of the free markets.

Instead of correcting the problem, which in this case would mean elimination of the Fed, elimination of the GSEs, elimination of government sponsorship of the rating agencies, elimination of the FHA, etc etc etc, Roubini wants to add regulation on top of regulation on top of regulation. The foolishness of such a scheme should be self apparent. Who is regulating the regulator responsible for overseeing the regulator?

My Challenge To Roubini And Others

Instead of more regulation, let's work on coming up with a solution and a time table for what ails the US. That solution needs to be based on free market ideology as opposed to never ending regulation. In other words how do we dismantle the system in place today, as fast as possible, with the minimum amount of disruption. At a bare minimum how and in what timeframe can the Fed and fractional reserve lending be eliminated or phased out with the least possible disruption.

Nouriel, are you game?

Mike "Mish" Shedlock
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