Monday Morning End to Wall St Socialism?

Last week found the Treasury literally on its knees begging the UK bank Barclays to rescue Lehman. Reports this am are that the Treasury, Fed and other regulators (working overtime at our expense) have given up on finding a buyer for an intact Lehman and now look to sell off parts of the firm, winding down the balance. Well find out soon enough, probably tomorrow.

Here we go again. What is this all about? What does this mean to US taxpayers? Is the preservation of these investment banks in the public’s interest?

One may consider the simplicity of the Chrysler bailout or the complexity of Wall St deals; they reflect the same change of order - government-sponsored socialism directed at frail or failing private industry. "We’re too big to fail," regulators are told by victims of poor judgement or other nuisances. Those who have losses want help; naturally a disaster of unimaginable consequences will be the result if they don’t get it. And most of the time - in the case of Wall St, because of the complicity, the near incestuous, clubby connection between the Federal Reserve, Treasury and the street’s major firms, and the pressure from major offshore investors such as China or the Saudis - they get it.

This time Treasury Secretary Paulson has resolutely stuck to his position that no taxpayer money goes to the Lehman bailout. Not really. Some of it already has. Still, this statement delivers hope. And if there is to be a change in government largess toward Wall St types it is because the growing public outrage is deafening. One may argue with the Treasury’s role but the Fed’s involvement, a mission-creep far from its original mandate of price stability, the role of Wall St deal maker at risk, is to some observers like retired St Louis Fed president Bill Poole, nothing if not appalling.

In March the Fed - in our view without any authority to do so - stepped in to manage the sale of a distressed Bear Stearns. The Fed extended a loan of $29bln to JPMorgan as an enticement for them to buy Bear. As collateral Morgan offered troubled mortgage-backed securities that were marked-to-market at $30bln but no one really knows what they are worth (at this writing there is no market for these securities). That is the problem for the taxpayer. The Fed will lose something, maybe eventually a lot. The Fed is a government bank and usually earns a surplus which is remitted to the Treasury. The losses will come out of that surplus, a taxpayer loss.

Next was the Fannie/Freddie bailout. This one was not so much the moral stretch due to the quasi governmental nature of both yet it will still cost us a fortune.

Finally, we will hear from other Wall St firms in the near term, perhaps next week as they too cry for help.

Why is it that we as taxpayers are asked to socialize the losses of fat cats whose third home was bought on the back of our recent mortgage, the same clowns who are now in a panic? Part is as noted above - the incestuous relationship between Wall St and its regulators, especially the Fed; it is done by reflex, aiding your pals. The factor driving the panic is the recent boom in what one keen observer called financial instruments of mass destruction - derivative securities. These are such things as "default swaps" and other arcane exercises that banks, hedge funds and other use to bet for or against certain market moves. The value of these instruments is in the trillions of dollars; most of this activity is unregulated. The fear is due to the size and complexity of it all. One party’s inability to honor its commitment could topple the rest. Or so we are told.

This fear is not as real as it is manufactured, and by guess who? Wall St types. A boatload of observers outside the club maintain otherwise - painful yes but a cataclysm? No way. One of the most credible of these being professor Alan Meltzer, a veteran economist at Carnegie Mellon. "I’ve heard this so many times," says Meltzer. "I don’t believe it." Janet Tavakoli, a Chicago-based consultant on derivative securities scoffs at the idea. Let’s find out she says, "It’s a good time to have a test case."

How then did we get into this mess? Greenspan’s mis-management of the Fed provides the beginning (see our Sep/2 sketch). The US government’s lack of understanding and lack of regulation of the derivatives market provides the ending. So things got tough for the financial masters of the universe. They now look to us for sustenance. As taxpayers we can no longer enable this behavior. Firms that may fail after doing stupid things should fail. There will certainly be more pain for the speculator, including the homeowner, but, the adjustment will be accelerated and then we can recover with a clean slate and a healthier economy. Finally, the government’s role is not to dole out our money to failing firms but to come to better understand the "maneuverings" of Wall St types and affect reasonable regulations aimed to prevent the mess in the first place. Where is Henry Gonzalez when we most need him?

Robert Craven