Simply Stunning

Throw a dart; it lands in the middle of a Des Moines pig farm. Ask the proprietor - "Do housing prices always go up?" "What? You nuts sonny? Been around much? Everything goes in cycles you dumb bunny." Indeed, and yet despite the fancy conduits, models, and the rest of the Rube Goldberg contraptions employed in the sub-prime crisis, no one factored in that truth.

Now we have seen the weekend decision to copy Darling’s plan. In Britain the government can decide to do something and, thanks to the parliamentary system, it becomes law in an instant. That is what happened.. Most striking about what might now be called the Brown-Bush, Darling-Paulson plan is that it represents an explicit repudiation of the first US administration proposal that passed through Congress two weeks ago. The old country to the rescue!

Now we have not just US and UK partial or majority ownership of their lending institutions, but world wide sovereign support of their respective lending institutions. This is simply stunning. How did we get here? What lies ahead?

Over the next week we will offer three installments, simplifying and explaining just what happened, and in some detail. However, in the most distilled sense: Greenspan’s mismanagement of the Fed created excess liquidity; it had to go somewhere. Most went into the best inflation hedge around - housing (not business investment). The twins under pressure from Congress supported the sub-prime mortgage market, converting risky loans into the near equivalent of Treasury bonds - but with higher returns. Lenders first resisted intimidation from ACORN and the like, but then went along willingly, discovering that the profits were as easy to come by as they were bloated. Wall St did its part to package the stuff; end line investors were happy. Problem is that no one bothered to call the Des Moines farmer.

Over the near term our core concern is that some nations themselves will have to be bailed out in order to bail out their own financial sector! Iceland of course comes to mind. In Iceland, the funding gap of the banking sector exceeds the fiscal capacity of the government. Period. There may be others; we will know before the year is out. If so this will call for an entirely new world bureaucracy.

Past that we want to believe that the state-ownership-and-control phase be as short as possible. History tells us that government is a dreadful owner and manager of anything. But then the idea is that this is all temporary. We want to believe that. And in the intermediate term the taxpayer may make a killing. This is certainly a real possibility. Yet key for now is to anticipate the new world financial landscape. Since the near collapse was due in large part to the old system of soft-touch regulation, or self regulation, or, in the case of the Democrats refusal to reform the twins - toothless supervision, we can assume that all will change before governments hand back the banks. What the banking industry now hopes will be necessary but minimal reform will likely be a comprehensive overhaul. We expect a world conference something on the order of the Bretton Woods of 64 years ago (created the IMF & World Bank) to sort these things out.

Robert Craven