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Friday, September 26, 2008

A Guide to Financial Turmoil


Those were the words on the cover of The Hitch-Hiker's Guide to the Galaxy, a collection of helpful travel tips for the intrepid interstellar traveler described in the comic novels of Douglas Adams.

Maybe a copy of that book should be placed on the desk of the President and every Senator and Representative in Congress. A little panic might have actually been productive about three or four years ago and might have helped apply some brakes to the feedback cycles and fraud that have produced our current situation. As things stand now on September 25, 2008, the vast majority of the damage to be done by 30 years of flawed monetary, regulatory and political processes has already been done -- we just don't know how bad it will be.

Events are unfolding so quickly, reaction times of the Federal Government and Federal Reserve really don't matter. Here are the highlights for just one 36 hour period:

1) 2:35pm EDT 9/24 -- a presidential candidate decided to suspend his campaign to "focus" on the economic crisis (#1)
2) 1:02pm EDT 9/25 -- by a 370-58 vote, the House passed legislation granting $25 billion in relief to automakers (#2)
3) 2:05pm EDT 9/25 -- Congressional leaders announced they thought an accord on a bailout plan had been reached (#3)
4) 5:44pm EDT 9/25 -- Congressional discussions reach an impasse on the bailout plan
5) 9:39pm EDT 9/25 -- Washington Mutual is seized by the FDIC and sold to JPMorgan, a $307 billion collapse (#5)

Think about those events for a second. A seven hundred billion dollar figure has been floated in front of the public for two weeks as the cost of the all-encompassing rescue plan. Theories abound as to how this number came about and why it's being used:

* a patronizing attempt to acclimate Americans to the eventual costs to be announced in stages
* a cynical lie to the sheep who need to hear just enough to be spooked but not enough to revolt
* the players involved flat out don't have a better number

If true, the approach of the first theory makes as much sense as docking a schnauzer's tail one inch at a time -- it really doesn't make it any easier on the schnauzer. The second theory doesn't make sense either because both the Congress and President know the American public doesn't trust either of them already. Anyone paying any attention for the past three years knows the financial players involved know QUITE well that more then $700 billion is at stake -- that number may be off by an order of magnitude.

It really doesn't matter. Just focus on that $700 billion price tag and the cost of today's failure alone. The Washington Mutual collapse is forcing a takeover of a bank supposedly controlling THREE HUNDRED FIVE BILLION DOLLARS in assets by another colossal bank with absolutely ZERO anti-trust review by Congress or the Justice Department. It's worth mentioning that in the "old days", a piddly little $16 billion telecom deal like the purchase of PacTel by SBC generated ONE YEAR of state and federal hearings and haggling between the parties and the Justice department. In contrast, the failure of Washington Mutual triggered a regulatory decision that consumed 43% of the emergency funding total already communicated to the public before any final deal is even official.

The events of September 25, 2008 alone make it clear Congress, the President (ANY President) and the Federal Reserve will NEVER succeed at playing a game of catch-up to panicked world markets. The bogus price tags being thrown are a consequence of the catch-up approach.

It might be more productive for the players to take a deep breath -- quickly -- then convene ALL of the players including the Supreme Court to create a framework for creating a firewall between assets and accounts associated with the "real" economy and those tied to hedge funds, derivatives and junk mortgages. At this point, the broken financial systems in the United States bear an unfortunate resemblance to the broken health care system in the country. In healthcare, we've allowed coverage, delivery and payment systems for catastrophic care to merge with those for routine care, causing the uncontrolled costs of catastrophic care to prevent basic care from being obtained. In banking, dismantling regulations enforcing separation between investment and consumer / retail banking has allowed disasters on the investment side to contaminate the viability of systems providing basic checking and savings for consumers and simple working capital safety for small and medium business.

Why should the Supreme Court be involved? Take a look at Section 8 of the original Paulson plan. It explicitly granted $700 billion of authority under one unelected official and explicitly rejected any congressional or judicial oversight. That is flat out unconstitutional. The issues are too urgent to have incompetent Executive Branch appointees or Congressional members waste time proposing terms which would immediately fail any legal challenge. The market needs to have confidence that once new rules are promulgated, those rules will not only be fair but will stick and not be overturned. Any fixes to these problems will involve complex legal issues so those might as well be identified up front with advice from those that would field the challenges eventually.

What are the priorities this Federal triage team should establish?

1) ensuring confidence in individual checking / savings via the FDIC
2) ensuring protection for working capital accounts for small/medium business (even above $100k) to protect payrolls and routine payments to other businesses / creditors
3) recovery of bonuses / stock options / pensions from execs of bailed out firms
4) establishment of inflation-adjusted dollar limits AND calendar limits for any relief provided to ensure this bailout program cannot morph into the next Fannie / Freddie monstrosity
5) increased funding of the Congressional Budget Office to support dedicated auditing of all programs launched as part of the bailout spending
6) establishment and funding of a dedicated court system to speed prosecution of related criminal cases and resolution of civil / regulatory debates about ownership, creditor pecking orders and dozens of other issues likely to arise from untangling the blizzard of paperwork produced by securitization
7) initiating reviews of "circuit breaker" mechanisms in stock markets (domestic and foreign) to ensure they can halt panics without interfering with fluctuations crucial to establishing transparent pricing

This crisis wasn't created in a day and cannot be solved with a single Congressional all nighter. It will continue to unravel for years. World markets might gain a higher degree of confidence in the path forward and be less likely to contribute to additional collapse if the effort conveyed any sense of prioritization and strategy -- preferably strategies which interacted with each other to produce positive synergies instead of placating one constituency at the expense of another. The current panic-stricken problem solving is only magnifying the sense of favoritism and unfairness seen by individuals and increasing uncertainty in world markets by seeding doubt about American companies and assets and our underlying currency.


#1) http://www.bloomberg.com/apps/news?pid=20601087&sid=abvT79Aou2Pw

#2) http://www.thestreet.com/story/10439329/1/house-authorizes-25-billion-in-loans-to-auto-industry.html


#4) http://www.latimes.com/news/nationworld/washingtondc/la-fi-bailout26-2008sep26,0,32401.story

#5) http://www.latimes.com/business/la-fi-wamu26-2008sep26,1,7648045.story