Last Nail in the American Free Market Coffin

What a week it was in American and world financial markets. Conditions became so disastrous that at the end of the week the American government, lead by the super active pair of Wall Street’s favorite buddies, err, excuse me, I mean public servants, Hank Paulson and Ben Bernanke, announced a $700 billion emergency bailout package. This is on top of the $500 billion or so already tossed into the black hole of “creative finance”.

Since this is a Federal government estimate of the funds that will required we can expect the amount to end up being multiples of the original $700 billion. Pretty soon we will be talking real money here. The American free market coffin is getting the cover nailed down good and tight.

Paulson and Bernanke have been working hard sticking their fingers in the dike trying to slow down the meltdown resulting from the smart guys on Wall Street having used massive amounts of over leveraging that has nearly tanked the American financial system. The financial black swans have been circling around just out of sight for some time and are now appearing one after the other. It seems the smart guys on Wall Street and at the banks and hedge funds didn’t get their risk calculations down quite right.

The events over the past few weeks have been building for many years, then last week broke with blinding speed. First the Fed and Treasury, lead by Hank Paulson and Ben Benanke, forced the sale of Bear Stearns, along with granting Morgan Stanley, the purchaser, a $29 billion Uncle Sam backstop. Then our fearless twosome in effect nationalized the US housing mortgage market by having good old Uncle Sam take over Freddie Mac and Fannie Mae. They then took a break by allowing the 158 year old Lehman Brothers to crash into bankruptcy (with over $600 billion of liabilities on its books), and then rounded out the action by making a $85 billion emergency loan to AIG.

Sounds like fun, eh? What a feeling it must be to decide who will live and who will die.

Finally realizing that a few hundred billion here and a few hundred billion there wasn’t going to get the job done Paulson and Bernanke decided to fire the big bad bazooka and to ask congress for a cool $700 billion so that the Treasury can buy up all of the toxic waste still held by the commercial banks and the two investment banks left standing in American and are working, I’m sure, at this very moment to hammer out the details. Hank Paulson didn’t earn his nickname of “Hammering Hank” for nothing. And Helicopter Ben has achieved his dream job of raining down cash to his Wall Street friends by throwing huge wads of taxpayers cash right out of the Fed helicopter’s open door.

While one has to give Paulson and Bernanke high marks for effort I have to wonder if loading up the US government with junk, more junk, stinking junk, toxic waste investments doesn’t set the stage for an even greater disaster. For one big thing for a nation that is already the greatest debtor nation in the world to take on what will probably amount to several trillions of dollars of additional debt is going to set off alarm bells in the foreign exchange markets. As American free market capitalism is to be replaced by a heavy dose of socialism and even more regulation you can expect the US dollar to get trashed.

I repeat. The emergency bailout now being put together in haste by the Washington big shots may well set off a mass exit from the dollar. In my opinion, it may well be the last nail in the coffin of American free markets. Politicians will no longer be able to repeat the nonsense that America still has the most free and most competitive markets in the world. The sad truth that this is no longer true will be there for all to see.

McCain-Palin represent everything wrong with politics 2008 style. I can’t believe that old man said only last week that our economy is structurally sound. McCain just started saying that he favors regulation in the past couple of weeks. How is it that McCain is going to put in new regulations, when he plans to appoint Phil Gramm, the man who authored the de-regulation, as Secretary of the Treasury? McCain’s take on it, and his comment today that he still thinks “the fundamentals of our economy are strong”, has drawn criticism from liberal and pro-Obama bloggers , who think it’s further proof that electing McCain (a “clone of George W. Bush” ) would spell disaster for the economy.

With a hard fall in the dollar and the resulting inflation at home Americans will not be able to maintain their current living standard. America’s financial crisis has triggered a severe credit crunch that is making the US recession worse, while the deepening recession is leading to larger losses in financial markets, thus undermining the wider economy. There is now a serious risk of a systemic meltdown in US financial markets as huge credit and asset bubbles collapse. The risk is still there even as the huge bailout plan is being implemented. Who can believe that the government will be able to manage well all of the financial institutions that it is getting directly involved with?

Investors need to wake up, so says Niall Ferguson, the Scottish professor of history at Harvard, who draws an ominous parallel between today’s markets and conditions prior to the financial collapse triggered by the outbreak of World War I in 1914. Investment bankers leveraged their capital 30 times or more compared to the 10 times or so permitted regulated banks. Financial engineering produced ever more esoteric and complex instruments which even the financial engineering boy wonders could not fully understand.

Market prices include a large illiquidity discount on top of the discount due to the credit and fundamental problems of the underlying assets that are backing the distressed financial assets. Capital losses have lead to margin calls and further reduction of risk taking by a variety of financial institutions that are now forced to mark to market their positions. Markets are extremely edgy and international investors are increasingly risk averse.

The US needs to borrow every year almost another trillion US dollars. The “mother of all bailouts” will increase that amount to such a degree that the US may be considered a sovereign risk on foreign exchange markets. As the US dollar’s position as the premier reserve currency in the world erodes Americans should not believe that they will be excluded from experiencing an Argentina like inflationary experience. Before the Argentines were able to get inflation under control their middle class had been decimated.

America has brought itself to the edge of one of the greatest disasters that a nation can confront. When the world loses confidence in a currency the sell off in the currency out of favor can bring a resulting financial turmoil that spirals totally out of control. America will have to be lucky indeed to make it through the current crisis and bailout without extreme damage to the American “way of life”. The new American way of life could be quite unpleasant in a socialistic America no matter who the next President may be.

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