Survival of the Weakest

There was a very interesting pair of articles over the weekend on the New York Times by Michael Lewis and David Einhorn called How to Repair a Broken Financial World. I agree with much of what they have to say.

Here are a few snips from the article describing some of the things the Fed, Treasury, and SEC have done wrong.

The Federal Reserve and the Treasury have already accepted, on behalf of the taxpayer, just about all of the downside risk of owning the bigger financial firms. The Treasury and the Federal Reserve would both no doubt argue that if you don’t prop up these banks you risk an enormous credit contraction — if they aren’t in business who will be left to lend money?

But something like the reverse seems more true: propping up failed banks and extending them huge amounts of credit has made business more difficult for the people and companies that had nothing to do with creating the mess. Perfectly solvent companies are being squeezed out of business by their creditors precisely because they are not in the Treasury’s fold. With so much lending effectively federally guaranteed, lenders are fleeing anything that is not.

Rather than tackle the source of the problem, the people running the bailout desperately want to reinflate the credit bubble, prop up the stock market and head off a recession. Their efforts are clearly failing: 2008 was a historically bad year for the stock market, and we’ll be in recession for some time to come. Our leaders have framed the problem as a “crisis of confidence” but what they actually seem to mean is “please pay no attention to the problems we are failing to address.”

In its latest push to compel confidence, for instance, the authorities are placing enormous pressure on the Financial Accounting Standards Board to suspend “mark-to-market” accounting. Basically, this means that the banks will not have to account for the actual value of the assets on their books but can claim instead that they are worth whatever they paid for them.

This will have the double effect of reducing transparency and increasing self-delusion (gorge yourself for months, but refuse to step on a scale, and maybe no one will realize you gained weight). And it will fool no one. When you shout at people “be confident,” you shouldn’t expect them to be anything but terrified.

There are also a handful of other perfectly obvious changes in the financial system to be made, to prevent some version of what has happened from happening all over again. A short list:

Stop making big regulatory decisions with long-term consequences based on their short-term effect on stock prices. Stock prices go up and down: let them.

End the official status of the rating agencies. Given their performance it’s hard to believe credit rating agencies are still around. There’s no question that the world is worse off for the existence of companies like Moody’s and Standard & Poor’s. There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided.

I agree with Einhorn and Lewis on the above points and have talked about the rating game scam on many occasions, most notably on September 28, 2007 in Time To Break Up The Credit Rating Cartel. But instead of getting rid of the big three rating agencies or breaking them up, the SEC is talking about adding more bureaucratic oversight and rules that will solve nothing. 

Moody’s, Fitch, and the S&P could not possibly survive without government support. That’s how bad their ratings were and still are. But interestingly enough, no one in authority wanted them to downgrade Ambac (ABK) or MBIA (MBI) for fear of repercussion in the bond market.

This is the epitome of the anemic protecting the weak.

And rather than let GM and GMAC go under, the Treasury Now Makes Subprime Auto Loans and the Fed opened up the TALF program to all borrowers including auto dealerships. I surmise that as a result of these programs, the Fed Destined Is To Become World’s Largest Auto Dealership.

Everywhere you look the weak are being propped up for one reason or another. Take a good look at AIG. There is no reason for the government to be pouring over a hundred billion dollars to prop up this sick puppy. I suspect but cannot prove the reason this was done was that Goldman Sachs (GS) and or JPMorgan (JPM) were on the other end of AIG’s credit default swaps gone bad. Whatever the reason, taxpayers are footing the bill.

Perhaps we find out eventually but the Fed and the Treasury are refusing to disclose what they are doing in spite of assuring Congress there would be transparency. Sadly, there is no transparency and no accounting of what either department is doing.

In response, Bloomberg Sues Fed to Force Disclosure of Collateral and Fox News Business Network Sues the Treasury Department for Failure to Respond to Freedom of Information Act.

Fed’s Yellen supports "experimental approaches"

On Sunday the Fed’s Yellen announced support for "experimental approaches" to prevent deflation. Here is my summary of Yellen’s proposal.

1) Yellen wants to "pull out all the stops to ensure an extended period of stagnation does not occur"

2) Yellen wants to do this even though the "approaches are experimental, and there is a great deal of uncertainty concerning their likely effects."

3) To top it off, Yellen admits that an extended period of stagnation will occur anyway: "Even with vigorous Fed action to restore credit flows, an extended period of economic weakness is likely."

Everywhere you look, the actions and statements by the Fed, the Treasury, and the SEC are tantamount to a policy of "Survival of the Weakest". Such policies cannot possibly work in nature, or the economy. Recessions and depressions need to clear the weak, the incompetent, and the superfluous. Attempts to keep them alive will only zombify the economy and push off the recovery.

Mike "Mish" Shedlock