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The Return of FDR, Part II

The abacus is one of the world’s oldest accounting devices. Its earliest use traces back to the Persian Empire circa 600 B.C.

The English version takes its name from the Hebrew word abaq, meaning “dust.” Before the dawn of sliding beads and counters, the abaq was a simple sand-covered board. Merchants and moneymen would draw their figures in the sand with a finger.

Thanks to the credit crisis, the underpinnings of modern-day finance feel as fragile as the ancient abaq. The free-market foundations of the global banking system have been blown hither and thither, like sand figures on a windy day.

There are many ironies in this. Allen Mendelowitz, former chairman of the Federal Housing Board, points to one in regard to the White House. The Bush administration began as “social conservatives,” Mendelowitz notes. They will finish as “conservative socialists.”

It’s hard to argue with this when Uncle Sam is force-feeding a quarter trillion dollars (for starters) into the banking system. The New York Times has the details:

Of the $250 billion, which will come from the $700 billion bailout approved by Congress, half is to be injected into nine big banks, including Citigroup, Bank of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The other half is to go to smaller banks and thrifts. The investments will be structured so that the government can benefit from a rebound in the banks’ fortunes.

In addition to the above, the FDIC has followed Europe’s lead in offering unlimited guarantees on all non-interest-bearing U.S. deposits. (This is meant to reassure American businesses that their operational bank accounts, no matter how large, are safe.) And, finally, the U.S. is expected to extend a three-year guarantee on all newly issued bank debt.

What does this mean? If you pay U.S. taxes, it means you will soon own a piece of nine major banks — whether you want it or not. You don’t have a say in how this investment will be handled. No one has a clue as to whether it will be profitable, or how much it will ultimately cost. (Maybe trillions.) But don’t worry… it’s all for your own good.

London Leads the Way

It was not the U.S., but Europe, that shaped the path of the global nationalization wave. American authorities felt squeamish about messing with the free market, and that squeamishness held them back as the credit crisis unfolded. Europe broke the logjam.

Standing on principle sounds like a good thing, and normally it is. But a half-hearted commitment without strategic action behind it is the worst of both worlds… and that’s what we had in this case. Treasury and Congress were more paralyzed by their principles than informed by them, and indecisiveness emanating from Washington only fueled the market’s panic.

So Europe, feeling more at home with socialist tendencies to begin with, stepped firmly to the plate. It was Prime Minister Gordon Brown of the UK (heretofore a great bumbler) who seized the reins.

When London effectively said, “Right — we’re going to bloody nationalize and stop the bleeding,” it snapped the rest of Europe into action.

Like a dam breaking, the injections and guarantees came flooding forth in Britain’s wake:

  • United Kingdom: $434 billion in bank guarantees, $64 billion in capital for three major UK banks.
  • France: $435 billion in senior bank debt guarantees, $54 billion to recapitalize French banks.
  • Germany: $544 billion in interbank lending guarantees, $109 billion in stakes for German banks.
  • Spain: $136 billion in new debt issue guarantees, $41-$68 billion to buy “high-quality bank assets.”

It didn’t take long for Europe’s bailout spree to run into the trillions. (How will they pay for all this? No idea.) And those countries listed are only a sample; other governments around the globe, as far away as Hong Kong and Australia, have gotten into the mix.

With the winds blowing so hard in this direction, the U.S. had to nationalize, too. Harvard economist Ken Rogoff thinks we had no choice. “The Europeans not only provided a blueprint, but forced our hand,” Rogoff says. If the U.S. hadn’t taken similar action, deposits would have fled American shores, accelerating the downward spiral at home.

Paulson Blows It

Treasury Secretary Hank Paulson didn’t want things to go this way. As the ex-head of Goldman Sachs and a die-hard free-markets advocate, he didn’t want to become a de facto socialist (buying stakes in the banks) any more than George Bush did. But he and Bush have no one none to blame but themselves (and maybe Greenspan) in being forced to swallow this bitter pill. Commitment to principle is worthless without the substance and the means to defend it.

As the banking crisis unfolded — a crisis of Wall Street’s making, — the Treasury failed to come up with any true alternative solutions. Paulson utterly failed the Einstein test, forgetting that “no problem can be solved from the same level of consciousness that created it.”

In hindsight (which is always 20/20), Paulson was probably a bad choice to run things in the first place. As Soros points out, he “represents the very kind of financial engineering that has gotten us into this trouble.”

What’s worse, Paulson’s big idea never actually made sense. His first thought was to buy back (with taxpayer funds) the very toxic assets he had once helped create… without any logical argument as to how this would help solve the problem.

It soon became clear the Paulson proposal was a fudge — and a poorly sold one to boot. If Treasury paid fair value for toxic assets, the banks would have to mark their huge losses to market and own up to insolvency. That would only have accelerated the panic.

If the Treasury deliberately paid too much, on the other hand, the banks’ balance sheets would have improved… but it would have been a sham transaction. This “solution” would thus have been a de facto transfer of taxpayer money into the hands of the banks, with no equity stake in return.

What Paulson really wanted, it seems, was “capitalism on the upside and socialism on the downside” writ large. He wanted to protect bank shareholders to as great a degree as possible, even after the banks were seen to be juggling hand grenades of their own making… and to avoid shareholder dilution even as huge sums of taxpayer money were spent.

Those in support of nationalization thus reason it something like this:

  • When the entire world is deleveraging, only governments are powerful enough to leverage up (Buffett).
  • Uncle Sam has to commit hundreds of billions (maybe trillions) no matter what, as the alternative is no real alternative at all (total systemic collapse).
  • If taxpayers have to pony up no matter what, they might as well have an ownership stake.

Free Markets on the Back Foot

Now that we’ve bitten the nationalization bullet, the next step is to “rebuild the financial system,” as Volcker puts it.

If there were a master checklist, the first item would be “stop the panic.” With that box checked off (assuming it is checked off), the next item would be “recapitalize the banks”… the process that is in the works as you read this.

After that, a few candidates vie for next-up priority: sorting out the good banks from the bad banks (and shutting down the bad ones as quickly as possible); dealing with the mortgage problem on the consumer side; figuring out how to arrest the free-fall in home prices; figuring out how to get credit and commerce flowing again.

It’s all a very top-down, heavy-handed way of going about things. These are the days of mass intervention and bureaucratic innovation. Free-market solutions are on the back foot. Government solutions are No. 1 with a bullet. (Make that a paper currency bullet.)

It’s a remarkable turn of events. Things have gotten so gummed up that even aggressive free-market advocates — yours truly included — now have little to say in defense of principles long held dear. We know the government is going to bungle things badly moving forward. But will they bungle them even more than the free market did? Maybe… but at this point it’s hard to see how.

In letting Wall Street run rampant, we screwed up. The greatest beneficiaries of the free-market system got so greedy and stupid — with the world cheering them on — that they all but killed the goose that lays the golden eggs. Now you and I, as taxpayers and voters and citizens, are paying for our lack of vigilance.

The Trouble With Leadership

It’s hard to know what to wish for more in the days ahead: leadership or lack of leadership.

Historically, America seems to do better when Congress is gridlocked. The pols can’t do as much damage when they are constantly at each other’s throats.

But in times of real danger, chaos and buffoonery at the top can be frightening. (Note W’s confidence-inspiring contribution to the public record: “This sucker could go down.” That’s one for the history books.)

Paul Volcker, for one, pines openly for a steady hand on the tiller. His interview last week ended on a nostalgic note:

I have been reading about Roosevelt’s fireside chat when the banks were all closed in 1933. And it is the most convincing speech he ever made. Eight days I think, maybe four days after he was inaugurated. My Fellow Americans, I want to talk to you. I want to talk to you. [There are] bankers who know a lot of this, but I want to talk to a lot of other Americans who don’t understand it all. Then he, in very simple terms he explained what the difficulty was.

It’s an interesting point. He said, we’re going to open up the banks again, the ones that are in good shape. We’re going to open them up basically next week. They opened them up next week, the ones that were conceptually in good shape – I don’t think anybody knew whether they were in good shape or not, how could you know after seven days – the banks they opened up, people brought their dollars back and reopened their deposits because they had confidence! They had confidence that Roosevelt had fixed things up, and they believed him.

The next American president, be it McCain or Obama, will get a chance to reprise FDR’s historic role. Not exactly, of course, but in spirit… and he will get to do it sooner rather than later.

The “lame duck” nature of the current administration, coupled with the seriousness of the times, means the new man will be taking the psychological reins of the country as soon as the final vote tally is in. (If we have another “hanging chads” episode, prepare for martial law.)

Washington is already abuzz with talk of new stimulus packages — this time aimed at Main Street rather than Wall Street. More spending will come. More promises will come. Sadly, more foolishness and idiocy will come, too. This is all but guaranteed. The hour of big government — gargantuan government — is at hand.

So what might this all mean for the dollar… and for gold… and the “Green New Deal” headed our way?

We’ll explore that next…

Warm regards,


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