Wednesday, October 08, 2008


Democrats say that this time is different. They say it is different because of deregulation, started in the Reagan years and continued in the George Bush years. The truth is that a horrible regulation, passed by democrats and enforced by Hank Paulson, is causing a great transfer of assets from "little boys" to the "big boys".

Throughout history, cash flow has been the key to success in business. Businesses can suffer catastrophic loses, lose tons of money, but stay in business and recover as a result of positive cash flow. Many a consumer, who paid too much for a car, has experienced this phenomenon. Car "owners" frequently go "under water" because a car depreciates in value dramatically, the moment it is driven off the lot. Consumers often owe more money than their cars are worth. However, we do not add insult to injury and take the car away at the worst of times if they are making the payments. If they make regular payments, over time, they climb back into the black.

In the condo rental business, condos that I purchased in 1996 were worth less than my loan balance after 9/11/2001. I was deeply underwater, but I made the mortgage payments and the values soared by 2005. Had Hank Paulson been in charge, after 9/11 he would have required me to sell my property in 2001 and realize huge loses which would have never been recovered.

Since Reagan's time, a number of new regulations have been passed. Regulations were passed that forced banks to make mortgage loans in the highest risk communities to the highest risk borrowers. The combination of low interest rates and unrestricted credit caused housing prices to soar. It became easy to pay too much and millions of people borrowed too much. November 2007, yet another new regulation took effect, FASB Rule 157. This accounting rule basically says that it does not matter what was paid for a house or if one intends to sell it soon, it must be valued it as if it must be sold tomorrow. Because banks, by design, work off highly leveraged capital, Rule 157 forces banks to sell assets when they go down in value. If you had to sell your house tomorrow? How much do you think you could get? Should the government be allowed to force you to sell tomorrow even if you are making timely payments?

While democrats and republicans are all to blame for this mess, it is painful to know that far more than a fair share of the blame is being heaped on republicans. One of my beefs is with gullible Americans who allow Obama to get away with blaming the crisis on deregulation. During times of stress, people want someone to blame; Obama knows he can divert the blame onto "big business" and the free market, because the complete story, including the major role of Fannie Mae and Freddie Mac, is a complicated story. Since Bush is a very unpopular President, it is easy to divert the finger pointing to him and in effect toward McCain, even though both men proposed reforms that were rejected by democrats.

It is not unusual for a significant number of businesses and households to be underwater during tough economic times. What is unusual is that Hank Paulson is insisting on "his solution" while businesses and families are being harmed. As Bob Tierman? said on CNBC this morning, the President has the right to suspend habeas corpus and the bill of rights during a national emergency but apparently FASB Rule 157 is sacrosanct.

With a stroke of a pen, rule 157 could be suspended. Even better, it could be modified. Only those very close to Hank Paulson could have known that he would be willing to use the stupid rules passed by democrats to rape and pillage. The mistakes made by democrats and then the support from them to pass the "Paulson solution" has given him all the cover he needs to cause a massive consolidation in the banking business (big losers and big winners being picked by Paulson and cronies).

As made evident during the Wachovia circus, CitiBank was to receive an investment from the government of 12 Billion Dollars in order to buy a bank recently valued at $78 Billion. WFC was willing to buy WB for about 12 Billion Dollars more than CitiBank would pay and without the 12 Billion Dollars of assistance from the government! Change the ridiculous mark to market accounting rules and WB could easily survive on its own. The shareholders would not be getting raped.

As Lord Acton said, "Power tends to corrupt: absolute power corrupts absolutely. Great men are almost always bad men." Our government has gained much more power than was authorized by our constitution. Tom Osborn voted for the Paulson Bailout Plan even after declaring the unconstitutionality of it. The machine has gotten too big. A mistake by the powers that be could bring an end to civilization as we know it. The size of government needs to be gut. The Acton Institute Power Blog is worth reading.

Any company that has the cash flow to pay its bills should not be forced out of business by powerful special interests. That has always been the rule. It is different this time.


The ECB and BE are finally bringing European interest rates down. These are powerful moves but until the Paulson wheel lock is removed, this train is not going to go anywhere fast. Paulson refuses to remove the wheel lock with a stroke of a pen, but by next week his program of buying up assets cheap will begin.

A friend wants to know why the government is not doing another RTC, the method used during the 1990-1991 recession. In that program (and in the HOLC program during the great depression), the government bought troubled real estate, not just the mortgage secured by the real estate. In many cases, legal title involved a court battle. In some cases, the RTC actually had to pay to unload unfinished buildings. The demolition costs were more than the value of the land. The Paulson system is far more efficient than the purchase, maintenance and reselling of real estate.

My memory is that that it took 25,000 government employees to administer the depression era program. Paulson will sub contract a lot of work and have only 25 or so government employees. The program will be efficient and successful in terms of making a profit for the public. The public will be fooled into the belief that Paulson saved the country from collapse. Stories will be written about how JP Morgan made out like bandits but they will keep the profits made and play the same game some years from now. So far, this process has already caused the changing of hands of billions (if not trillions) of dollars of assets at very deeply discounted prices.