Only Government Could do this to Us

It must have been quite a meeting.

It began at 3:00 pm this past Monday at the U.S. Treasury’s plush offices in Washington, D.C. On one side of the table sat U.S. Treasury Secretary Henry Paulson. He was flanked by Federal Reserve Chairman Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair.

On the other side were the chief executives of the nation’s biggest banks. They were arranged in alphabetical order, with Bank of America’s chairman on one end and Wells Fargo’s CEO at the other. Between them sat representatives from the Bank of New York Mellon, Citicorp, Goldman Sachs, J.P. Morgan Chase, Merrill Lynch, Morgan Stanley, and State Street.

Although no reporters were present, journalists later pieced together what was said. All accounts agree on the following: For over an hour, Paulson and Bernanke told the assembled bankers just how grave was the situation threatening not just this country, but all the known world. (All together now, can you say, "the gravest financial crisis since the Great Depression"?)

At the end of Paulson’s and Bernanke’s remarks, aides handed each banker a document. The pages contained the government’s terms for becoming their partner. It detailed how much money the Treasury would "invest" in each bank (a total of $125 billion for those present), how much ownership it expected, what their new dividend policies would be, even the limits that would be imposed on executive pay. (The top five officers at each institution could not receive more than $500,000 a year.)

While discussion was permitted, negotiations were not. Paulson explained the deal was for their own good and the good of the country. Then it was time to "shut up and sign." And every banker did.

Any questions, any doubts, any disagreements were blithely ignored. Thus was born a new age in what was once the land of the free and the home of brave. Government would "save" capitalism by becoming its partner … nay, its boss.

It may not be a Brave New World. But I can guarantee you, folks, it’s going to be an expensive one. Time will tell how expensive – to our wallets and to the free-enterprise system.

The ancient Chinese saying, "May you live in interesting times," wasn’t meant to be a blessing. No, I’m told that it was always intended as a curse.

To call the past two weeks "interesting" would be the understatement of the decade. Whether in the markets, in Washington, or in politics, I can’t remember a time when we’ve experienced so many startling reversals and unexpected shocks.

The largest S&L in the country, Washington Mutual…gone. It’s younger sister, Wachovia, is about to disappear.

The nation’s largest insurer, AIG, will have a new owner when Uncle Sam steps in with $85 billion (subsequently raised to $120 billion-plus) and ends up with 80% of the company.

Two of the most venerable (and, as it turned out, most vulnerable) of Wall Street’s august institutions, Bear Stearns and Lehman Brothers…gone. Merrill Lynch, meanwhile, exists in name only. The employees there are about to call Bank of America "boss."

Over the past two weeks, the stock market experienced what some have called a "slow-motion" crash. Many investors felt as though they’d stepped into a boxing ring against Smokin’ Joe Frazier. Bam!, down 500. Wham!, down 300. Slam!, down another 400. Then last Friday came the most incredible day of all. Moments after the opening bell, the market plummeted over 700 points. The Dow dropped all the way to 7900. Then it started back up.

What a recovery it staged over the next five hours. Before you could say, "no mas!," the Dow gained back all of the 700 points it lost and tacked on 300 more. I wish someone had rung the closing bell then, but no, worried investors couldn’t leave well enough alone. Mr. Market gave up all of those gains and a bunch more before the session finally ended at 4:00 pm.

When the dust finally settled, the Dow closed down 128 points last Friday. Come Monday, a lot of investors decided all that selling was a mistake. With a weekend to think about it, on Monday morning they became buyers instead. And buy they did – in record numbers. By the time the final bell was rung, more than 1.5 trillion shares had changed hands and the Dow had gained a record 936.42 points.

On Tuesday, volatility returned with a vengeance. First the market soared 400 points. Then it plummeted 700. Like someone tied to a bungee cord, it bounced back up again. Then it fell again. When the day was finally over, the Dow finished down 72 points. That’s barely a blip on the radar, compared to what the past few weeks had seen.

On Tuesday and Wednesday, the Dow gave back nearly 80% of those record gains it notched on Monday. I gotta tell you, my tired old ticker can’t take much more of this. (Not to mention my wallet.)

Are we there yet, mommy? Is the bottom finally behind us? No one knows for certain. Of course Monday’s explosion to the upside was a delight to see. It was the biggest one-day point gain ever, and the largest percentage gain (11.1%) since March 15, 1933.

Still, it was nowhere near enough to bring us back to break-even. The Dow is still down 34%, or more than 4,775 points, from its record high back on October 9, 2007. More than $5 trillion in investor assets have gone to money heaven.

A lot of pundits are predicting the market will hit more lows before it comes anywhere near its old highs – especially if, as seems likely, President Barack Obama is greeted by Democratic majorities in both branches of Congress when he takes office in January.

Meanwhile, let’s talk about the legislation that’s supposed to end all of this travail. I’m referring, of course, to the $850 billion bank bailout bill, officially known as the "Emergency Economic Stabilization Act of 2008." It’s got to be one of the most odious pieces of legislation ever approved by Congress and signed by the President.

How did a $700 billion bank rescue turn into expenditures of $850 billion? It’s simple, folks. In the words of an old television show, they socked it to us. The Senate packed the measure with $150 billion worth of pork. The so-called "sweeteners" included $397 million for a "domestic production activities deduction" for the motion-picture industry (hooray for Hollywood), $33 million for an economic development program in American Samoa (hey, Samoans vote, too), $100 million in tax breaks for "certain motor sports racing track facilities" (gotta love those NASCAR fans), and even a $2 million excise-tax exemption for "certain wooden arrows designed for use by children" (you aren’t against kids’ toys, are you?).

If there ever was an event where our elected representatives showed their complete and utter disdain for the numbskulls who elected them, this was it.

By the way, some of you may have wondered how a spending bill could originate in the U.S. Senate. Doesn’t the Constitution require that all appropriation bills begin in the House of Representatives? (Not that anyone in Washington, on either side of the aisle, pays any attention to the Constitution anymore.)

Here’s how that particular trick was done. The Senate took a bill that had been passed in the House some time ago – in this case, the Paul Wellstone Mental Health and Addiction Equity Act of 2007 – and voted to replace all of the text with their spanking-new measure. Presto-chango, a new (but unconstitutional) spending bill was transformed into an appropriations bill that originated in the House.

Did I already mention how this measure, more than any other I’ve seen, shows the total and complete disdain our representatives have for us? I guess it doesn’t really matter if its origins were strictly Constitutional, since the measure itself will finance the biggest government takeover of business we’ve ever seen in this country. Would someone please show me where the Constitution says that the Treasury can take taxpayers’ money to buy stock in a bank, an insurance company, or another financial institution?

But I keep forgetting; we don’t operate under the Constitution any more. Haven’t for decades.

The authors of this monstrosity call it a "Troubled Asset Relief Program," or TARP. I think J.T., one of my Alert Readers, was a lot closer to the mark when he said it should be called the Special Official Congressional Institute for Assuring Liquidity In Secure Mortgages. What a perfect acronym: SOCIALISM!

I’m running out of space for today’s rant. But before I say goodbye for this week, let me make a few observations.

While everybody and his brother (including a lot of my conservative colleagues and friends) agree that government had to rescue the financial system, no one ever said what the alternatives were. What would have happened if we didn’t allow Uncle Profligate to spend an additional trillion dollars (which he doesn’t have) to bail out the banks? We’ll never know.

What will the rescue cost? And will it work? Again, we don’t know the answers to either question. I think it’s a safe bet that the final cost will be many times higher than even the worst estimates we’re hearing now. How can I say that? Because that’s been true about every government program since FDR wheeled into office.

Whatever the nominal cost of this rescue plan, the hidden costs will be many, many times worse. The Federal Reserve is about to flood the country with a tsunami of new money and credit. In 2007, loans from the Fed to our nation’s banks averaged $10 billion a month. For the first eight months of this year, they soared to over $100 billion a month.

But listen to this: Last month, the Fed increased its lending to an astonishing $2.7 trillion. The total for the year is over $3.5 trillion and climbing. Makes a billion-dollar bank bailout seem puny by comparison, doesn’t it? No wonder some wags say that FED actually stands for "frantically expanding dollars."

At this point, every single helicopter in Ben Bernanke’s fleet is in the air.

And what happens when tons of new money and credit flood into the economy, class? Can you spell i-n-f-l-a-t-i-o-n?

The money masters in Washington, aided and abetted by academia and the media, have fooled the public into believing that "inflation" means rising prices. You and I know differently, don’t we?

Inflation is an increase in the supply of money and credit. Period. Yes, it causes higher prices, as people realize their dollars are worth less and less. But blaming rising prices on inflation is like blaming wet streets for causing rain.

John Maynard Keynes, the famed economist, understood the process very well. Nearly a century ago he warned, "By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens."

That is precisely what our government is doing to us, folks. It is stealing your wealth – a lot of it through the direct and indirect taxes you pay. But a lot more through the loss in value of every dollar-denominated asset you own.

I’ll have a lot more to say about all of this in the future. But for now, let me conclude by saying that we have just witnessed the greatest financial heist in all of history.

We should be putting the culprits in jail. Instead, we’re going to elect them to Congress – and one of them to the White House. Others will be rewarded with fancy titles and plush offices in Washington and New York.

Truly, we live in a world gone crazy.

Until next time, keep some powder dry.

Chip Wood
for The Daily Reckoning
October 22, 2008

Not much time to write this morning; we’re on our way up to the Andes to check on our cattle and our cabbages. If things get really bad, we may have to live off the fat of the land up there. Trouble is, there’s not much fat on that land.

(By the way…we’ll be out of email range for the next few days…will write again on Monday.)

In the meantime, let’s keep it simple.

After a big boom, you get a big bust. That’s what we are seeing now.

And there is no evidence anywhere in the historical record that the financial authorities can stop it. They can hold it off – for a while. They can distort it. They can possibly divert it. They can make it worse. But there is no evidence that they can make it better.

Losses are losses. Mistakes are mistakes. They don’t go away when government throws money at them. They can be moved around…shifted from the people who deserve them to, say, the innocent householder. But somehow…some time…someone has to write them off and work them out. That’s the basic plot of almost every financial story you read in the paper and see on the news every day – the deleveraging…the unwinding…the downscaling of the world economy.

Almost every business is reporting worse results than last year. An exception is the pawnshops – they say business is running 50% ahead of 2007. Another exception is Apple, whose iPhone has boosted profits 26%.

Everyone else is singing the blues. Stocks are down all over the world. More money has been lost than in ’29 – much more.

Yesterday, the Dow dropped 231 points, following a strong showing on Monday. Oil slid further – to $72, and then below $70 overnight. The dollar rose to $1.30 euros. And gold dropped another $16 – to $773.

If you lend money to the U.S. government for 91 days you will be earning only about 1% annually. Still, there’s a rush to do it. Money is pouring into money market funds.

Most likely, there will be a big rally in the stock market – as there was in ’29. It lasted about six months and took prices back to shouting distance from their highs. But it was a sucker rally. In April of ’30, stock prices collapsed again. And then the economy fell apart.

These things take time, dear reader. Businessmen are only now beginning to realize that they need to cut back – fast. They cancel orders for new equipment, new projects, and new employees. Then, after they’ve stopped the new spending, they look around the shop to see what else they can cut. And then they see that middle-aged Baby Boomer drinking coffee. He’s tired. He’s already thinking about retirement. And he costs a fortune.

‘Get rid of the guy,’ they say to themselves. Then, they say it to the poor employee.

The "Boomer Bust" will make it very hard for this economy to recover, says the Wall Street Journal. The boomers led the boom. Now, they’re going to lead the bust. They’re going to be forced to cut back on spending. In fact, they’re going to cut back so much they’re going to make thrift popular again. Fashionable. Almost hip.

But if the boomers don’t spend…who will?

That’s the other half of the story. Paul Krugman and other economists are urging Congress to "spend baby, spend," as TIME magazine puts it.

Word in today’s news is that the feds will spend more than $700 billion bailing out the banks.

New York says its faces a $13.5 billion budget gap. Over on the other coast, California says it has a big gap to fill too.

Meanwhile, Congress is taking up another "stimulus" package…said to be worth $300 billion, even before it gets decked out.

And then, there’s this headline: "Fed to provide up to $540 billion to aid money funds."

"The US deficit is set to soar," continues TIME.

So, the pols are beginning to do what they do best – squander money. And now they can do it under the cover provided by one of the most popular economists of the 20th century: John Maynard Keynes. Now, they’re not just greasy politicians handing out stolen goods. Now, they’re providing the necessary "stimulus" to an ailing economy!

*** Money is pouring into the gold coin market. Apparently, dealers can’t keep up with the demand. Of course, financial analysts tend to view the gold coin market as a place for nuts and kooks. "If the world really does fall apart, you’d be better off buying ammunition," said one analyst. But it depends on how apart the world falls. If commerce were still done peaceably, gold coins would be a good thing to have in your pocket. But, he’s right; when things really fall apart, you’d be better off packing heat than Krugerrands.

But we’re not worried about that kind of world – it is too wild and too unpredictable.

*** But luckily the market is getting back to normal – right?

"It’s only normal if you enjoy 800-1,000-point swings in a matter of one or two days," says our intrepid correspondent, Byron King.

"Really, this is not a bear market. It’s a great white shark market. This is a Jaws market. Rallies are nothing more than churning chum in the water. It’s as if you were to dip your toe in and get your foot bitten off. Swim at your own risk.

"So let’s remember the beaches of Amity. Is there any reason to stay in the water when a mean, hungry shark is out there? In the same vein, is there any reason to stay in the market right now? Would you be better off just selling out and converting it all to cash? Why turn yourself into shark bait, right? But still, if you sell out now, it will be for a low price. Lower than in the past, that’s for sure.

"Then again, if you buy stock, it will also be for low prices. Certainly, almost every share of stock on every exchange is selling at lower prices than in the past. But what about the future? If you can buy low now, is it possible that you might be able to buy even lower in the future?

"Oh, man. What I would not give for a copy of The New York Times Sunday business section from about next March. And I sure wish that the government people and big bankers of the world were half as good at their jobs as the likes of Roy Scheider and Robert Shaw were at killing monsters of the deep. Only in the movies, I guess."

*** "Bill, do you realize that one of your neighbors up there produces one of Argentina’s finest wines?" asked a friend last night.

We bought a bottle from Tacuil and had it with dinner. It was a very interesting wine…a mixture of Malbec and Cabernet grapes, we were told. Produced at high altitude.

What a relief! We can roast our own cows, eat our own beef, with cabbage on the side, and wash the whole meal down with the fruit of our neighbor’s vines.

So we’re not going to worry. We’ll be all right. Even if it doesn’t blow over…

"But you know," said another dinner companion, "that’s why I like it here in Argentina. Because I think this world is getting more and more dangerous. Did you read today’s paper? It says Pakistan is on the verge of anarchy. The Taliban is going across the border and operating in Pakistan just like they do in Afghanistan. They took over a bus and killed everybody. They blow up police stations. They could take over the country. Of course, I wouldn’t care who runs Pakistan, but it’s a nuclear country.

"Down here, at least you feel like you can live well without worrying too much about these things. We have plenty of sunlight. We have plenty of water and food. We even have very good wine."

Feeling tempted to leave it all and head to Argentina? You’re in luck…our friends at Agora Travel are headed to the "Europe of South America" from November 5-20. While there, they will be exploring real-estate and lifestyle values that will astound you.

*** A Dear Reader currently living in Buenos Aires sends this comment: "My cab driver here (and in Caracas) understands and cares more about currencies and inflation than all my friends in the states combined."


Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. If you haven’t taken advantage of Agora Financial’s Free Emergency Retirement Recovery webinar, there is still time. Simply click on the link below and follow the instructions to download your video. Hurry, this offer is only good until next Tuesday, October 28.

The Daily Reckoning