The Delusion of Regulating Risk

At first, when I listened to the accounts of old-time deals and devices I used to think that people were more gullible in the 1860s and ’70s than in the 1900s. But I was sure to read in the newspapers that very day or the next something about the latest Ponzi or the bust-up of some bucketing broker and about the millions of sucker money gone to join the silent majority of vanished savings.

— Reminiscences of a Stock Operator, circa 1923

Poor Zuckerberg. He’s got all those Facebook shares. And they’re dropping in price. The stock closed a bit over $31yesterday…and then kept sinking… It was down to $30 in afterhours trading.

What did you expect? The company has sales of $4 billion. IF…IF…it were able to claw out a 10% profit margin…and IF a fair multiple for its earnings were, say, 10…the company would be worth $4 billion. Not $100 billion. Four billion dollars. And instead of having shares valued at $15 billion, Mr. Zuckerberg would have shares worth about $800 million.

The Dow itself was flat yesterday. Not a very good showing after so many down days. We’ll keep our ‘Crash Alert’ flag up. The bottom could drop out at any time.

The Facebook IPO looks more and more like the end of an era. The end of the pie-in-the-sky social network era. The end of the post-crisis recovery rally. The end of the public’s residual confidence in Wall Street. The end of America’s youthful energy…its era of growth, innocence and hope for the future.

Now, growth rates are low; they’ve been falling for the last 30 years. The baby boomers are neither booming nor babies. Stocks are passé…people want bonds now. And 63% of voters think their children will be worse off than they are.

At least Zuckerberg has it made. He’s got about 500 million shares and options. But every two dollars they fall costs him about $1 billion. So, he’s lost $5 billion since the company went public on Friday.

Still, we’re not going to feel sorry for him. He’s still got $15 billion or so.

Not that we care how much money he’s got. He could have twice as much; he’d still be a putz. We saw the movie!

Seriously, Americans care far too much about money. That’s what people who don’t have it say. They say that too much money is a sign of greed. And that people with too much money can’t relate to everyone else. We lose our sense of community…our public space. People with money live separately from the rest of us. They buy elections and use too much energy…and leave small tips. They’ve got too much power, too much influence, and too much of the pie.

Paul Krugman, Thomas Friedman and Barack Obama want to solve this problem by taking money away from the people who have it. And making it harder for them to earn more.

The guys at J.P. Morgan lost a few billion. You’d think the anti-money crowd would be happy about that. Instead, they want to make a federal case out of it. Practically every pundit is calling for more regulation. “If even good bankers can lose so much,” they say, “we’ve got to get control of them!”

The whole idea that they can regulate risk out of the system is loony. It doesn’t work that way. The more they regulate, the more they distort the market, and the more mistakes investors make.

Investors are buying US treasury bonds, for example, by the boatload. Why? Because the regulators at the Fed have taken the risk out of buying bonds. If interest rates rise, the Fed will buy bonds itself.

Dear Readers and connoisseurs of regulatory FUBARity will appreciate the flexibility of America’s central bank. Its aim is to drive investors into risky assets…by suppressing yields on “safe” treasuries. The unintended consequence is to create depression-like yields…and capital gains for bond buyers. Investors flee stocks…and go into the Treasury bonds the Fed was trying to get them out of. Thus does the Fed manage to bend its right leg far enough to kick its own derriere.

People who don’t like the rich should spend a little time thinking about how the rich got that way. Were they smarter than others? Greedier? Or just luckier?

In our humble observation, we’d say they were a little of all those things. But most of the big increase in wealth the rich enjoyed has come thanks to those same regulators whom the feds want to sic on them.

Yes, dear reader, the rich got richer because of the fixers…not because of the rich themselves. In 1971, Richard Nixon changed America’s money. The old money — backed by gold — flowed to the hardworking producers. It was saved, invested, and put to work. This new money had different ideas. It ran around in different circles. It preferred a different class of friends — bankers, money managers, investors, speculators, venture capitalists, derivative mongers, private equity operators…

You can see this shift illustrated in the difference between Mitt Romney and his father. The ol’ man ran an auto company. He made cars. That’s where the money was back then. He made the Rambler. Remember that? We had one. It was cheap. It was ugly. It ran. What more could you ask for?

But the son never made anything…but money itself. He didn’t run productive companies. Instead, at Bain Capital he was a leading member of the new class of people who fiddled with them.

By 2007, this class had gotten far too big for its britches. The whole capital structure began to wobble. Left alone, it would have crashed to the ground…bringing rich people down to earth with it.

Left to its own devices — without the generous support of the feds — the Dow might have fallen to 6,000 in 2008…and kept falling. And it probably would have brought down J.P. Morgan…and Goldman Sachs…the Bank of America and most of the rest of Wall Street. Even GM, which by then had become a finance company, would have gone out of business.

And today…there wouldn’t be nearly as many rich people to complain about. Problem solved.

Instead, the fixers fixed it so the fixees stayed fixed.

Hey…here’s another bubble…getting ready to blow up. Bubble bubble student trouble:

Student Loans With Over $1 Trillion are Likely One of the Next Hindenburg Zeppelin Financial Infernos

Barry James Dyke, author of The Pirates of Manhattan II: Highway to Serfdom predicts that student loans, in excess of $1 trillion, will likely be one of the country’s next financial infernos.

Federal student loans interest rates will rise to 6.8% on July 1st 2012 from their current 3.4% base if Congress does not act. Banking lobbies oppose any reduction in interest rates. If Congress does nothing, the average student’s $23 thousand subsidized loan costs will increase an additional $5,000 over a ten year period.

The author states, “Student loans are a form of indentured servitude as student loans cannot be discharged in bankruptcy. Student loans do not die with death. Collection agencies can call day and night to collect student loan debts. Garnishment to pay student loan debt is common. Students are not getting enough well-paying jobs to pay back these enormous loans, yet The Department of Education through the Department of Treasury can attach tax refunds to pay off student loans. What is more, our Congress drove the getaway car for academia and the banks in 2005 with the Bankruptcy Abuse and Consumer Protection Act of 2005 — which turned student loans into non-dischargeable debt.”

According to the Department of Education, two thirds of students who earn a bachelor degree use some type of loan to finance their education with an average loan of roughly $23 thousand. The New York Times recently reported that as much as 94% of students borrow to get a college degree.

The taxpayer underwrites roughly $105 billion a year in Title IV student loans a year, with $24 billion going to for profit schools owned by Wall Street asset managers. Student loans guaranteed by the taxpayer are a major source of revenue for the US higher educational system and if default rates accelerate, it could bring about a Greece like debt problem to the nation’s colleges.

“Excessive borrowing for an education will be a dark cloud hanging over this generation for decades,” claims Dyke. ”Default rates on student loans for traditional undergraduate and graduate rates are currently as high as 15.8%, and as high as 48% for for-profit colleges. The New York Fed reports that nearly one in four student loan holders are falling behind on their student loan payments.


Bill Bonner
for The Daily Reckoning

The Daily Reckoning