The Dumbest Man in America

AIG…Lehman…Fannie…they believed their own guff! It wouldn’t be the first time that something like this happened.

Where did he go wrong? The question probably crossed his mind…perhaps even when he mounted the scaffold on January 21, 1793. The Bourbons had been the most successful family in Europe. They had ruled Europe’s biggest and richest country since Henry IV. And now they were on thrones all over Europe. But in the language of the City, Louis 16th blew himself up. He was supposed to be an absolute monarch. Ah…there was the dynamite! He believed it. He had surrounded the Parliament with troops and turned the country against him. And now, he had absolutely no control over anything. Not even the power to save his own skin.

"Sire, you have committed something worse than a crime; you have committed an error…" Talleyrand might have told him. Poor Louis! He already had the bag over his head. And the blade at his neck. He must have felt like the dumbest man in France.

Dick Fuld must have felt pretty dumb too. His firm had survived the Civil War, the Railroad Bankruptcies of the late 19th century, the Bankers’ Panic of 1907, the Crash of ’29, the Great Depression, WWII, the Cold War; Lehman Bros. had outlasted spats, prohibition and disco music. But it couldn’t keep its head through the biggest financial boom in history.

John Edwards, recently claimed the title of the "dumbest man in America," when the press got wind that he was two-timing his wife and running for president at the same time. But Edwards has more competition every day. By Monday of this week, Fuld had completely destroyed Lehman Bros. In January of 2007, the financial industry put a value on the firm – a company it knew well – of $48 billion. This week, the bid went to zero. And then, on Wednesday, came more disquieting news: the world’s largest insurance company, AIG, was failing. Martin Sullivan had run it into the ground, said the analysts. Now, it needed an $85 billion bailout.

There was no one there to bail out Louis when he needed it. France was not too big to fail; it was too big to bail out. And everything had been going so well! When Jacques Turgot was Controller-General, he was getting rid of the internal customs barriers, lifting price controls, abolishing the trade guilds and the corvee (the system of forced labor used to build roads). The political system was being reformed too – evolving towards a parliamentary democracy.

But along came those plucky Americans to stir up trouble. They sucked France into war with Britain. France supplied money, materiel and troops – landing 5,000 soldiers in Rhode Island and ultimately winning the war by blockading Lord Cornwallis at Yorktown.

"The first shot will drive the state to bankruptcy," Turgot warned the king. He was right. By 1786, the French were in desperate straits, with half the population of Paris unemployed and a national debt equal to 80% of GDP. The French were counting on the Americans to begin repaying their $7 million in loans, but the United States was broke too. And soon, French credit was so bad, the king could no longer borrow from the moneylenders in Amsterdam nor even from his own creditors in Paris. Having borrowed too much, Louis no longer had any room to maneuver. All he could do was to march up the scaffold steps like a real monarch…

And now the heads roll on Wall Street. James Cayne at Bear Stearns. Stanley O’Neal at Merrill Lynch. Charles Prince of Citigroup. But who’s the dumbest? Surely Dan Mudd and Dick Syron at Fannie and Freddie are still in the running. Even with the deck stacked in their favor, they couldn’t stay in the game. And let’s not forget the rescuers – Ben Bernanke and Hank Paulson. They’ve practically nationalized not only America’s mortgage industry…but, taking an 80% stake in AIG, the insurance industry too! Where does the money come from? It’s borrowed too – hundreds of billions worth. Surely, there’s a guillotine waiting for them somewhere.

The last 15 years have been too kind to finance. Wall Street and the City are essentially debt mongers; and in the boom, nobody didn’t want to borrow. Financial profits soared. Since 1980 the profits of the U.S. financial sector as a portion of GDP have gone up 200%. Industry owners and managers could have taken their money off the table and retired to Greenwich. But on the back of this outsize success grew a monstrous hump of self-delusion; the masters of the universe began to believe their own grotesque guff. The financial markets were perfect, said the academics. All-knowing and all-seeing, they wouldn’t make a mistake. And the chiefs at the big financial firm must have thought they supped with the gods themselves; they had the paychecks to prove it.

Of course, some Wall Street bosses were more cunning than others. In selling itself to Bank of America, for example, Merrill Lynch dodges the scaffold; but it becomes a ward of the state, almost like Fannie and Freddie before they were kidnapped outright. Bank of America has easy access to Fed funds; Merrill figures it might need more money too.

The old regime on Wall Street was dominated by just five large investment companies. But the more they talked their own books, they more they came to think it was true – they were all too big, too smart and too rich to fail. Not only did they package and sell explosive packages of debt; they put the stuff in their own vaults too. Now, Lehman, Bear, and Merrill have blown themselves up. Only two more to go.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

September 19, 2008 — Courtomer, France

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.

"I’ve never seen anything like it," said Capital & Crisis’ Chris Mayer.

The Dow rose more than 400 points. Gold was up $46 at the close of the day. The dollar is falling…oil is holding steady.

We’re hosting a meeting of financial analysts here at our conference center in Normandy. Last night, after dinner, we all gathered around a computer screen – amazed, aghast and appalled.

"I can’t believe it…" "Incredible…" "What will they think of next?"

Your Daily Reckoning editor loved it. He didn’t know what to laugh at first!

From England came word that the financial regulators had banned short selling of financial stocks. What did they think…that they could keep prices up by decree?

But the Americans did the same thing, only dumber. The SEC issued an emergency edict prohibiting "abusive" short selling. What the heck is that, we wondered?

Maybe it’s when you sell a company when the share price has already fallen more than 10%… Like kicking a man when he’s down; it’s not very sporting.

The feds announced a program of coordinated intervention…with $250 billion to be made available to the financial industry to cover its bad debts…

And get this…CNBC: "Bad Debt Plan May Cost up to a Half a Trillion Dollars."

Where do the feds get that kind of money? Ha…ha…ha…

But we’re not the only ones… Russia is new to the ways of late, degenerate capitalism. But it’s getting the hang of it fast. It too is manipulating markets with a $20 billion injection "to boost the stock market."

And then, there’s this item from Bloomberg:

The latest crises "expose the flaws" and "tarnish the image" of the U.S. economy.

They’re missing the point completely. It is not "flaws" that are being exposed – it’s the whole consumer economic model and the whole generation of jackass economists who created it. They rejected the insights of classical economics. Instead of encouraging saving and capital formation, they thought they could nurture growth by luring consumers to spend more money.

"Tarnish the image?" No, this crisis will eventually destroy the image altogether, not tarnish it.

But let us return to the story as we’ve been telling it. There’s a war going on…a battle between a natural market correction…and an artificial attempt to avoid it. On the one hand, Mr. Market wants to correct the excesses of the boom/bubble period that began in 1982. On the other, Misters Bernanke and Paulson want to prevent him. Mr. Market takes down asset prices. Mr. Market Manipulators push them back up.

We know who the ultimate victor will be. Mr. Market never loses. One way or another, real prices must come down. That’s just the way it works. Night follows day…whether you like it or not. Stocks, bonds, property, art become expensive…and then they become cheap. Recently, they’ve been expensive…soon, they will be cheap.

As recently as a few months ago, it looked like the feds might be able to hold off a correction. Government-caused inflation was pushing up prices all over the world. Oil hit $147. Gold shot over $1000. Investors were getting rich in Chinese stocks and London property. Consumer price inflation was rising everywhere. Back then, it looked like consumers would be the big casualties of this war. They were facing much higher prices…with declining incomes.

But then, financial institutions began to take incoming…and pretty soon…the whole battalion of investors, worldwide, were getting beaten back. Stock market investors suffered flesh wounds in the United States; the Dow is down about 17%. In China, investors have practically had their heads blown off; the Shanghai index has lost 67%. Commodity investors got whacked too. Oil is down a third from its high. Yesterday, it closed at $97. Gold lost a quarter of its value, from the high. And investors in many of the safest, surest and smartest companies on earth – investment banks, mortgage lenders, and other financial institutions – have been wiped out.

But this week reminds us that the war isn’t over. The feds still have some ammunition left. The Fed has 200 basis points left to zero; it can cut rates further. The government can intervene directly in markets; it can seize companies; it can lend to anyone at half the rate of inflation; it can send out checks… In fact, judging on recent evidence, it can do anything…

…but the one thing it cannot do is create real money. Every intervention costs money. And money is the one thing the feds don’t have. Not real money. They only have phony money. And when investors finally realize the difference – between real money and funny money – that’s when things will get very, very interesting.

So far, only one major asset class has escaped Mr. Market’s correction: bonds. U.S. Treasury bonds have gone up (meaning, yields have gone down) as investors sought the safety of what used to be, and should be, the surest credit on earth. But bonds depend on not only on the ability of the issuer to repay…but also the value of the money in which they are calibrated. And if that money starts to sink in value, bonds take a hit.

U.S. Treasury bonds are unique. They depend on the value of the dollar…which the issuer itself controls. But as the war between Mr. Market and the feds continues, the U.S. Treasury will have a harder and harder time maintaining the value of the dollar. Because wars are costly. The feds will have to stretch the dollar farther and farther in order to meet the expense. Eventually, the elastic dollar will snap…and bonds investors will have their turn. Bonds will crumple over too…

Dear Reader, this war has already caused millions of casualties…from Wall Street’s masters of the universe…to the little guy with a sub-prime mortgage on his double-wide. But when the shooting stops and the smoke clears – only one man will be left standing. That man will be gold. Make sure you are standing next to him.

*** A note from Short Fuse:

"If there are any of you out there who haven’t made it to the theater to see I.O.U.S.A. yet, there is still time. We just added a theater in Ventura, California – so come out and support the film!

"And for our local [Baltimore] supporters, if you don’t mind a nice drive on this beautiful weekend, come out and join us at the Chesapeake Film Festival.

"The first screening will be at 10 AM on Saturday. The second will be at 1 PM on Sunday. David Walker, Patrick Creadon, Maryland Comptroller Peter Franchot and Addison will be on hand for the question-and-answer sessions following the screenings.

"If you make it out, make sure to look for either myself or Addison and say ‘hi’!"

*** "Is the United States no longer the global beacon of unfettered, free-market capitalism?" asks the International Herald Tribune.

"We have the irony of a free-market administration doing things that the most liberal Democratic administration would never have imagined itself doing in its wildest dreams," says Ron Chernow, a leading American financial historian.

Where has he been? Where have they all been? They might as well be a spider watching a couple make love; he sees the action but has no idea what is going on.

The Bush Administration has been the most liberal administration since Franklin Roosevelt. It has added more debt, more restrictions, more jackass programs, wars, spending, humbugs and bamboozles than any U.S. government in half a century. The one thing it hasn’t done is raise taxes to increase federal revenues; thank God. But it spent the money anyway!

Not that we’re complaining. Far from it. We’ve enjoyed the show.

Besides, our role here at The Daily Reckoning headquarters is not to gripe and moan…but merely to try to understand. How is it possible for a "conservative" government to nationalize the insurance business? What comes into the heads of "conservative" leaders that makes them want to spend a half trillion they don’t have bailing out investors? Why would any U.S. official with his wits about him want to raise the possibility of war with Russia…over Georgia? Maybe Atlanta would be worth defending…and even there we have our doubts. But Tbilisi?

How does it work? How do people come to think such things? We don’t know, but we have a theory:

People come to think what they must think when they must think it.

In other words, history follows certain patterns. Not predictable. Not exact. But broadly reflecting the inherent blockheadedness of the race…and generally in line with historical precedents.

America is in a period of imperial decline. Its economy is slipping. It citizens are getting poorer, both absolutely…and relative to the rest of the world. The "smart" thing to do would be to hunker down, cut costs, bring troops home, reduce Medicare and Medicaid, raise interest rates, encourage saving and give the country time to get back on its feet economically…so it could enjoy its relative decline with good grace.

But that’s not the way history works. Did Alexander stop at the Hellespont? Did Napoleon stop at the Rhine? Did Hitler stop at the Oder? George Bush I stopped at the border of Iraq. But George W. Bush, under the sway of the neocons, kept going. His mission: to destroy the U.S. empire.

No, of course…he doesn’t know that’s his mission. He’s an agent of change…a useful idiot, as Lenin would have said…a stooge…willing to do what isn’t so smart, but what helps the course of history along to its end.

And now, we have a financial crisis. Does the government respond like Andrew Mellon in the ’20s? "Liquidate labor…liquidate the banks…liquidate the farmer…" said Mellon, willing to let the chips fall where they may. No. That would be smart. Get it over with. Move on. But because the U.S. economy is in a long-term decline, moving on is the last thing people want. In the ’20s, the United States could let chips fall…because it had a growing, dynamic economy. Other chips would rise up quickly. But now it must try to keep the chips from falling…because it is mature…aging…decaying. It wants to hold on…to keep things together…to avoid change.

That’s why socialism is so attractive to Americans…it offers the illusion of safety and stability.

The Daily Reckoning