Sen. Joe McCarthy and the Sub-Prime Crisis

When saintly Sen. Joe McCarthy asked witnesses if they were or ever had been associated with the Communist Party they were shocked, aghast, and horrified at such blatant, militaristic effrontery. They painted it as nothing less than modern, deadly, witch hunting. In the end, the simple truth was that most of the witnesses were communists who didn't want their treason or near treasonous behavior discovered by the free society in which they lived. If not, the hearings would have been unnecessary or, at worst, a great chance for those under suspicion to triumphantly demonstrate their patriotism.

When the cold war ended we learned what was obvious, namely, that in fact there were many communists in the gov't (in fact, some tried and hung) who, among other things, were successful nuclear spies for the Soviet Union. Oleg Kalugin, head of the KGB in Washington during the cold war, said,...... "we looked among the liberal Democrats for recruits." So it's not coincidental, 60 years later, to find that Hillary (a Democrat) worked for a communist law firm while in college and that Obama, (a Democrat) "gravitated toward Marxist professors during college." It's not surprising to find that Rev. Wright (a Democrat) wants God to dam capitalist America or that Hillary and Barak are among the most liberal Senators in America, who, one might suspect, are Manchurian Candidates now pragmatic enough to hide their Marxism as mere "caring" liberalism. After all, neither has ever said how big they want the gov't to be even though it is far bigger and more expensive than American socialists of the 1920's ever dreamed. After 200 years of increasing taxing and spending they both still stand for nothing more than even more taxing and spending and regulating. Both want to socialize medicine, end free trade, and now regulate the tenebrous financial markets.

So how is that even now, after the failure of the USSR, Communist China, East Germany, North Korea, and Cuba, that communism lives, and lives in America no less? Possibly, it lives through the same mechanism that God lives, i.e., as a manifestation of our need for a loving, caring God in an often scary, painful, and, ultimately, deadly universe.

We are taught to deeply love and need our families and friends and yet they are naturally ripped from us, and often by slow, wasting, and disfiguring deaths. The more we love, the more we have to lose. It's no wonder that we are crazies with a Stockholm-like Syndrome who have always imagined communist, monarchical or benevolent despot Gods who can protect us from the cruel world we imagine they created for us.

Similarly, in the case of the current credit crisis we imagine an academically inclined "regulator socialist " God who will see that it, and all bad things will never happen again even when what seems apparent from human history is that the most regulated economies (the communist ones, in particular) have failed the most. Nevertheless, Democrats are perpetually tempted to regulate America, albeit on a much smaller scale, and they have failed here too, and for the same reason.

The Federal Reserve System, for example, was perhaps the first big regulatory effort; yet it is now widely blamed for starting the Great Depression. Then, FDR thought to fix the Depression with massive new taxing, spending, and regulating. It resulted in prolonging the Depression for 10 years that ended only with World War II, but didn't dampen anyone's profoundly blind faith in FDR or the Democrats. After the War, Keynes emerged as the most important economist of his time, and most thought, for all time. He was certain that through fiscal regulation (policy) the gov't could tax and spent its way to consistent economic growth. It turned out that the taxes necessary for the spending, exactly counteracted the effect of the spending. And in fact, there was a net loss because gov't spending is less efficient than private spending, and, disruptive to free market functioning. Nixon, a Republican Keynesian of all odd things, then tried wage and price controls, thinking he could achieve heaven on earth by mere gov't regulation. The concept is now considered absurd or child-like, at best.

The list of gov't regulatory missteps goes on and on, but, importantly, none of them have been fatal simply because none of them have been of communist proportions, despite the Democrats, and thanks to the Republicans. Freedom still lives in America! The gov't, generally, didn't tightly regulate the whole economy; so the whole economy didn't fail on a dystopian communist scale.

The current credit crisis, which has the potential to be huge, can lead us in the Republican or Democratic direction; so it's instructive to recall some of the Democrats' most recent and innovative attempts at regulatory nirvana. All agree, for example, that the current crisis was caused, for the most part by too many mortgages given to too many unqualified people; yet few can admit that gov't on both the Federal and State level was massively organized to make home ownership as common as possible. Many huge agencies, including the entire Federal Reserve System, were functioning to help people toward the dream of home ownership. Sadly, it turned out that those who were most in need of help, and got it, are the people most responsible for the sub-prime problem.

But never fear, at least the gov't housing agencies, despite what now seems like an absolutely mistaken mission, were well managed, weren't they? Well no, not exactly. The biggest accounting disaster of recent years occurred at Freddie Mac and Fanny Mae which are gov't agencies partly responsible for almost 70% of the mortgages in America. Wanting to be so carefully regulatory, the gov't hired 200 accountants to look after these two agencies on a full time basis, just to be sure, and yet it still resulted in two of the biggest accounting misstatements in history. That can be consequential when you're talking about 70% of all mortgages in America. It seems gov't agencies are stupidly conceived and impossible to manage, just as the communists found out, but on a far larger scale.

But maybe we just need the right man in charge - a sort of benevolent, socialist, monarch. Such a man was none other than Robert Rubin. He was a genuine master of the financial universe at the hugely successful investment bank, Goldman Sachs, and then a hugely successful Treasury Secretary, under Bill Clinton, who presided over eight years of economic growth. When he left Clinton, Rubin went to one of the top positions at CitiBank, the nation's largest bank, where he absolutely failed to notice or say one word about the unfolding sub-crime crises that was to cause his bank to write down about $50 billion in losses. In fact, he may be most famous now for publicly supporting the CEO responsible for the bank's losses. In fact, he publicly supported him until the very morning he was fired. Still, Rubin is undoubtedly a great and successful man, but would you want him regulating the entire economy when he is obviously and understandably so subject to human fallibility?

And then there is Hank Paulson the current Treasury Secretary; also from Goldman Sachs. He was yet another master of the financial universe who didn't remotely see the sub-prime freight train coming while he was supposedly on watch looking for it. Ironically, he is now the one responsible for new regulations to prevent the next crisis or to at least make it visible to those who will be charged with watching for it in the future.

Interestingly, the entire concept of regulation here is probably absurd since the free market stopped buying sub-prime mortgages long before gov't regulators even thought to convene a committee to discuss the matter. Dutifully though, Paulson says, "regulation must keep up with innovation," when of course that is impossible because regulators aren't innovators. They are the opposite: bureaucrats.

Paulson is equally famous for his assurances to Goldman Sachs that it should invest $100 million in, and underwrite the IPO of, a company called WebVan which took Internet orders for groceries and delivered them via truck from huge warehouses. Paulson was sure the Internet would make traditional supermarkets obsolete and asserted that Goldman Sachs would suffer the same fate if it too did not modernize with the Internet times. In a year or so WebVan and its competitors were bankrupt while traditional supermarkets were still thriving. Again, would you want this very great but very fallible man gambling with and regulating the entire economy or just running one small company like Goldman? Isn't one of the beauties of capitalism that it naturally contains failures and teaches others how to learn from them in the process?

Nevertheless, there are still those Democrats who insist that some very sophisticated folks out there somewhere can somehow produce some very helpful financial regulations. The problem is that at the subtle academic level where we are now - at least before a Democratic Presidency and Congress - no one understands regulations or their effects until it is too late.

For example, we often read about off-balance sheet SIV (structured investment vehicle) accounting through which banks are able to create entities in which they can hide what they are doing from shareholders, regulators, accountants, and/or tax collectors. This is outrageous but it is technically permissible as a response to, among other things, accounting rules that would leave an investment bank, for example, in a poor competitive position versus a commercial bank. The bureaucracy is so huge and the concepts so complex that it will take years for i-bank accounting to be equalized with commercial bank accounting on an international basis - which is important, if not critical, in a globalized economy. And, the process only starts after American and international accounting standards boards realize and agree that i-banks have found a plausible rationale to utilize off-balance sheet accounting, within existing accounti