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 accounting rules, and that the rules must be changed to one degree or another depending on how plausible or legitimate the rationale is determined to be.
It turns out that off-balance sheet accounting is used all over the financial world when it is necessary to hide something, and it's mostly legal. Grantor trusts are a good example. If you don't want to pay taxes you simple move assets to an off-balance sheet trust and they are then no longer taxable as part of an the original taxable entity. When Leona Helmsly said, "only the little people pay taxes" she was mostly right. It's as if our divided gov't is saying, "look, we know the regulations are stupid, but the Democrats want to see them, and believe that they work. But, if you are smart enough to find it and there is significant money involved, we've provided a loophole for you; that way everyone is happy, even those who have no idea what we've really done."
And then there is mark to market accounting rules which deal with asset valuation accounting. Enron was able to interpret these rules to mean that when it leased a gas well, for example, it could book all the revenue it would realize over the 20 years life of the well on the day it signed a lease for that well. This obviously overstated the value of Enron at any one point in time. Fast forward to today and you see i-banks forced to use mark to market rules to value assets at their current market values even when there is no current viable market for their sub-prime assets (mortgage backed securities). If homeowners were forced to value their estates this way, in today's moribund real estate market, they would be mostly bankrupt on paper too.
Despite these huge problems in classifying and valuing assets, most of the Democratic regulatory geniuses seem to agree on the new Basel II regulations which call for, primarily, higher capital requirements. The idea here is to require banks to keep more capital on hand so if there is a loss they can cover it without going bankrupt and dragging down the whole intertwined banking system on which we all depend. But, Bear Stearns made a mockery of the capital requirement rule when its capital dropped from $12 billion to $2 billion overnight. Northern Rock, in England, had the same problem. Just days before they went bankrupt they were about to declare a huge dividend thinking their capital position was more than adequate. If banks often don't know what their capital position is how could Democrat regulators know days, weeks, or months beforehand?
Of course, the more capital banks or individuals keep on hand, the less they can make from investing it. Democrats could require a 50% capital reserve for banks or 50% down payments on house purchases, but is that good regulation or would it severely dampen all economic activity and dramatically depress our standard of living? What Democrat regulator knows what capital reserve levels should be? If Columbus had been regulated away from risking his capital he would not have discovered America. Economic growth requires risk, and often great risk, and it is individuals or individual enterprises who must determine what risk is personally tolerable, not Democrats who lack the wherewithal (to be polite) to understand the nature of capitalism. To prove the point, the Soviet Union did not produce one consumer product innovation in 70 years because regulating precludes risk.
The ironic truth is that SEC regulators don't know what a banks capital is despite being charged with that responsibility under current SEC rules. In fact, they really don't even examine banks to determine capital because there are too many classes of capital with too many possible values which are often impossible to know, and they can change daily too. Moreover, assets are often hedged and insured with complex credit default swaps which then too would have to be valued to determine if they represented good insurance or not. Some CDO's are divided into 100's of tranches with 1500 pages of documentation each to explain how they are constructed and what variables are built into them that can effect their values on a daily basis. In the real world, regulators know better than to even try, while their regulatory masters never lose faith that the impossible can be done.
Managing all that risk is what bankers do for a living every day for 12 hours. And of course each bank does it in a very different way. Regulators would have to make the same commitment in time, energy and education, for the same compensation, to do it as effectively, but regulators of course don't have the same interests, abilities, incentives, or compensation. If they did they wouldn't be regulators, they'd be bankers.
This author once met a recent Ph.D. in physics from Columbia University who told me about how almost all of her graduating class had been hired away by Goldman Sachs. Hiring "quants", as they are called, has become fairly common on Wall Street because they have discovered that only the very best mathematical minds in the world can understand and analogize the tons of numbers flying around the financial world these days. The likelihood that a GS 12 auditor from the SEC could figure things out is fairly remote isn't it?
Still, the SEC is the regulator of capital requirements under the current regime. They simply don't bother much with it because they understand it is an impossible job despite how the Basil II dreamers and American Democrats need to fantasize about regulatory Gods. In the real world regulators are reduced to asking banks to tell them what they are worth. The quantitative models banks use to determine this are perfectly arcane works of mathematical genius. In short, the concept to grasp here is that boards of directors, management, customers, and bank counterparties are the regulators. They know infinitely more, and have the necessary incentive to do their jobs well, while Soviet style regulators simply do not and never can be less than ten steps behind.
In theory, capital should be set aside in sufficient quantity to cover credit risks, e.g., the risk that home owners won't pay their mortgage. And that might makes sense if you could determine the sufficient capital quantity, but even if you could, should that quantity be adjusted if the economy changes and the mortgage holders' ability to pay is then, in theory, reduced? What if interest rates change and so make all capital securities more or less valuable, or what if the overall health of the banking industry changes, or if the regulators' assessment of the operational safety of the mortgage service industry changes? Do they change capital requirements in all those cases, and if so by what amount?
Some analysts the socialist Paul Krugman would have us believe that brilliant and extensive new regulations are needed to keep up with the "shadow banking system" which has supposedly developed to evade the old regulations which stretch to 1000's and 1000's of pages. Of course new regulations and higher taxes are a socialist's knee-jerk response to every problem. In truth, some far simpler deregulation might be in order. For example, the SEC has created a cartel among three securities rating agencies: Standard and Poors, Moodys, and Fitch. Suppose the SEC had allowed free market competition to correctly rate the mortgage backed securities at the heart of the current crisis. That deregulation alone might have averted the entire crisis.
Another proposal calls for bankers to have "skin" in the game so if they go under they lose some of their own money too. But now that Bear Stearns has been bailed out, primarily to protect the counterparties to Bear transactions, why wouldn't a banker put his capital in counterparty transactions, like swaps, which would be protected in the event of another bailed out bankruptcy? One doubts accounting rules would ever catch up with this risk management strategy even if regulators or accountants were able to determine it was being used significantly.
Other problems abound. If a loan requires a corresponding amount of capital according to a Basel II or SEC regulation, a bank might simply carry the loan off its balance sheet or refinance it with very short term commercial paper that has been mostly unregulated. If Basel ll requires capital for loans of a year or longer the bank might simply securitize the loans internally as 364 day loans. Beating slow witted regulators can become a process that distracts from real risk management which is what bankers should be free to do. Sadam Hussein fell to a similar mentality while he was so intent on staying one step ahead of arms inspectors from the UN that he forgot the larger picture, which turned out to be quite deadly for him.
And then too, the biggest danger here might be in the illusion of God-like gov't regulation. If too many people believe it is perfectly safe to deal with big banks, they don't approach with the requisite amount of caution as they would in dealing with any business. The Democratic illusion of regulation means banks don't have to sell safety. Customers assume the gov't has got their backs. But, if regulators announced they were getting out of the business tomorrow, banks would have to begin selling safety tomorrow. That would be a very effective kind of free market regulation to which all businesses are subjected when not hijacked by phony gov't regulators.
But what if Democrats did somehow succeed in making banks have more capital on hand than they would have if left to their own devices? Wouldn't the banks, in theory, then feel more comfortable about making higher risk investments with their "investment" capital. And wouldn't that make the banks exactly as safe or unsafe as they would have been without regulation? And that of course all assumes there is a distinction between a bank's capital and its investment capital, which there is not. Municipal bonds, for example, were long considered safe capital, but when the monoline insurers were weakened by losses in other areas of their business the muni-bonds were then no longer safely insured, according to some analysess. In the end, all capital is dependant on all other capital, and so meaningful distinctions are problematic at best.
To be sure, the geeky geniuses at the world's banks made huge and unbelievable mistakes; seemingly out of greed and complacency. When banks make millions of loans to people who can't pay them back it's like automobile manufactures making millions of cars and forgetting the steering wheels. In their haste, the banks used instantly available FICO scores. 95% did not take the the extra 2 days to verify income through a very efficeient IRS program designd specificaly for that task. On the other hand, banking regulations run into the millions of pages and obviously didn't work either in even the simplist of bank transactions, and, let's not forget, a personal regulator and officer of the court (a lawyer) is assigned to each transaction at great expense just as and added measue of gov't largess, and that didn't work either for the banks or home purchasers. Fortunately, bankers can learn or re-learn as a matter as a matter of survival, while Democrats can not learn.
All this helps explain the huge problem socialists ran into when they tried to own, manage, or regulate business. A business is a highly individualized function of those who created it and own it; not something that can be subjected to simplistic and generalized rules applied by dull bureaucrats who fail to realize that business is the creative source of human progress; not merely a cash cow to finance their failed careers, impotent egos, or Utopian schemes.
No one buys the Democratic fantasy of God-like regulation in a more childlike way than the thoroughly insular and in-bred New York Times. They say, "[The Bush Administration is ] complicit in the credit crisis because of their the anti-regulatory ethos." It will be up to the Congress and the next administration to create the [grand, magnificent, idyllic] necessary new rules for 21st Century financial markets." Their perfect faith in regulation is like our perfect faith in God. God help us all!
Ted Baiamonte
thedumbdemocrat
the intellectual republican
th424fff
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