Friday, September 19, 2008

Taking the Socialist Road

I just listened to Henry Paulson, US Secretary of the Treasury, announcing what maybe the largest bailout in history of the most irresponsible, greedy and predatory companies on Wall Street. There is the most supernal irony in the fact that within the span of a single week, the Bush administration has accomplished what they have claimed the Democratic Party has been trying to do for decades--the transformation of US free enterprise capitalism into something that looks more like the Union of Soviet Socialist Republics of yesteryear. As Jeffrey Sachs opines, the bailout of AIC amounts to a nationalization of the world's largest insurance company. But if the Dems want to tax and spend, here we have spend and tax.

Perhaps the most insightful explanation of what happened may be found in this piece from The Big Picture: How SEC Regulatory Exemptions Helped Lead to Collapse which quotes an article by Lee A. Pickard, former SEC Director for Trading and Marketing Division

"The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.

The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.

Making matters worse, according to Mr. Pickard, who helped write the original rule in 1975 as director of the SEC's trading and markets division, is a move by the SEC this month to further erode the restraints on surviving broker-dealers by withdrawing requirements that they maintain a certain level of rating from the ratings agencies.

"They constructed a mechanism that simply didn't work," Mr. Pickard said. "The proof is in the pudding — three of the five broker-dealers have blown up."

The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts. It requires that firms value all of their tradable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut.

The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1, although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it, so broker dealers often keep their debt-to-net capital ratios much lower.

Having taken the socialist road, now we are in uncharted territory. No one knows what we will find here. Thanks to Bush, we are all socialists now.


blackshama said...

Perhaps ole' Karl was indeed correct. Capitalism will really be replaced by socialism. What is unlikely is that the ruling classes in Washington DC (for now composed of Republicans) will ever be replaced by the mortgage paying proletariat!

DJB Rizalist said...

it's absolutely incredible what's happening ben. uncharted territory they call it, except of course by the russians, chinese and cubans.

Pedestrian Observer GB said...

That's corporate socialism for you, lol....... I keep the profit you pay for my losses, fair enough?

Amadeo said...

Indeed, especially to the outsiders this idea of government taking over private companies is history making, treading into uncharted socialistic territory.

But for us who have been here since the 80’s, these government actions now are more like déjà vu.

In the late 80’s the government created the Resolution Trust Corporation (RTC) which took over an entire industry – The savings and loan association industry, and liquidated all the insolvent ones which was most if not all of them, again because of mortgage liquidity problems. And we had mortgage rates then as high as 12.14% p.a. And this move wiped out that industry which used to handle most of consumer mortgages, that is, most of the mortgages of people buying houses here. The RTC presided over hundreds of billions of dollars of assets and to date, it is still extant and has become a big bureaucracy.

Thus, the talks here are that some kind of RTC-like body will be created for the current troubles in the financial markets.

So the sky is not falling down. Yet.

DJB Rizalist said...

i was still living in the US when that S&L scandal happened. I remember the Keating Five (one of whom was ... tadahh, John McCain!). If Barack Obama is a socialist, these guys are the Central Committee of the Politburo. Btw, at least in the S&L thing there were real assets to be taken over and sold. This time it's all "toxic paper". This won't play well on Main Street I think even if Wall Street rejoices.

Anonymous said...

The hypocrisy of the US has also been exposed. They have been criticizing Asian countries for bailing out their distressed financial corporations, now they do it themselves.

john marzan said...
This comment has been removed by the author.
john marzan said...

the problem with obama is that the guy is a talented but inexperienced new candidate (not unlike palin) during a crisis situation. some of the things that are happening now are way over his head. kung si hillary ang naging nominee ng dem party, i'd be more comfortable with that choice.

Amadeo said...


In fairness, let me mention that McCain was exonerated with John Glenn, and he was the only one Republican, the rest were Democrats.

No real assets in the current cases? AIG will most likely be broken up and many will vie for parts of it that are good and profitable, like its insurance operations. And the same is true with the others.

And nobody can really say that there are no assets involved because in the final analysis the sub-prime mess is founded and anchored on real houses. What is needed is time. RTC as I said is still in existence more than 20 years after the fact and it has presided over assets totaling almost 400 billion dollars.

Bren said...

Get your checkbook ready when Resolution-Trust-Version2 kicks into operation. Money to be made when the government turns to cash the junk paper it gets from Lehman and others.

Bren said...

And in Wisconsin campaign stops, Mccain espouses his thoughts on Social Security :
"We have to have some straight talk for America. The Social Security system is going to go broke. It will not be there for present day men and women who are working. And we have to fix it and we have to do it in a bipartisan fashion," the Arizona senator said Wednesday during a town hall meeting with running mate Sarah Palin in Grand Rapids, Mich.

The Republican presidential nominee says all options must be considered to stave off insolvency for the government insurance and retirement program, and top McCain advisers say that includes so-called personal retirement accounts like those President Bush pushed in 2005 but abandoned in the face of congressional opposition.

john marzan said...

The day the news was so shocking that it knocked Chuck Schumer out of his partisan mode.

DJB Rizalist said...

for me, this is the grimmest news about america since 9/11.

Anonymous said...


I thought I saw that in 1998, the Resolution Trust got dissolved (and its people were hired into the FDIC) .


America becoming more and more leftist? Why Dean, this is some news!


If it's any consolation, size matters, i.e., America will be the biggest socialist (left-wing) country in the whole world!


The Nashman said...

kasi, why do people buy 4wds when they never go offroad and do they really need that swimming pool...puro utang

anyways, sweden and denmark are still socialists and they seem to be doing fine. oh wait, subtle differences in definition....

it's nice to live in a socialist country. you should try it sometime. :D