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New Regulations Will Shape
the Next Crisis
Gary North
Lew Rockwell.com
Wednesday, April 9, 2008
Treasury Secretary Hank Paulson put forth a number of "new"
ideas for changes in the regulatory structures. Nothing I saw
will help all that much in the current crisis. It's more like
re-arranging the deck chairs as the ship is going down. It seems
like most of it is being proposed to prevent another crisis
like the one we are in from occurring in the future. That simply
insures that Wall Street will have to invent whole new ways
to create a crisis in the future. I am sure they will be up
to the task. ~ John Mauldin (April 4, 2008)
We have seen this before. In 1980, Congress abolished the law
that prohibited banks from paying market rates of interest on
deposits under $100,000 – a law that had been designed
to hurt small investors and also make low-cost funds available
to banks. It was a price control. It blew up after 1976. Price
controls restrict the supply of whatever is controlled.
The new law was the Monetary Control Act of 1980. Why did Congress
pass it? Because the banks were hemorrhaging money. Why? Because
Federal Reserve policy had changed. Under Arthur Burns and his
short-termed successor, G. William Miller, the FED had pumped
in fiat money with abandon. This began in the 1970–71 recession,
which was caused by tight-money policies imposed after Johnson
left office in 1969. In fiscal 1971 and 1972, Nixon's administration
ran back-to-back deficits of $23 billion, which were considered
gigantic at the time – and were.
The FED's policy of monetary expansion accelerated the outflow
of gold, which had begun under Eisenhower's second term and became
a major problem under Johnson in 1968. So, Nixon unilaterally
took the country of the gold exchange standard, under which foreign
governments and central banks had been able to buy gold from the
U.S. Treasury at $35/oz. That marked the beginning of the stagflation
of the 1970's.
(Article continues below)
The FED accelerated this inflationary process in the recession
of 1975. Interest rates rose in response to rising prices.
Paul Volcker replaced Miller in the fall of 1979. Under him,
the FED changed policy: from targeting interest rates to tight
money. Short-term rates soared as the new conditions – high
demand for loans, tight money – pushed rates higher than
they had ever been in the 20th century.
In 1974, an entrepreneur created the Capital Preservation Fund.
It invested only in short-term Treasury debt. It was not a bank.
It was called a money-market fund. It could legally offer investors
a rate of return close to what the U.S. Treasury was offering
big investors. Banks couldn't. You could write checks off of it.
Savings accounts in banks offered no such option.
I worked for Howard Ruff as a telephone consultant from 1977–1979.
We recommended Capital Preservation Fund. It was a time of rising
interest rates.
The fund had imitators. Soon, money was flowing out of banks
into a new investment medium, money market funds. The banks could
not compete. They were trapped: rising interest rates, falling
deposits, and a price control on what they were allowed to offer
to small depositors.
Meanwhile, the loans that they had made to Latin America as agents
of the oil-exporting nations' gigantic inflow of funds began to
go bad in 1980. The market value of these loans began to fall,
threatening the biggest banks' balance sheets. So, Congress changed
the rules that year. It allowed the banks to keep these bad loans
on the books at book value: the price originally paid.
That decision led to today's subprime crisis, where bad debt
that was rated AAA turned out to be worthless. New accounting
rules, adopted last year, require banks to mark their value to
market. This has threatened the banks' balance sheets.
In 1980, Congress intervened in another area. It abolished Regulation
Q, the interest rate ceiling on small deposits (under $100,000).
This raised the cost of funds for the banks, but it kept them
from bankruptcy.
As part of the payoff to the banks, Congress allowed banks to
make mortgages, putting them in competition with the savings &
loan industry.
Soon, the S&L industry responded by raising its rates to
"depositors" (legally, investors) and making more long-term
mortgage loans. This was the ancient carry trade: borrow short,
lend long.
With Carter's recession of 1980, which ended but then was replaced
by a worse one under Reagan in 1981, the S&L industry went
into a crisis. They began going bankrupt in the mid-1980's because
of a slowdown in home sales due to the recession and its aftermath.
It took Congress hundreds of billions of dollars to bail out the
S&L industry.
Step by step, Congress solves one crisis by sowing the seeds
for the next one.
THE HORSES ARE OUT OF THE BARN
The subprime real estate loans have been made. The slightly safer
Alt-A loans have been made. The unqualified borrowers bought their
homes at the top of the housing bubble: 2005, 2006. In 2007, the
market visibly reversed. Now the delinquency rate has risen. As
the subprime crisis has spread around the world ever since last
August, over-leveraged hedge funds and investment pools have been
hit with hundreds of billions of dollars of losses. The Carlyle
Capital fund, created in 2006 to buy Fannie Mae mortgages with
borrowed money (32 to one leverage) is the poster child of stupid
money invested by supposedly very smart people. It got a $400
million margin call on $16.6 billion in debt and went bust in
just one week – the week of the Bear Stearns disaster.
The investment banks that loaned smart people all that stupid
money are now hemorrhaging. They are lining up to get paid by
busted hedge funds. When the courts and the lawyers get through
with them, whatever is left over will have to be put on the books
at market value, not book value.
Mayday! Mayday!
Full
article here.
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INFOWARS:
BECAUSE THERE'S A WAR ON FOR YOUR MIND
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