Paging Milton Friedman

The most important single central fact about a free market is that no exchange takes place unless both parties benefit.

Milton Friedman

10 months ago, the Federal Reserve & the Treasury Secretary told us that our banking system was on the verge of collapse.  Recently enacted Financial Accounting Standards Board statement 157 (FASB 157) required the financial institution to re-value their high-risk/exotic assets, like subprime mortgage-backed derivatives, at market rates.  The banks had bought these “assets” for millions of dollars (book value), but as the real estate collateralizing the underlying loans lost value, their re-sale market dried up, rendering them valueless for accounting purposes.

The FDIC requires each bank to maintain a market capitalization based on a percentage of total assets (varying with the size & performance of the bank). Intrusive regulations thus forced many banks to value their high-risk assets at staggeringly low levels. These banks therefore risked insolvency, and the result was a banking crisis created by the government.

Pouring lighter fluid on the inferno, outgoing Treasury Secretary Paulson colluded with incoming Treasury Secretary Geithner to “correct” the problem.

Knowing that most of the mortgages involved were federally insured through Freddie Mac & Fannie Mae, did Paulson & Geithner loosen the FDIC’s market cap requirements on banks?

Of course not, that’d be Occam’s razor.

Paulson & Geithner could’ve let banks notify their customers and shareholders about any exotic assets on hand. That way, depositors and stockowners could’ve made their own decisions about risking money in these banks. Did Paulson & Geithner do so?

Not exactly.

Did they explain the principles of the free-market economy a la Friedman? “Our economic system isn’t just based on profit. It’s a profit and loss system. It’s the combination that sustains and enhances our standard of living. Yes, the potential for profit encourages people to take risks. But without the potential for loss, you have reckless risk-taking. You have risk-taking without prudence. Without the potential for loss, irresponsibility goes unpunished.”

(That was a rhetorical question.)

What Paulson & Geithner did was start us down a long, miserable path to our economic ruin, opening up the government checkbook and passing out the taxpayers’ money.

In the first of what soon became a tsunami of bailouts, the government gave JP MorganChase $30 billion to buy BearStearns with. That bought BearStearns’ portfolio assets, **$29 billion of which is guaranteed by the Federal Government.

In other words, JP MorganChase risked $1 billion of its own money to receive $30 billion in assets.

Aided & abetted by a willing President & Congress, Paulson & Geithner continued to spend taxpayer money profligately, destroy any semblance of a sensible fiscal policy, & desecrate the very fundamentals of individualism and self-reliance upon which the Republic was founded.  The complete list of handouts is here if you can stomach it.

In a final insult to conservatives & libertarians, President Bush asked Congress to release the second half of the $750 billion in Troubled Assets Relief Program funds scheduled to be spent by President-elect Obama’s administration.  Why the new President couldn’t ask a Congress controlled by his own party, I don’t know.  We’re saving the patient by administering a generous dose of Pavulon.

A few principled legislators showed some backbone, including Senator Chuck Grassley (R-Iowa):

“Market participants no longer know when or where the federal government will intervene.  This unpredictability has a chilling effect on investors and undermines the ability to raise capital and make new loans.”

Unfortunately, Grassley & Co. didn’t prevail.

Bank of America received $25 billion in taxpayer money from the first round of TARP funds. That’s just an estimate, because our free and open government refuses to disclose which banks received its largesse.  Excuse me, your and my largesse. Today, the Treasury Department handed over another $20 billion in taxpayer money to Bank of America.

As of Friday, Bank of America’s book value is $36 billion.  In other words, the taxpayers were forced at gunpoint to surrender enough money to buy the entire corporation, plus a 25% tip for outstanding service.

Back to Professor Friedman’s quote; the fatal flaw in each action taken by Paulson and Geithner is that only 1 party benefitted – the bailed-out bank.  What’s exceptionally repulsive is that Paulson and Geithner weren’t necessarily getting duped by a shrewder party in a voluntary marketplace exchange. They were acting as agents for another party – us. Of course, there’s little incentive for them to seek a reciprocal benefit when playing with someone else’s money.

It’s time we stood up to Washington and demanded no less from our elected (and appointed) officials than we do from ourselves. They should live within their means; accept their losses and move on; and not favor some industries, special interests or constituencies over others. Most crucially, they should get out of the way and let Americans be the innovative, exceptional, successful, hardworking people who built this nation.

*Fox Business Network has tried unsuccessfully to obtain documentation of the distribution of TARP funds and any repayment of same.

**A recent Bloomberg business report cites a letter from Fed Governor Elizabeth Duke stating that the Bear Stearns portfolio (known as Maiden Lane LLC) has been written down to $27.1 billion.