By Don Bauder
Published Wednesday, Oct. 15, 2008

'I don't think the American taxpayer needs to be stepping in," Treasury
Secretary Henry Paulson assured the citizenry on February 27 of this
year. Half a month later, the Federal Reserve bailed out Wall Street by
financing a shotgun marriage of Bear Stearns to a larger firm, JPMorgan
Chase. Nonetheless, on May 6, Paulson declared, "The worst is likely to
be behind us." Then on July 20, he exuded confidence: "It's a safe
banking system, a sound banking system," quoth he. "Our regulators are
on top of it." Then on September 18 - after the Fannie Mae, Freddie Mac,
and American International Group rescues - Paulson begged for a $700
billion taxpayer bailout of Wall Street, warning that if the
banking-welfare package didn't pass, "Heaven help us all."

Paulson wasn't alone in his dead-wrong pronouncements. On March 11,
Christopher Cox, chairman of the Securities and Exchange Commission,
declared, "We have a good deal of comfort about the capital cushions at
these [Wall Street] firms at the moment." His agency was making
"constant," sometimes daily reviews of financial institutions, declared
Cox. Three days later, Bear Stearns was saved via the shotgun.

Then there is Ben Bernanke, chairman of the Federal Reserve, the
nation's central bank. Early in the current financial crisis, he had to
be educated about the quadrillion dollars of derivatives threatening to
send the world's banking system into a tailspin. During a recent
congressional hearing, Bernanke and Paulson were asked if Wall Street
owed Main Street an apology. Both waffled.

Get this: these three people will be key among those spearheading the
$700 billion bailout package. Paulson and aides will have
near-dictatorial powers. Cox and Bernanke will be on the Financial
Stability Oversight Board.

As Paulson said, "Heaven help us all." Now, as governments essentially
take over the world's banking system, guaranteeing deposits and lending
among banks, Paulson's quote is more apt than ever, although he hardly
meant it that way, having been a cheerleader for the nationalization of
formerly private banks.

I asked some prominent San Diego financial experts about this state of
affairs. "These guys [did not] understand the derivatives problem or,
more important, its magnitude," says retired banker Peter Q. Davis.
Derivatives with no regulation or oversight "took on a life of their
own. [They were] out-and-out gambles."

Says former Wall Street veteran Arthur Lipper III, "With someone as
intelligent and experienced as Paulson is, I find it hard to believe he
failed to understand" the explosive possibilities of a derivatives chain
reaction.

Maybe, like some on Wall Street, Paulson knew that an explosion could
take place, but he was making too much money to fret about it.
Derivatives came to dominate the financial world because the commissions
are so high for those peddling them. Wall Street is all about greed and
mendacity - two reasons its practitioners are unfit for government
positions.

In May of 2006, San Diegan Gary Aguirre warned the Senate Banking
Committee that Wall Street was re-creating 1929, piling up multiple
layers of financial leverage that could crash. After the Bear Stearns
collapse this year, he reminded the committee that the Securities and
Exchange Commission had failed to foresee this calamity and would
probably fail to foresee further disasters. Aguirre, brother of City
Attorney Mike Aguirre, was right on target.

Springfield, New Jersey-based economist A. Gary Shilling says, "Perhaps
the least credible of all the Washington players has been the SEC." In
2006, the agency's staff identified the risks of the subprime mortgage
crisis but didn't exert influence over Bear Stearns to plan for a
subprime meltdown. The agency permitted the firm to use its own
auditors, instead of independent ones, in assessing Bear Stearns'
risk-management policies. Then the SEC botched its attempt to shore up
financial shares. It banned new short selling on 1000 financial issues,
but it put nonfinancial stocks, such as IBM, GM, and Ford, on the list,
while ignoring authentic financial institutions.

"They [SEC staff] don't know what they are doing now," says Aguirre. "It
is panic over there."

"The SEC could require regulated firms to disclose on an ongoing basis
their current debt-to-capital ratio so those considering trading with
the firms could make a decision as to risk," says Lipper. Such
disclosure would have helped in the Bear Stearns disaster.

Playing politics trumps telling the truth these days. "Paulson allowed
the wish to become the parent of the thought in his quest to serve the
Bush administration," says Lipper. "It appears that he was part of the
decision-making which resulted in there being few, if any, independent
economists testifying before Congress in the bailout-plan deliberations.

"Of course, Bernanke, as chairman of the [Federal Reserve], also sought
and seeks to serve the Bush administration," says Lipper.

"Bernanke loves to tell folks he is an expert on the Depression - thus,
I think he sees all roads leading to one," says Davis. "As the old
saying goes, 'When the only tool you have is a hammer, every problem
begins to look like a nail.' "

Paulson's " 'Trust me' three-page proposal and request that he not be
liable to judicial review or punishment was simply offensive and
probably a violation of federal law," says Davis.

What about the bailout plan? "What Paulson did was an ambush," says
Aguirre. "In March, after Bear Stearns collapsed, everyone should have
known that Bear was a sign of what was coming. Paulson should have
convened the Senate Banking Committee, conducted highly public hearings,
explained what was going on with Bear Stearns to garner public support."
Instead, Paulson kept insisting that all was well. After it was clear
the financial sector was on the brink, "The politicians were stampeded
by Paulson's warnings and passed a bill that is a complete disaster for
the public."

Among many things, the bill allows Paulson and his minions to purchase
toxic assets at whatever price they deem consistent with the purposes of
the act. They could pay above a reasonable price if they so desired -
supposedly as a way to pump liquidity into a bank. Doesn't Wall Street
proselytize "buy low and sell high"? Even Paulson, Cox, and Bernanke
should have learned that maxim. The bill permits Paulson's dragoons to
purchase credit default swaps and other derivatives that are at the root
of the problem. Such purchases would bail out Wall Street while screwing
Main Street.

The villains are institutional gambling with excessive debt and the
ideological insistence on nonregulation. And now officials who
encouraged such irresponsibility, or looked the other way while it
occurred, and never saw the possibility of a derivatives nuclear
reaction are in charge of steering the nation out of the crisis.

"Were there not institutional and public demand for ever-increasing
profits, the excesses would not have occurred," says Lipper. "As has
always been the case, leverage is dangerous, and without significant
minimum capital requirements it typically ends in disaster."

We may be at the edge of that disaster right now. The nationalizing
moves over the weekend will only lead to more inflation down the road,
says Lipper.

By Don Bauder | Published Wednesday, March 19, 2008

The United States is behaving like a drug addict groping for another fix or an alcoholic reaching shakily for a hair of the dog. Our central bank, the Federal Reserve, keeps lowering interest rates and pumping liquidity into the financial system to fight the credit squeeze. The Fed will even take smelly mortgage-backed bonds off the banks’ hands and replace them with gilt-edged Treasury bonds. Last Friday, the Fed arranged a bailout of a gambling-crazed Wall Street house and Sunday financed a takeover of the firm, Bear Stearns, at a discount of 99 percent. The federal government, too, is advancing plans to bail out certain mortgage losers, including banks.

To accommodate such actions, the Fed has to create money out of thin air. Bingo: inflation rises. And the dollar keeps sinking to new lows. The buck has plunged more than 42 percent against key currencies since 2002.

The Fed and the federal government “are advocating and facilitating actions which will inevitably weaken the U.S. dollar for a long time to come,” says Arthur Lipper III of Del Mar, chairman of British Far East Holdings Ltd. and a veteran of Wall Street and international finance. The U.S. is letting the dollar slide “to save financial institutions which abandoned sound policy for the sake of competitive gain.” That’s a polite way of saying the bankers went bonkers and now want a bailout. Since last summer, the government and central bank have thrown more than $1 trillion at the credit crisis, which continues to get worse. When there’s a bailout, the stock market rejoices for a day or two, then falls again.

Perhaps investors are aware of a looming calamity. We are slowly losing our role as dominant international currency, and that plunge may well accelerate. What country wants to hold a currency that has lost more than 42 percent of its value? “International transactions are increasingly going to be settled in currency baskets,” says Lipper. (For example, a weighted average of currencies such as the euro, U.S. dollar, and Japanese yen could be used instead of the dollar alone.) “The world is tired of America borrowing to live the good life, and the unpopularity of the present administration and its policies increases the tendency to find alternatives to traditional reliance on the U.S. dollar as the world’s currency.”

The buck is a very special currency. Since the end of World War II, the dollar has been the center of the world’s financial system. Most international transactions take place in the dollar. Being the center of the financial universe gives us unique advantages: after selling their products, countries wind up with dollars. There is a natural tendency to invest those dollars back in the U.S. as a way to protect against currency risk. If those dollars are invested in our bonds, our interest rates may be lower than they otherwise would have been. If they go into our stocks, our citizens enjoy more paper prosperity. With the dollar as the world’s currency, our traders and financial institutions have an easier time: they can deal in their own currency rather than foreign ones. All these factors give us a big financial advantage.

Because of these many advantages we have, other countries complain of “dollar hegemony.” They argue that international trade is a game in which the U.S. cranks out dollars and the world makes things that dollars can buy. Also, their countries are forced to hold more dollar reserves than they would ordinarily, partly because of the need to defend against attacks on their currencies by global speculators, the modern equivalent of pirates.

Unfortunately for us, the dollar’s role in the world has been receding. In 2002, the U.S. dollar accounted for about 70 percent of the money used for financial transactions (and also used as reserves to fight pirates). Now that’s below 64 percent. This year, with the Fed aggressively dropping interest rates into the teeth of 4 to 5 percent inflation, the dollar will decline more swiftly in value. And its use as the international currency will no doubt also decline.

In days past, our currency was dominant because we were “economically competitive and politically stable,” says Lipper. “At the present time, we are no longer economically competitive in manufacturing, and our banking system is suspect. [Remember, it was Arab nations that bailed out Wall Street’s big firms not long ago.] The U.S. dollar will be less attractive to those having alternatives to using our currency as a safe haven.”

Our inflationary fixes are hastening the world’s move to other currencies. But there is one way we may try to keep our hegemony: through warfare. Many people, myself included, believe that one reason we attacked Iraq was that in the year 2000, Saddam Hussein decreed that Iraqi oil would be sold in euros, not dollars. We sent in troops to warn other oil-exporting nations not to do the same. Lipper doesn’t agree or disagree with that supposition: “I can accept the possible validity of a range of theories,” he hedges. In any case, it’s quite possible that oil will be denominated in something other than the dollar — perhaps a basket of currencies. “The oil-producing countries have their own self-interest, and we are presently dependent on their oil,” says Lipper.

Some folks think the only people immediately hurt by a weak dollar are those traveling or living abroad. ’Taint so. The price of oil zooms as the dollar plunges. Says Lipper, “My guess is that we are looking at over $5 and probably $6 per gallon gasoline, and only then will we, as a people, get serious about conservation and alternative energy sources.”

In the financial realm, American citizens have lost their ethical compass. For consumers, “bankruptcy is becoming destigmatized,” says Lipper. “The morality of the American credit consumer is changing, and not for the better.”

Ditto for the financial institutions. There is a scary $513 trillion of complex derivatives floating around the world. The risk “is far greater than presently recognized,” he says. In the financial industry, many of these instruments are off–balance sheet. Hence, banks and insurance companies have fewer reserves than prudent business requires. “The architects and marketers of these transactions earned enormous fees, and the executives and attorneys for the participants didn’t see reason for reflecting the liabilities on the books of the parent organizations,” says Lipper. “If it all becomes unwound, it would be nice to think that some of those who could have blown a whistle will be recognized and dealt with appropriately.”

Today, optimists acknowledge that the U.S. economy is slowing sharply, but they insist that if there is a recession, it will last only a couple of quarters, and then we will come roaring back. They concede that the dollar is weak and inflation is high, but the Fed will be able to raise interest rates, boosting the dollar and squashing inflation, once the economy recovers, say the Little Mary Sunshines.

But the optimists don’t see the global picture. “I believe it is perfectly possible and perhaps probable that we will suffer a depression or prolonged recession,” says Lipper. (A recession is an economic contraction lasting from half a year to a year or more. A depression is a massive decrease in economic activity spread over a longer period, accompanied by deflation.) Borrowers will remain more tight-fisted; companies and entrepreneurs will have a difficult time getting credit. “We are in for some tough times.”

Arthur Lipper

14911 Caminito Ladera

Del Mar, CA 92014

858 793 7100 - Cell: 858 353 7100

Not recognizing an opportunity

is the same as failing