Dangerous Markets

The dangerous market has been and gone. Only the danger of government meddling remains...

WE LOVE THIS NUGGET of irony, idiocy or just plain cant so much, we have to repeat it - clutching our sides and doubling-up in laughter, tears streaming down our disbelieving faces:

"The reality of the situation is that an open, competitive, and liberalized financial market can effectively allocate scarce resources in a manner that promotes stability and prosperity far better than governmental intervention..."

So said Henry Paulson, US Treasury secretary and ex-Goldman Sachs chief, in Shanghai on 7th March 2007. Hank was lecturing Chinese officials (who this week allowed short-selling on their domestic equity markets for the first time) at the so-called China-US Strategic Dialogue summit.

Of course, Paulson bent their ear before Bear Stearns "Enhanced Leverage" mortgage-bond hedge funds blew up in June '07. The following month, Ben Bernanke, chairman of the Fed, made his first guess-timate of total bank losses - "in the order of between $50bn and $100bn" - to come from the subprime collapse.

Now the terrified trio of Bush, Bernanke and Hank want $700bn just to re-finance the US investment banks and their foreign landfill sites, let alone home-buyers, mortgage lenders and house builders.

Yet five UK banks alone hold $175bn of qualifying junk - fully one quarter of the sum requested. So no wonder Bill Gross - boss of Pimco, the world's biggest bond fund, and a cheerleader for governmental intervention ever since Bear Stearns' hedge funds went "hiccup!" - says the "troubled asset relief program" will need another $500bn on top, just for starters.

(Wherever did they get that name - "troubled asset relief program" - by the way? Maybe "someone" in the room...now as changed from their former self as George Bush is forgetful of his role in creating this mess...was reminded of a drying-out clinic from long, long ago...)

Paulson's ideological grand-standing in Shanghai last year preceded a few other events that may have forced his Damascene conversion. With $700 billion...if not $1.2 trillion or the end of civilization itself at stake...these events are worth recalling:

• The first of five "big freeze" spikes in world money market interest rates (Aug. 9th, '07);
• Collapse of UK mortgage bank Northern Rock - last visited by UK regulators two years before (Sept. '07);
• Stan O'Neal's resignation from Merrill Lynch (Oct. '07);
• Bush administration launches of Hope Now to help "one million [US] home-owners stay in their homes", plus the downgrade of "monoline" bond insurance credit ratings (both Dec. 07);
• Biggest one-day fall in major world stock markets since 9/11 (Jan. 21st '08);
• G7 leading nations forecast $400bn credit losses in total (Feb. '08);
• Final collapse of Bear Stearns into the welcoming - and Fed-assisted - arms of J.P.Morgan for 10¢ in the dollar (March '08);
• Last gasp of 100% loan-to-value mortgages here in the UK (Apr. '08);
• Swiss giant UBS raises $15bn after suffering $37bn in losses (May '08);
• FBI arrests more than 400 people, including bankers and brokers, for mortgage fraud (June '08);
• Collapse of IndyMac - not even on the US watchdog's list of "at risk" banks 10 days earlier (July '08);
• First 10% twelve-month drop in average US home prices since the 1930s' Depression (Aug. '08); and then
• The nationalization of Fannie & Freddie, the collapse of Lehmans, the seizure of AIG, the fire-sale of Merrill Lynch to Bank of America, the fire-sale of London's HBOS to Lloyds TSB, and now the collapse of Washington Mutual into - surprise! - the welcoming arms of J.P.Morgan (Sept. '08).

All this while, of course, the developed world's central banks were pouring cash into the credit market, trying to fix Problem No.1 at the top of our list above.

It just keeps coming back, however. Because the people who know best the liquidity and solvency of major banks - the other banks - refuse to lend whatever money they get, hoarding it instead for fear of a run at their own branches.

"British banks have squirreled away nearly £6bn [$11bn] with the Bank of England rather than lend it to each other for more than a few days," reports the Financial Times, "using its safe but low-interest deposit standing facility in a sign of the fear gripping money markets."

Little surprise that inter-bank lending rates are holding near an eight-month high for US Dollars - despite the Fed now offering more than $290bn to foreign authorities for their own domestic money markets - while the banks' price for borrowing Euros has reached a record high for the single currency, launched in 1999.

And all this while as well, of course, the Federal Reserve has been busy slashing US interest rates...finally joined by the UK, Aussie and New Zealand authorities in making debt cheaper even as the free market - both the interbank market and the commercial market of home-loans, overdrafts and corporate lending - pushed in the other direction.

This privilege, allowing central banks to set the price of money whenever it thinks the economy needs tweaking, might seem to jar with Paulson's tidbit from Shanghai.

But shepherding the free market is why central banks, regulators and government itself exists today. And as they've proven so adept at this task, guiding the lambs of Wall Street to the slaughter of Florida and California condo's, it would surely make sense to extend their powers - and shepherd the free market a little more closely from here, using their tried and tested skills.

Right?

"We thought Resolution was just suspended, not delisted," said a spokeswoman for City watchdog the Financial Services Authority last Friday.

You'd think they might know. But no; Resolution, a UK insurer, was delisted in London after being bought out in May. Yet it still found its name on the banned list of 29 "no shorting" stocks proscribed by the FSA.

"It will be removed," said the all-powerful watchdog. "A revised list will be up on our website later today."

Meantime in New York - where Hank Paulson's "open, competitive, and liberalized financial market" is also taking a break - the Securities & Exchange Commission (SEC) has banning short-selling of GLG, the giant London-based hedge fund, along with 798 other financial stocks and 100 or more stray sheep like GE, GM and Ford.

Funny, but GLG itself paid a $3.2 million fine in June '07 for "multiple violations" of the SEC code, after shorting some 14 public offerings in the US and making $2.2m over two years in "illegal" profits.

Still, there is more rejoicing in heaven over one lost sheep found, eh?

"Markets are usually right," says Anatole Kaletsky in the London Times, "but sometimes they are dangerously wrong - and they need to be managed with decisive and competent government intervention."

Ignore Polly-Ana's morality if you can; fact is, markets often get dangerous. Whether they're right or wrong doesn't matter much if you're buying high and then forced to sell cheaper.

Danger came in Tokyo real estate priced so highly, the Emperor's Palace was worth more than all of California in 1989. It returned to the markets when the Nasdaq got so high, it was discounting tech-stock earnings until A.D. 2146 back in early 2000. Markets got dangerous once again when the average house here in the United Kingdom was valued at 8.5 average earnings in the summer of '07, just as WaMu teetered above $45 per share, AIG bounced back towards $80, and Lehman Bros. announced record quarterly earnings for the last ever time.

Here and now, the market - right or wrong - is pricing toxic debt and derivatives at zero or worse. US subprime mortgage bonds, if marked-to-market - rather than against the apparent "final redemption value" used to help pay $66 billion to Wall Street staff in 2007 - are also worth zilch. That's why there's no danger of anyone buying them, no one outside Washington, that is. And there's the true danger today.

The dangerous market has been and gone. It popped when Florida condos stopped selling to buy-and-flip wannabees without a red cent of cash but one million in debt. Only government meddling - just like Hank Paulson said - risks further danger; the danger that US taxpayers will pay through the nose (and through inflation) for $700bn of utterly worthless "investments".

Any danger of letting the free market do what needs doing, and dissipate the danger in over-priced junk?