Friday, February 17, 2012

2008 Bailouts Under a UV Blacklight

Most people think the bailouts were about the banks and Wall St., that these top 1% pulled a fast one and got the 99% to bail them out.  After much deliberation, it is my contention that the banks were at best pawns in the real game played by our Treasury and Federal Reserve.

First, I disagree with most people who maintain that the Fed is a distinct entity separate from the government.  I agree with Modern Monetary Theory practitioners that the Fed is an unannounced part of our beloved government.  As an analogy, I am a war veteran and thus considered an independent.  However, I live in my parents' house, eat their food when they are not looking, and run up their light bill.  For all intents and purposes, am I not part of the household?

When the treasury needs to auction...treasuries, our secretary of treasury calls up Bernanke at the Fed to make sure the auction goes smoothly.  When Bernanke wants to raise/lower interest rates, he lets Geithner know.  Sure these guys are technically independent of one another, but it is obvious the left hand knows what the right is doing.

This is where these too big to fail banks come in.  Crony Capitalism has been misdiagnosed as the encroachment of corporations/big banks into government.  Rather, it has been the federal government (including the Fed) calling the shots.  The TBTF banks are nothing more than conduits to ensure a successful treasury auction 100% of the time.  Investment banking?  Asset management?  Underwriting?  Prop trading?  These are side shows.  Uncle Sam lets these banks have their fun as long as when it's time to get serious (treasury auction time), every bank shows up and looks super pleased to buy treasuries regardless of yield.  There is a reason bid-to-cover ratio rarely goes under 3 and this is with real yields less than 0%!

So in 2008, there stood a distinct possibility that treasury auctions will stop going as smoothly not because of lack of demand, but because of the lack of primary dealers, especially if they were all in bankruptcy court.  So everybody who had a watermark on their business cards met behind closed doors and everybody who was anybody got bailed out.  Sorry Lehman, your name got cut off when they photocopied the paper. 

Now here is where I start to lose people (it's how I lost my girlfriend): The United States government does not need treasury auctions to sustain itself.  It does not need the permission of Grandma Perry the fixed income saver or Mr. Wu the Chinaman to print some dollars and use it to build a schoolhouse in Iowa.  As long as people continue to accept the dollar, our government can keep printing more (one can see how the limit to this game is inflation rather than a self-imposed debt ceiling).  If anything, treasuries are just an account in a giant ledger somewhere keeping track of how much of dollar are out there.  Nobody expects the debt to be repaid as that is not the point.  As long as the dollar remains in good standing in America and abroad, we can credit a building contractor's bank account and credit some laborers' bank accounts and they will come and build the schoolhouse.  They are not going to care whether you had issued treasuries beforehand or not.  However, in this day and age of complex finance, nobody really knows what is going on or who is holding what.  Thus the only thing that matters is perception.  If people see that treasury auctions are routinely failing in America, the great Capitalist hope, all is lost.

At end of the day, Geithner recognized the crisis of confidence and allowed the status quo to continue.  Because we come from a proud gold standard tradition where government and its people were frugal and balanced debits and credits, most people cannot quickly accept how deficits truly work in a fiat regime.  Thus the charade continues, with endless treasury auctions and pandering politicians politicizing a monetary nonevent called the debt ceiling every so often.