This Too Shall Pass

I know that you’re probably reeling from all that’s happened over the past two weeks. Lehman and Mother Merrill (MER) gone. We the people own AIG (AIG). The Fannie (FNM) and Freddie (FRE) bailout. A new housing bailout which will cost hundreds of billions. The Fed creating whole new programs to provide liquidity. Did you notice they loaned some $250 billion last week to banks all over the world? Halting short selling?

Here’s, in graph form, what spooked Paulson, Bernanke and company to act so quickly. Look at these graphs from my friends at Casey Research. 30 day commercial paper went to 5% from 3% a week ago. The market was literally freezing. The amount of paper issued is in free fall. Commercial paper is the life blood of the financial and business world.

 
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As President Bush said, it doesn’t help to find who is at fault. What matters is we have to get out of this mess. While I think the losses from AIG will be rather minor overall, if you add up Fannie and Freddie and a new RTC, coupled with the stimulus package, you can easily get to $500 billion.

For such a price, we’d better get a new regulatory scheme that requires reduced leverage. Want to get really mad? Up until 2003, all investment banks were allowed only 12 to 1 leverage. Then in 2004, the SEC basically gave five banks the ability to lever up 30 or even 40 to 1. Bet you can guess the five banks. Bear, Lehman, Merrill, Morgan (MS) and Goldman (GS). Three down.

As Barry Ritholtz wrote: "While the SEC runs around reinstating short selling rules, and clueless pension fund managers mindlessly point to the wrong issue, we learn that it was the SEC who was in large part responsible for the reckless leverage that led to the current crisis."

No matter how much investment banks and hedge funds scream, we absolutely must move credit default swaps to a regulated exchange. And while we’re at it, a thorough revamping of the rating agencies and their rules should be at the top of someone's list.