Red Friday's Fallout
What a shift to state-organized capitalism means for markets.
September 19th, 2008 may go down in history as the day the United States shifted from free-market capitalism to state-organized capitalism. The day came after 2 weeks of ad hoc policy-making in which 5 major financial organizations lost their independence and the rules regarding short selling were changed no fewer than 3 separate times (no panicking there).
Even more disconcerting was the fact that several notable financial firms were left off the extensive list of 799 companies for which short selling is prohibited. Evidently, it was a careful decision-making process. We saw the executives of major financial firms blame their woes on hedge funds and short sellers - who coincidentally are among their best clients.
This reaction was surprising: As a general rule of thumb, a company blaming short sellers for its troubles is a generally a sign of much bigger problems.
The Treasury submitted a bailout proposal which could be called a "Patriot Act" for financial services: It provides the Treasury Secretary with ultimate authority over who gets saved and how much assistance is given, without recourse or oversight.
Despite criticism of the ad-hoc responses over the past 2 weeks, that's exactly what the early proposal provides for. It doesn't matter who's elected President this fall, the important question is who will be Treasury Secretary, a person whose power will now eclipse that of the Fed Chairman.
The United States is a country of principles. As Americans, we hold ourselves to a higher standard. In times of adversity, we don't compromise our principles. Our elected officials talk about the "Rule of Law," but evidently, that term is used loosely.
The federal government missed every sign of this crisis, even after it was well under way. Despite the Fed Chairman's assertion that financial firms needed to raise capital throughout the first half of the year, the Fed provided financing that enabled firms to raise only grossly inadequate sums.
Following the near-failure of the largest mortgage originator and the first major investment bank, one would think the government would have begun to prepare for future challenges. Instead, the focus shifted towards blaming the very individuals who helped unearth the trouble in the financial system.
While every industry has its "bad apples," this witch hunt was misdirected. Remarkably, several of these short sellers shared their proprietary research with the world in a very public manner. At minimum, these tactics prompted greater transparency from the companies in question. The reality is that these individuals were correct, and did a more effective job of catching the red flags than the regulators.
Is there another Bear Stearns out there?
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