How To (Mostly) Save The Financial System

First, do nothing. Yes, that's right: no bailouts, no alphabet soup programs from the Fed, no emergency liquidity injections, no "initiatives". Nothing beyond the customary daily operations - and make sure everyone knows it, particularly Wall Streeters.

What good will this do, you say? A ton of good, I say. Because it will immediately force everyone to accept and deal with reality, instead of hoping for "solutions" from the Fed, Treasury or Congress. The credit crisis is too widespread and ultimately beyond their intervention capacities; it is becoming increasingly obvious that conditions are deteriorating despite their efforts. There is too much debt compared to the earned income necessary to service it properly, so a large portion of it will go bad no matter what they do.

Now, throw in resource depletion plus environmental degradation. Debt is a one-way bet on rising future activity; scarcity and climate change are already forcing us to rethink the outdated Permagrowth model and we will soon be forced to abandon it altogether. Therefore, it is better to liquidate excess debt quickly, instead of wasting precious resources attempting to keep it afloat. Referring to a post from last July: putting patches on threadbare tires may temporarily prolong the Bong Bus trip, but will result in a catastrophic accident later. Better to stop now and force all the dopeheads to change the tires.

But what about the innocents, those middle-class depositors and investors who may see their lifetime savings disappear in a generalized credit melt-down? Fortunately (well, un-fortunately) they don't have all that much to lose: the vast majority of Americans (latest data from 2004) had much less than $100,000 in financial assets, including bank deposits, securities, 401(k)'s (see chart below, click to enlarge). Current programs in force like FDIC and SIPC will more than adequately cover them.

Financial Assets by Percentile of Net Worth (Chart: FRB)

The efforts currently being undertaken by the authorities are not directed at them. They aim at helping the very top, where most financial wealth resides: those debt instruments (and their issuers) that are owed by the bottom 90% of the people, but owned by the top 10% of them. I am most definitely no sans-culotte, but even to me this smacks of "Let them eat cake".

Unfortunately, instead of acting in the best interests of the vast majority of the people, we have now embarked on a course that leads to the following statement:

The analyst, Prashant A. Bhatia of Citigroup, said in a research report Friday, “It’s tough to have a liquidity-driven meltdown when you’re being backed by government entities that have the ability to print money.”

In whose interest is it to make our currency the harlot of the "free world"? Not the 90%, that's for sure. But here's the rub: pretty soon it won't be in the interest of the 10%, either.

In the early stages of the Great Depression then Secretary of the Treasury Andrew Mellon made the mistake of advocating liquidation because that was the way previous boom-bust business cycles worked ("Liquidate labor, liquidate stocks, liquidate farmers"). Like most short-sighted generals, he assumed he was fighting the previous war. It is the same with Bernanke, Paulson and Co. : like the Polish generals of 1939 they are stubbornly throwing masses of cavalry against Guderian's Panzers.

It is a familiar pattern of incompetency: the Iraq and Afghan wars are wasting hundreds of billions of dollars and hundreds of thousands of lives to prolong the Oil Era. The Fed and Treasury are destroying the good faith and credit of the USA to prolong the Debt Era. We will all suffer for it.