The Government Infected us with the Disease, Now it’s Killing us with the Cure

On February 10, 2007, The Group of Seven Finance Ministers met in Germany to discuss worldwide financial problems. One of the main concerns was the lack of regulation of hedge funds. This was identified as a huge source of risk for the financial system. The hedge fund red flag at the Group of Seven meeting should not have been the only one. Treasury Secretary Henry Paulson spoke. That alone should have been a red flag. He noted that the U.S. residential housing market had been cooling over the last year but “appears to have stabilized.” Yes, he actually said it appears to have stabilized.

Was anyone listening about the lack of regulation of hedge funds? Apparently not. Hedge funds are largely unregulated, unlike Mutual Funds. They manipulate the market by buying huge amounts of stock to drive prices up and engage in short selling to drive stocks down. They also use Credit Default Swaps to their advantage. These are basically insurance policies that companies pay to insure against default on bonds they have sold to investors. As companies’ losses climb and value dives, the cost of this insurance skyrockets. This is what happened to companies like Lehman Brothers in 2008. Instead of paying, say $10,000 to insure $1 million in debt, Lehman had to pay 10 times that.

As selling in the stock market accelerated, hedge funds had to generate cash and meet client redemption demands. They did this in part by profiting on shorting the stock, and simultaneously buying Credit Default Swaps. Lehman’s losses and insurance costs soared, and they finally failed. This was due in large part to the actions of hedge funds. Shareholders and employees were wiped out. Hedge funds made billions by shorting the stock all the way to zero; then got paid massively when the Lehman credit default swaps were settled (this happened on October 21, 2008). So who underwrote and paid on these CDS contracts, you might ask? If you guessed AIG, you’re correct. The same AIG that we, the taxpayer, gave $85 Billion to last year. How convenient. Did that money go to actually to help AIG, or to pay the huge windfalls on the CDS contracts that AIG sold? We’ may never know, you can guess what I think. In the end, we, the taxpayers are paying for all this madness. And the hedge funds keep manipulating, and keep operating, all legally.

Back on May 17, 2007, Federal Reserve Chairman Ben Bernanke said the growing number of mortgage defaults “will not seriously harm the U.S. economy.” Yes, he actually said defaults will not seriously harm the U.S. economy.

3 banks failed in 2007. On February 28, 2008, when testifying before the Senate Banking, Housing and Urban Affairs Committee, Federal Reserve Chairman Ben Bernanke said, "There probably will be some bank failures." Well, he was right about that. From January 2008 through October 2008, 17 more banks failed.

Then, the collective brain trust really got to work. Last October, the government essentially began nationalizing banks by taking large bank interests with tax payer money, and in doing so, they set into motion a series of events. As part of the TARP Program, they purchased banks’ preferred shares (rather than common shares) in order to, among other things, avoid common share dilution. Keep in mind that this was done by the supposed brilliant minds in our government with the intention that it would help ‘stop the bleeding’ and begin to put a bottom in the market. Of course, they were wrong.

When the TARP Program was announced on Oct 14, 2008, the DJIA was at 9,310. Bank losses and the market downward spiral continued. Since banks’ equity ratios have plummeted because of price decline, banks realized that they would need to raise more equity. Well, the easiest way to do that is for the government to convert preferred shares into common shares. Many common shareholders, seeing the writing on the wall and fearing further decline and dilution of their shares, started to accelerate their selling. Potential bank stock buyers have avoided banks stocks for the same reasons, and stock prices, helped along by massive selling and poor earnings have continued their precipitous decline.

So, in effect, we have actually been dealing with a government induced run on bank stocks. The government began a process which effectively eliminated bank stock buyers, accelerated selling, and furtherer bankrupted and diluted common shareholders. If the government converts from preferred to common shares, it would then own huge stakes, with voting rights, in Bank of America, JP Morgan, Citi, Wells Fargo, KeyCorp, and others. If you’re a common shareholder, this is like owning a house with your brother at 50% each, and suddenly other investors come in and now your share is only 20%.

All in all, 25 banks failed in 2008. 16 More have failed in just the fist two months of 2009. Today the DJIA stands at 6,865, a drop of nearly 27% from the October 14 TARP announcement. The February 2009 drop for the S&P 500 was the second worst on record, second only to the slide in 1933 during the peak of the Great Depression.

The ‘infection’ is the cumulative effect on us by our elected and appointed leaders, some of whom still don’t know what they were doing; and other charlatans who have made decisions that were clearly not in the best interest of the American people. And many of these people are still steering the ship.

The government ‘cure’ is massive spending of money that we must borrow, bigger government, more intervention into your life, and tax increases on the very people who can help grow the economy and create jobs.


"These capitalists generally act harmoniously and in concert to fleece the people, and now that they have got into a quarrel with themselves, we are called upon to appropriate the people's money to settle the quarrel."

- Abraham Lincoln in his speech to Illinois legislature, Jan. 1837.



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What we should have done (and can still do) to jumpstart the economy, curb the rise of unemployment, and help slow the decline of stocks and 401K’s; without borrowing money or raising taxes.