The government owns this problems because they set policies in the 90's that "encouraged" sub-prime lending and deregulated insurance companies.

Both sides created the mess.

Posted on Monday, September 22, 2008, 12:00AM
The
headlines scream doom. There are endless references to the economic
situation being "the worst since The Great Depression." Immense names
in finance have collapsed and sunk beneath the waves of the financial
crisis. Please allow me to try to explain a bit of what's going on.

First
of all, all you have to do is look around you to see that in terms of
daily life, we are not anywhere near The Great Depression. Unemployment
is barely about six percent. It was 25 percent at the nadir of The
Great Depression. Real per capita incomes adjusted for inflation are at
least five times what they were during The Great Depression. Airplanes
are full. High-end restaurants are full. Prices are painfully high for
food. These are not signs of a Great Depression.

On the other
hand, the losses in financial products have been devastating. The Dow
is off 23 percent from its high in 2007. Financial stocks even after
the recent rally are off staggeringly. The biggest insurer in America
has become a basket case.

Most of all, there is REAL FEAR in the
air. Decent, hard working people are terribly afraid as they see their
life savings melt away. Retirement has become just a forlorn dream for
tens of millions of Americans.

How did it happen?

Here s
one big part of the answer. First, the alert reader will notice that
Ben Stein said many times that the amount of money at risk in the
subprime meltdown was just not enough to sink an economy of this size.
And I was right...to a point. The amount of subprime that defaulted was
at most - after recovery in liquidation - about $250 billion. A huge
sum but not enough to torpedo the US economy.

The crisis
occurred (to greatly oversimplify) because the financial system allowed
entities to place bets on whether or not those mortgages would ever be
paid. You didn't have to own a mortgage to make the bets. These bets,
called Credit Default Swaps, are complex. But in a nutshell, they allow
someone to profit immensely - staggeringly - if large numbers of
subprime mortgages are not paid off and go into default.

The
profit can be wildly out of proportion to the real amount of defaults,
because speculators can push down the price of instruments tied to the
subprime mortgages far beyond what the real rates of loss have been. As
I said, the profits here can be beyond imagining. (In fact, they can be
so large that one might well wonder if the whole subprime fiasco was
not set up just to allow speculators to profit wildly on its
collapse...)

These Credit Default Swaps have been written (as
insurance is written) as private contracts. There is nil government
regulation of them. Who writes these policies? Banks. Investment banks.
Insurance companies. They now owe the buyers of these Credit Default
Swaps on junk mortgage debt trillions of dollars. It is this liability
that is the bottomless pit of liability for the financial institutions
of America.

Because these giant financial companies never
dreamed that the subprime mortgage securities could fall as far as they
did, they did not enter a potential liability for these CDS policies
anywhere near their true liability - which again, is virtually
bottomless. They do not have a countervailing asset to pay off the
liability.

This is what your humble servant, moi, missed. This
is what all of the big investment banks and banks and insurance
companies missed. This is what the federal government totally and
utterly missed. This is what the truly brilliant speculators in these
instruments did not miss. They could insure a liability they could also
create and control. It is as if they could insure a Cadillac for its
value upon theft - but they could control what the value the insurer
had to pay off was. The insurer thought it might be fifty thousand
dollars - but it was manipulated into being two million.

This is the whirlpool sucking down finance.

Now,
we are about to have a similar phenomenon happen with commercial
mortgage debt, debt from mergers and acquisitions, credit card debt,
and car loan debt. Many trillions of dollars in Credit Default Swaps
have been sold on all of this, and the prices of all of them have
fallen and can be made to fall more.

As I said, the pit of loss
is bottomless. Warren Buffett, the smartest man of all time in the
world of finance, has called financial derivatives - of which Credit
Default Swaps are a prime example - "weapons of financial mass
destruction." And so they are. As with the hydrogen bomb, no one
thought they would ever be used to end the world. But unless someone
figures a way out - and maybe the new RTC is and maybe it isn't - we
are in real peril. This should never have happened. Now that it did
happen, should the taxpayer pay to make the billionaire speculators
whole on their bets? What the heck is to be done?

Yes, the "problem" in this case is that "Wall Street's" house can in some situations be "our" house as well. One issue in this case is that there is disagreement on whether it is or is not.

Few people really understand enough to have an opinion worth much on what, if anything, should be done. Unfortunately, a great many of those who have that knowledge also have a vested interest in one answer or type of answer over another.

The best we can do to get at the truth of whether doing nothing is a viable option and the best choice, or whether the current package or some other package is the best way to go, is, probably, the top economists. Of course they disagree with one another. Thus the need for no-questions-off-the-table Congressional hearings televised to the public.

I doubt this would happen. It's outside of the box a bit, I'd say. It certainly will not happen if the markets continue to melt down this afternoon and the politicians sufficiently fear the possibility of there being no end in sight if they do nothing. In which case we'll probably be seeing another vote on something, anything, no later than tomorrow if not this afternoon or tonight.