The meddlers can't tame the market

By Bill Fleckenstein

Capitalism, free enterprise and free markets have all been given a bad name. Not because they are inherently bad but because of the people who have meddled with them.

When government knuckleheads interfere with capitalism, you can bet the law of unintended consequences will be quick to rear its head.

Interfering with the markets was a function of the Federal Reserve during Alan Greenspan's reign. That meddling was a major contributor to the tremendous edifice of debt and speculation that had built up over the past 20 years.

Now it has come toppling down, most recently on more than 50,000 Citigroup (C, news, msgs) employees -- casualties of Citi's appetite for risky investments.

I'm sure some of these newly and soon-to-be jobless would like to know just what Citigroup director (and former Treasury chief) Bob Rubin was doing to receive his huge compensation package, since he obviously didn't stop management from acting like fools.

Meanwhile, Gov. Mark Sanford of South Carolina recently noted two successful examples of capitalism unimpeded by outside interference: the vibrant auto industry in his state and the steel industry in Alabama. Had the latter industry been bailed out in Pittsburgh, the good steel-producing jobs in Alabama would not exist.

Now Congress is debating the bailout of General Motors (GM, news, msgs) et al. But without a radical restructuring, a bailout would be a waste of money.

Equally flawed is the call for more regulation. What helped get us into this mess was not a lack of regulation but the failure to enforce the laws already in place.

Had the Fed, the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Office of Thrift Supervision done their jobs, there's no way all the financial institutions could have become so badly impaired, and consumers would never have been allowed to borrow so much money.

Support intelligent solutions, not house prices

Now for some thoughts on the bailout plans and why they wouldn't work. Treasury Secretary Henry Paulson (despite his truly heroic efforts) and the government appear not to understand the root cause of so much of the financial turmoil -- that being the size and scope of the housing bubble. They seem to be operating under the misguided notion that they need to prop up house prices in order to solve the underlying problem.

However, that is dead wrong. The problem is that house prices are still too high relative to incomes. And recently tightened lending standards will put additional pressure on home prices. The price of housing will eventually decline to a level that can be supported by incomes.

A more intelligent approach toward ameliorating the mess would be for the financial institutions and the government to try to figure out just where that level of house prices might be and what the size of the losses would be. Then it could be decided how the losses might be shared among the government, the public and the financial institutions. I've seen variations on some creative approaches, not the least of which is trying to find a way to allow folks to stay in their homes, if possible.

Salute the unsung savers

In addition, something must be done for the people who have behaved prudently. They should get some sort of reward, just as those who behaved imprudently are going to receive aid. Folks who have lived within their means deserve some amount of tax-free saving, which would help instill the right kind of attitude in consumers at large. That way, no one will feel taken advantage of.

As it now stands, the government expects the prudent to bail out the reckless, which is completely unjust and impossible.

I don't have detailed thoughts yet about the framework of the ideas I just shared. But it seems to me that planning ahead -- by attempting to estimate and factor in potential future losses -- is a far more sensible game plan than trying to prop up asset markets, which won't work and will lead to more problems.

Finally, I keep getting questions as to how gold, the dollar or Treasurys can trade where they do, as well as related questions as to why XYZ stock doesn't go down when it should or why ABC doesn't go up when it should. Folks need to keep in mind that these are markets, and they can trade wherever they want to.

Getting richer is harder

We have just come through a decade-plus in which the Fed intervened "successfully" enough so that folks came to look upon the stock market (and then the real-estate market) as pet kittens that spit out hundred-thousand-dollar bills. Markets are not like that at all. They are more like savage beasts looking to rip your head off.

The era of "pet markets" that effortlessly make people rich is definitely behind us.

That is not to say that folks can't get rich via the markets. I don't mean to imply that. What I mean is that it's a lot harder and riskier than it has looked over the past couple of decades.

At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column.