Bill Fleckenstein

Contrarian Chronicles9/22/2008 12:01 AM ET

Whatever we do, it will be wrong

It's time to start thinking about digging out from this crumbled financial house of cards. With heaps of blame to go around, it's clear that past policies won't help.

By Bill Fleckenstein

This is one of the most extraordinary periods in U.S. financial history. Given the widespread recounting of the details, what I would like to focus on instead are the major takeaways.

The first is something I began writing about in June 2007, that we had crossed over from "too big to fail" to "too big to bail out."

A house of cards is reduced to shards

As I have said so many times, the housing bubble was the economy. When it burst, it left behind bad debts at the consumer and financial-institution levels and, as everyone knows by now, it broke the housing ATM.

That sounds like a simple explanation, but it's a bit more complicated. What needs to be grasped is not just the headline news -- i.e., that financial companies are in trouble -- but the underlying problem the country faces, namely the brutal recession.

Beginning with the American International Group (AIG, news, msgs) bailout, it is both good news and bad news (more about the bad news below). I believe it's good news in the sense that the government figured out a way to punish the shareholders while, at the same time, not allowing the policyholders and annuity holders to be crushed, thereby forcing the country to deal with the knock-on effect of such a crush. (One might argue that the policyholders should have been more careful, but that is certainly an argument for another day.)

I never liked the way Bear Stearns was handled. However, I was fairly comfortable with the way Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs) were handled, given that there'd been an implied backing by the government all along. As for Lehman Bros. (LEH, news, msgs), I think that was handled the way it should have been.

While I'm sure most of us find these bailouts repugnant, it's important to understand that the problems we are facing -- which the current crew is trying to fix -- built up over the 20-year reign of Alan Greenspan at the Federal Reserve.

As the dust settles and people want to learn how all this dislocation became possible, let's hope that blame is placed squarely on those shoulders. Greenspan's irresponsible monetary policies, his refusal to stop bubbles that were obvious to see because he felt he could clean up the aftermath, and his unflinching support for financial deregulation and securitization got us to where we are.

Of course, greed, carelessness and stupidity on Wall Street also contributed to the mess, as did the willingness of homeowners to suspend disbelief. But without the financial nuclear weapons unleashed by Greenspan's policies, none of this tremendous turmoil would have been possible. (Thankfully, it appears that the Greenspan put has expired.)

Video on MSN Money

Federal Reserve © Hisham Ibrahim/Corbis
Bailouts aren't helping stocks
The Fed bailed out American International Group, so why isn't the stock market happy? Maybe because Wall Street is shocked by how little its biggest companies are worth, Jim Jubak says.
We can see the scope of the problems and the rot by looking at the unintended effect of Lehman: The Reserve Primary Money Fund (RPFXX), run by the Reserve Group -- which launched the first money market fund in 1970 -- broke the buck last Tuesday because of exposure to Lehman paper, with its value falling below $1 a share. Other money market funds will probably find themselves in this situation.

Which is exactly why I raised the subject of Treasury-only money funds many months ago in "No shelter from the housing storm."

It's also likely why the Treasury on Friday offered insurance to any "publicly offered eligible money market mutual fund -- both retail and institutional -- that pays a fee to participate in the program."

The short-sellers aren't to blame

While I'm on the subject of Lehman, much has been made about the notion that short-sellers undermine financial companies. So much so that the SEC on Friday announced a temporary ban on short-selling. (I'll have more to say about Friday's breaking news in next week's column.)

I continue to see arguments that short-sellers and the no-uptick rule can ruin companies. Lehman is a perfect example of how that is not the case. Lehman's books were shown to virtually every person on the planet older than 16 with more than 50 bucks in his pocket, and nobody wanted it. People didn't want it because it was essentially a bankrupt entity (once its assets and liabilities were netted out).

To suggest that short-sellers made this happen is just ludicrous. If short-sellers were so stupid as to drive a viable, valuable company down below where it was worth, buyers around the world would have leaped at the chance to buy it. I know that's a bit of a digression, but I'm sick and tired of hearing the wrong people blamed.

Continued: Took too much risk

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