In Government We Trust

As I sit to write this I have $21 in my wallet, a $20 bill and a (soon to be worthless) $1 bill. Looking on the back of these bills I see the words “In God We Trust.” On the $20 bill these words sit in the sky above the White House.

I wonder how long it is going to take Congress to change those words to “In Government We Trust.”

Our country was built by groups of malcontents and misfits who left their countries of origins to seek opportunity in a new land. They risked much to come here. They sacrificed. They produced. They overcame. With hard work, these (predominantly) God-fearing men and women defied the odds and created the finest nation this world has ever seen.

The United States grew from a unique combination of human nature and freedom. Individuals were free to stretch their abilities as far as they could go. Government’s role was protection and a bit of infrastructure. Taxes were low. We didn’t have an income tax until the “temporary” tax was instituted to help fund World War I. So much for temporary.

One of the great prices of freedom is the freedom to fail. Great success comes at great risk. Modest success comes at modest risk. I remember reading about our “energy shortage” back in the 1700s, when newspaper headlines read “World To Go Dark,” because of the shortage of whale blubber (for lamps.) I remember studying about market crashes and economic turmoil long before the Great Depression. Somehow we made it through all that, emerging stronger and better.

Make no mistake. Those days are gone. We are now entering an era of government planning and control that is fundamentally different that what our nation has ever seen.

We have ourselves to blame. And I fear there is no turning back.

To begin with, our entire banking system is bankrupt. A quick review of the math will prove my point. Before this “mortgage crisis” occurred, worldwide capital in the banking system was somewhere around $2 -$3 trillion. Based upon their capital, banks are able to make loans. The aggregate total that a bank can loan is a function of their capital—usually no more than ten to fifteen times that capital. Banks are able to “borrow” capital as well, but let’s keep things simple.

Somehow, the banking system figured ways to lend $50-$60 trillion based primarily on the inflated equity value of U.S. homes. As home values plummeted, so too, did bank capital. The United States has pledged $700 billion to the banking system. Governments around the world have pledged a somewhat similar amount. I estimate that it will take another $4 trillion or so, in the U.S. alone, to replace our banking system’s capital. This far exceeds the historic high water mark for banking capital. Ever.

We have always seen booms and busts in our economy. Remember hula-hoop’s and pet rocks? Cabbage Patch Dolls and Pong? These minor product fads take place on a much larger scale in the world economy. The latest craze was Mortgage-Backed Securities. But when economic crashes occur, we all suffer.

I have always believed that the free market gives the greatest number of people the greatest opportunity to succeed. But we have just witnesses the free market lead the world (except for government-run China) into bankruptcy. How sad is that? This is where I would use one of my little-used swear words.

There are a number of solutions to this problem. We can force our banks to fess up to their true capital position and let Bank of America and Citi fail. We can relax our banking capital standards, allowing banks to operate with no capital. This would require greater government guarantees, or there would be a further flight of deposits. The government can buy insolvent banks. This will mean that most major banks will become nationalized. Or, we could create a single national bank that would buy up the bad mortgage debt and high values, thereby replacing bank capital to working levels.

If we allow companies like Bank of America and Citi to fail, we will face another Great Depression. If we relax banking standards, our nation will have as much faith in banking as they have in politicians. If we nationalize many banks, we will have the government creating more social and political policy through its banking policies. In the long run, this might make the problem worse, not better.

As I see it, the only viable solution (I am simplifying here) that will allow the United States to keep any vestige of what made us great—our freedom— is for Washington to give banks a do-over, buy purchasing the bad debt and replacing capital. This would require a separate national bank whose only job is to purchase bad mortgages, negotiate new terms with homeowners and restore an orderly housing market.

In a later blog I will tell you who should get the blame for all this. It is a long, long list and it will surprise you.

I will also tell you why I am still optimistic for our nation’s economy.

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