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March 28, 2008

Tax-payers and Savers: Game for a Laugh?
by Adrian Ash

"...We need a continuing message from tax-payers and savers that they will do what it takes to support economic growth..."

JUST BEFORE the staff here at BullionVault start their monthly experiments with the cocktail cabinet, how about a thought experiment to get this party started.

If you're game for a laugh, I'd like you - in reading the following quotes - to imagine the words "tax-payers' cash" wherever you see the words "government" or "central bank".

Better still, imagine they spell out the words "your savings" instead. Here's goes...

"We need concerted action by governments, central banks and market participants to help stop this wave [of liquidations]..."
- Josef Ackerman, head of Deutsche Bank, speaking in Frankfurt on 17th March

"The government is prepared to do what it takes to maintain the stability of our financial system..."
- US Treasury secretary Hank Paulson to Fox News, March 16th

"In every country in 2008, every government has one aim - to maintain stability through the world economic slowdown. Britain with its central role in the world's financial system is no exception..."
- UK finance minister Alistair Darling, in his Budget speech of 12th March

Not quite with it yet? Check these examples, already done for you...

"The US tax-payer last week agreed to help J.P.Morgan acquire Bear Stearns after a run on Bear, once the second-biggest underwriter of US mortgage bonds. In an effort to shore up Wall Street's other firms, you also agreed to become lender of last resort to all 20 primary dealers in Treasury notes..." (Bloomberg)

"US leveraged institutions, which include banks, brokers-dealers, hedge funds and tax-sponsored enterprises, will suffer roughly $460 billion in credit losses after loan loss provisions, Goldman Sachs economists wrote in a research note released late on Monday..." (Reuters)

"The [investment] banking system is facing the 21st-century equivalent of the wave of bank runs that swept America in the early 1930s. And your money is rushing in to help, with hundreds of billions from the tax payer, and hundreds of billions more from tax-sponsored institutions like Fannie Mae, Freddie Mac and the Federal Home Loan Banks..." (Paul Krugman in the NY Times)

With it now? Great fun, isn't it! Just cut to the chase about bail-outs and financial aid by remembering what the state's big generous hand-outs are made from - your tax payments, both current and future, plus the spending power of your savings, ripe for inflating away by elected officials and their unelected agents and staff.

This game beats playing "Spoof" any day, we reckon...which is funny again when you come to think about it.

Because Spoof - played in pubs and bars across the world to decide who buys the next round of drinks - is a game without winners, only a loser. Exactly like this game, then.

Fancy another cocktail before playing (and paying) again?

"We need a continuing message from tax payers and cash savers around the world that they will do what it takes to support economic growth. That will not be easy. It may necessitate taking some risks with inflation. But the message has to be unambiguous..."

So said John Varley - or as near as damn it - in a long open letter to government, published by The Banker magazine at the start of this month.

Varley is group chief of Barclays bank here in London. According to the annual report released on Thursday, he took home £2.4 million last year ($4.8m), just down from his 2006 pay-out of £2.5m after annual group profits fell 1% to £7.08 billion "due to the global financial turmoil" as the BBC puts it.

Don't get us wrong here; BullionVault has no problems - moral or otherwise - with the concept of multi-million-dollar salaries. Executive pay merely puts flesh on those inequities which life itself thrives upon. The profit motive in finance is precisely what created the joint-stock company, mortgage lending, the safety-net of insurance, credit cards, overdrafts and all the other monetary tools developed by homo economicus in the last five hundred years.

But what sticks in the craw and makes us choke on our martini-olives, however, is the "privatization of profit [and] the socialization of loss" as Martin Wolf calls it in the Financial Times. Every time the bankers screw up, your money steps in to patch up the losses. Letting the crisis wear on is simply not possible, because no one has dared to try it before. "The authorities feel compelled to intervene," writes Charles Kindleberger in his history of Manias, Panics & Crashes. "The dominant argument against the view that panics can be cured by being left alone is that they almost never are left alone."

Hence the pleading from Wall Street and Washington alike today.

"Tax-payers need to continue to supply liquidity," Varley's article in The Banker very nearly goes on, "and they can help the restarting of the residential mortgage-backed security and commercial mortgage-backed securities markets by being prepared to accept this paper as collateral."

More than that, "it would have a significantly (and disproportionately) positive impact if your cash savings were to buy commercial paper."

Ain't you brave, gentle reader, stepping into the breach so gamely like this! And so modest, too. Thanks to you covering Wall Street's losses with your tax-dollars, "we're going to have maybe a mild recession, but we're going to avoid anything worse," reckons Jeremy Siegel, professor of economics at Wharton.

Yet the plaudits will go to somebody else, with nary a murmur from you, reckons Siegel. "[Ben] Bernanke may very well easily turn out to be a hero here," he explains.

Which I guess was precisely your aim in putting money aside to provide for your future.

"Systemically important institutions must pay for any official protection they receive,"
Martin Wolf continues for the Financial Times. "Their ability to enjoy the upside on the risks they run, while shifting parts of the downside on to society at large, must be restricted.

"This is not just a matter of simple justice (although it is that, too). It is also a matter of efficiency. An unregulated, but subsidized, casino will not allocate resources well."

This quid pro quo - the "this for that" stated so bluntly by Varley at Barclays and Ackerman at Deutsche Bank - is fast-becoming the surest financial consensus in history. If we bail out the banks to stop their stupidity creating a second Great Depression, they must accept far tighter regulation by those governments and bureaucrats who step in to save the day. No redemption without legislation.

Thing is, of course, we've all been before. Across the world, hundreds of times. New regulations come in to stall the last crash...and a new complex system of finance sprouts up, thriving on excessive risk which ends up needing your money - your tax receipts and your savings - to mop up the mess when it explodes in turn.

From Barnard's Act of 1734 - which sought "to prevent the infamous practice of stock-jobbing" that had already peaked and exploded with the South Sea Bubble 14 years earlier - through to Sarbannes-Oxley in 2002, which tried to stop Enron and Worldcom once they had crashed, new standards come in after it matters. Financial risk-taking, meantime, simply moves on to find new ways to gear up, using the latest regulations to pin-point those loopholes that will, in due course, be closed up when it no longer counts.

"After the collapse of Equitable Life in 2000," notes a letter to The Times of London today, "the Financial Services Authority [UK watchdog] set up a review team on the regulation of the assurance society. Among the important 'lessons to be learnt', identified in 2001 were - and I quote verbatim - that 'the FSA management take steps to ensure that the supervisory team is properly constituted with persons with the necessary expertise and knowledge'...

"[Yet] from the recent internal audit by the FSA on its regulation of Northern Rock [the top 5 mortgage lender which blew up in Sept. 2007] we learn that the bank 'was monitored by supervisors with expertise in insurance, not banking'..."

More than that, the FSA failed to conduct a proper review of Northern Rock's operations for the entire 18-month period leading up to its collapse. Even then, prior to that last full review of Feb. 2006 - and "contrary to standard practice" as this week's official report into the scandal revealed - "formal records of key meetings were not prepared."

Thus the quid pro quo of bail-outs for new rules becomes, in the end, a straight swap of excessive risk for incompetence. Underpinning this long-run historical fact you'll find the assumption that "if one cannot control expansion of credit in boom, one should at least try to halt contraction of credit in crisis," as Charles Kindleberger concludes.

For you, the tax-payer and saver, all that means is you get to pay twice - first in higher deductions and then through inflation.

Bet you're glad Ben Bernanke will get all the thanks.

Cheers!

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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