The Soviet experiment showed beyond reasonable doubt that, even with no restriction on authority and compulsion, one could not successfully control an economy. Today, the Soviets are mocked. How could anyone think that you could control an entire economy?

Today people expect the Fed, with limited authority over the monetary base, bank regulations and interest rates, to succeed where Gosplan failed. And they see no contradiction in doing so. Amazing. What is especially amazing is that even Mr Bernanke, who is an economic historian, appears to believe that he can steer the economy. Yet the evidence is clear that government attempts at economic management always increase entropy.

Well it turned out that the Friday denial by the Fed was a lie, as the announcement this evening is that the Fed board approved discount window lending to Fannie and Freddie. How anyone has an confidence in any statement of the government, especially the Fed, when they are willing to just flatly lie is beyond me. Paulson is also asking for a bigger line of credit with the Treasury for the GSEs, and authority to buy equity in them. As Gretchen Morgenson says in the NYT, “Bill Coming Due“.

Because the federal government established the companies, investors view them as backed, at least implicitly, by taxpayers. And that implied guarantee is what drove Fannie and Freddie’s business models.

The advantages the companies gained from this unique arrangement were huge. They had to keep less cash on hand than traditional lenders, for example. They also made more money on their mortgages than lenders because they paid less to borrow money in the bond market. These profits enriched Fannie and Freddie shareholders over the years and bestowed significant wealth on the companies’ executives.

Now it looks as if the bill for that largess is coming due. Of course, it will be borne by the usual bagholders: United States taxpayers. You and me.

Anyhow, futures are being bought on speculation that this is all good, and will make things “better”. Nonsense. It is panic. It is just another in the endless series of “bailouts.” If I held shares in the GSEs, which I don’t,  I would be looking at any rally as an opportunity to become an ex-shareholder. These bailouts would not be happening if there were any capital left in the GSEs after a proper and honest accounting. And by the way, if I had any bank deposits not covered by FDIC insurance, I would be remedying that exposure forthwith. Real estate in its various forms accounts for something like 60% of bank lending, and the losses are going to be staggering. Not just residential mortgages, but the developer loans with their capitalized interest and the wild and wooly “covenant-lite” corporate lending that has been going on. The nasty thing about these loans is that they can drag on without technical default for a long time, but when they do fail eventually they will provide little or no recovery.

The great deleveraging is well underway. Jim the Realtor has posted a good piece by Brad Inman of Inman News. He outlines the consequences of the credit crunch that is now unfolding. His conclusion is that the housing market will be starved for capital. And he is right.

Remember, the economy has been dragged into modest growth with the weakest increase in employment since forever by an enormous injection of new credit. Total credit market debt has grown from $38 trillion in 2004 to $50 trillion in Q1 2008, a one-third increase. That growth is in the process of reversing itself. Figure out the likely consequences. Bailouts will keep the institutions operating. They won’t stop the deleveraging.

Well, all you taxpayers out there,  thanks to Mr Bernanke, you’re in the mortgage business now. You’ve just inherited the Fannie Mae and Freddie Mac debts, totalling about $5 trillion, roughly equivalent to the current net Treasury debt. Now you did get some assets, the mortgages that went along with the debt. Unfortunately, the Fannie and Freddie automated underwriting systems were full of holes to start with, and of course the collateral is declining in value on a daily basis. So good luck with that. Oh, and by the way, Fannie and Freddie don’t have any capital worth speaking of in relation to their debts (about 1%) so there’s nothing there.

At one level, these bailouts are OK. After all, I want to get paid. The problem I have is that the burdens are being shifted onto the taxpayer without any consequences for those who caused the problems. There will only be learning if there are consequences. What Mr Bernanke is doing is creating so-called moral hazard. If there is no punishment for crime, people will commit crimes because the risk-reward motivates them to do so. Here the taxpayers are paying the bills while the Wall Street folks who did this, including, but not limited to, Mr Potato Head, are off living it up in the Hamptons without a care in the world.

Edit: After the close the Fed issues a denial of the news that the GSEs are being permitted access to the discount window. Solid bet that no-one will be pursued by the SEC for that little piece of market manipulation.

Edit: Good backgrounder in the NYT on how Fannie and Freddie exploited Washington corruption.

A veritable bombardment of government nonsense today. Mr Bernanke speaks up, asking for more regulatory powers. The Fed having done such a good job with the ones it has, of course. In nearly the same breath, he announced that the Fed would crack down on lending to borrowers with poor credit. Which it needs no new powers to do, and should have done several years ago. Instead, Mr Bernanke, your predecessor Mr Greenspan egged on the lenders, helping create the current crisis. He also encouraged borrowers to take on adjustable rate mortgages. More powers for the Fed will doubtless result in an even bigger disaster down the road.

Then Mr Paulson says that we should ignore the prices that houses trade at, because the data include a lot of foreclosures, which everyone knows “sell at a discount.” Actual people selling their houses should, therefore, receive higher than market prices. Mr Paulson, you should know by now that the price is the price and encouraging house owners to hold out for higher prices than the market price is not good advice, well not if they need to sell, anyway.

Then Mr Lacker of the Richmond Fed asserts that “On the whole, then, I expect growth to be positive, but quite modest for the rest of this year, and to gradually pick up over the course of next year.” Dream on, Mr Lacker.

Mr Lacker, I think you are trying to talk the economy into a better position by bolstering confidence. You are not bolstering mine. Either you are uninformed, or stupid, or mendacious. Or possibly all three. I would feel better if you acknowledged the problem. I know you can’t fix it, but a little humility would help us all.

It is frequently pointed out that bonds are not a good investment, because the yield on quality bonds, i.e. Treasuries, is insufficient to compensate for inflation.

The problem is, there are no good investments available. Where investment is defined as an income-producing asset with low risk of principal loss. Essentially all asset classes are overpriced. Equities have been overvalued continuously since 1991. Real estate, well don’t go there. Commodities and currencies aren’t investments, they don’t produce income.

So one does what everyone else is doing, one becomes a speculator, betting on future prices. Yuck. I hate it, but there is no alternative. This has meant, and continues to mean, markets where there is no tie to investment value, price action is the only thing. Manipulation is prevalent. But in the long run, I believe that value will govern. I’ve been in the speculation mode since 1997. I want to go back to being an investor. The overvaluation is driven by an excess of cheap credit. People borrow because they can, drive up the price of assets with the borrowed funds, and come to believe that they are investment geniuses. The great deleveraging, which will remove the supply of cheap credit, has started. The banking system is a collection of zombies, dead companies still trading, their capital an accounting fiction. I am just stunned that seemingly intelligent people think that the economy can resume growth with securitization of credit essentially shut down, and a banking system that is desperately short of capital already, and facing more losses in the future.

There is nothing that the Fed can do without a well-capitalized banking system, it is not a lender to end users of credit (except the brokers, I guess). It needs to look at the Japanese example and learn, not to wait as long as the BoJ did to restructure a broken system. It will not, and cannot, heal itself. Of course, the systemic failure is largely due to the actions of the Fed itself and recognizing this will be difficult. It is perhaps not something Mr Bernanke is capable of doing, given that he is so imbued with the nonsense of modern monetary “economics.” It is not what we don’t know that hurts us, it is what we know that isn’t so.