The Death of Capitalism

Most of the time, a crisis brings out the best in people -- but not our current credit crunch. This crisis has unfortunately highlighted the hypocrisy of our government and our business leaders.

The banks have long claimed to be avid capitalists opposing regulation. They've fought against regulation in the energy markets, and Citigroup's (NYSE: C  ) lobbying efforts were instrumental in the repeal of Glass-Steagall, a Depression-era act that prevented banks from being both lenders and brokers.

Similarly, the Fed has been cautious about interfering with the free market. Even now, former Fed chairman Greenspan is warning against overregulation.

So how come all these free-market capitalists are suddenly becoming Marxists?

The pinnacle of mismanagement
Capitalism works because people who succeed are rewarded, and people who fail miserably face the consequences of their actions. And that's fine, unless you're a Washington Mutual (NYSE: WM  ) executive.

First, the company lent money to people who couldn't pay it back. To cover the loss, WaMu had to take a $1.6 billion charge in its fourth-quarter earnings report and dilute shareholders with a convertible preferred offering. Then, New York State Attorney General Andrew Cuomo alleged that he had discovered a "pattern of collusion" between Washington Mutual and First American (NYSE: FAF  ) to inflate house appraisals.

How did Washington Mutual's board punish management for these losses and the alleged inflated housing appraisals: Fire them, or just ask them to resign?

Neither. Instead, the board protected the executives from their capital-destroying decisions. Next year, the calculation of management's multimillion-dollar bonuses will exclude the effects of loan losses and foreclosure-related expenses.

If you're looking for atrocious corporate governance, a compensation plan that totally ignores executive responsibility, and a board subverted by management to the complete exclusion of shareholders' interests, you've found it at WaMu.

Reinflate that bubble
Now consider Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) . These businesses have always been only semi-capitalistic, with their laudable goal of expanding affordable public housing. Somehow, though, the definition of "affordable" has become synonymous with "low monthly payments."

But that's typical of the reasoning that got us into this mess. Is a house affordable just because you can service an interest-only loan, or pay the teaser rate for two years before your adjustable rate mortgage resets? The "affordability" provided by interest-only loans seems more like indentured servitude.

There is another definition of affordable, in which houses are priced within your means. You know, the type of affordable that doesn't require you to pass your mortgage on to your grandchildren. With that definition, houses become more affordable when prices fall.

So why are Fannie and Freddie eager to support home prices, further decreasing affordability, by upping the jumbo loan limits? With recent new rules, these companies can purchase loans as big as $729,750, up to 125% of the median home in the area. In my book, someone who can afford to pay more than $400,000 for a house doesn't need help from a government-sponsored enterprise.

Of course, this change stems from political pressure. It's positioned as helping homeowners, but really, it's just another way to bail out lenders and reinflate the housing bubble with government-backed money.

Back in the USSR
The Fed seems to have sworn off capitalism as well. In the initial terms by which JPMorgan Chase (NYSE: JPM  ) acquired Bear Stearns (NYSE: BSC  ) , the Fed decided that taxpayers should take the first $30 billion in potential losses.

What's more, according to people involved in the negotiations, the Fed set the price of the deal at $2 per share. It didn't want it to look like it was bailing out Bear -- though apparently it's fine with bailing out all the banks and hedge funds to whom Bear owed money. So the government is taking all the risk, and even orchestrating the price at which the deal would take place.

Ironically, the Fed, in its eagerness to dictate terms, totally forgot that Bear's shareholders had to approve the deal. For some reason, those shareholders didn't see the upside, requiring the agreement's renegotiation. Now shareholders get $10, and Morgan Chase risks the first billion dollars in possible losses.

The CEO of Wells Fargo (NYSE: WFC  ) summed the situation up well: He would "not be averse to a Fed-assisted transaction." If the government's forcing businesses to be acquired at below-market prices, and handing out billions of dollars in free insurance in the process, he'll volunteer to reap the gains.

The Foolish bottom line
Hopefully, these sorts of decisions won't become the norm. In fairness, the government is interfering because everyone's terrified about the consequences of this bust. Hopefully next time, the Fed will recognize that if a company is too big to fail, it's cheaper to regulate it now than bail it out later.

That said, the one advantage of everyone being terrified is that some excellent stocks have become cheap -- really cheap.

Our Motley Fool Inside Value team has found stocks trading at less than half of their fair value. When this crisis passes -- and it will eventually -- these stocks could have amazing returns. If you're interested in seeing our top picks, we offer a 30-day free trial.

Fool contributor Richard Gibbons wishes Greenspan had been a bit less fervent in his anti-regulation religion. He is both long and short Wells Fargo calls, but does not have a position in any of the other stocks discussed in this article. First American is an Inside Value pick. Washington Mutual and JPMorgan Chase are Income Investor picks. The Fool's disclosure policy is not now, nor has it ever been, a commie.


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