This Can Not Possibly be the U.S. Government's Position

So per the new 200+ page regulatory overhaul proposed by Bush administration Treasury secretary Paulson, the U.S. taxpayer could now, going forward, be held responsible for losses at U.S. investment banking institutions. Paulson says it (allowing investment banks direct access to the Fed's balance sheet, accepting of collateral of questionable value, etc.) will be done in the future, only in the case of emergency. Based on the current environment though, we have already defined any possibility of a large investment bank failure as an emergency. Therefore, effectively the major investment banks have implicit U.S. taxpayer backing, i.e. they are effectively to become government sponsored enterprises (GSE's), similar to Fannie Mae and Freddie Mac.

I won't even pass judgement as to whether or not this is appropriate, as given that more lending is being done outside of then inside regulated commercial banks, something has to be done. But the "something" that Paulson proposes is simply completely irrational and can't possibly be what the administration would actually hope would occur. Paulson actually proposes creating a new set of GSE's, and still, incredulously, is not proposing any real formal set of additional regulation of the proposed GSE investment banks. Rather then have any type of standardized set of rules for capital requirements for 30x leveraged investment banks dealing in unregulated and illiquid derivatives, rather then make any attempt to provide for regulating the $500 trillion+ shadow banking system, the Fed will be allowed to "collect information" and to "send swat teams" to investigate the investment banks books.

So is it then up to the arbitrary discretion of the individual swat teams, or the current Fed management at the time as to what to do with this information? Even from the investment bank point of view, this can't possibly be viewed as helpful, i.e. no standards, no defined set of rules, just leave it up to whoever at the Fed happens to be analyzing the "information" on the investment banks at the time to come up with his or her judgement as to what to do with this information. This is the desired so called system of oversight? What an absolute mess, for all involved. How is either side, the bank or the regulator, supposed to operate efficiently in such a "system". So, effectively Paulson is not just proposing U.S. taxpayer backing for the investment banks and the $500 trillion shadow banking system, but he is proposing that it be done with on the fly arbitrary regulation of it!

To get an idea of just how irresponsible this is, perhaps a bit of "what if" will do. In his previous role at investment bank Goldman Sachs, would Paulson have proposed that Goldman provide funding for say a similar set of players, the hedgefund industry, without having any set of known and agreed upon covenants regarding capital requirements, leverage levels, instruments traded, etc? Taking it even further, would any responsible bank of any type, commercial or investment, ever agree to take on potential liabilities under similar terms? In the extremely unlikely event that some inept bank would though, fine, let them do it, it's their choice.

In this case though, were not just talking about some bank, were talking the U.S. Government. The potential ramifications are absolutely stunning. So if in some strange twist of objectivity, the ratings agencies were to actually apply their criteria and were to downgrade the U.S. government debt to junk based on this silliness, what happens to "financial market stability" then Mr. Paulson? Even if they didn't, if you think that the dollar is weak now, who in their right mind would want to own the currency backing the shadow banking system while actually choosing to regulate via "we'll figure it out as we go along"? I know the so-called "strong dollar" policy of the U.S. treasury is not exactly taken too seriously these days, but isn't this a bit much?