The Death of a Myth?

First, the U.S. Treasury nationalized Fannie Mae and
Freddie Mac, which hold over $5 trillion in combined assets and guarantees
most of the mortgages in the country -- an implicit acknowledgement by the
government that the mortgage market is broken.

We've overthrown regimes and threatened others
with military action for nationalizing industries. When other governments do
it, it's evidence of their evil, socialist heart. When our government
does it, it's necessary.

Next came Lehman Brothers filing the largest bankruptcy
in U.S.
history. Then, the following day, the Federal Reserve gave an $85 billion
"bridge loan" to AIG, the largest insurance company on the
planet, holding over $1 trillion in assets with 100,000 employees across the

What we are witnessing is what economists Douglas
Diamond and Anil Kashyap call "the most remarkable period of government
intervention into the financial system since the Great Depression."

At the heart of this credit crunch mess is something
called "derivatives." The Initiative for Policy Dialogue at Columbia University offers a good primer:

"A derivative is a financial contract whose value
is linked to the price of an underlying commodity, asset, rate, index or the
occurrence or magnitude of an event. The term derivative refers to how the
price of these contracts is derived from the price the underlying item."

It's kinda like playing craps at the casino,
where instead of gamblers betting on the dice-roller to crap-out, with
derivatives, investors are betting on whether a creditor is going to go under.
But instead of buying chips, the lender buys risk-insurance and makes a
"swap" with a third party. If the borrower doesn't pay the
loan back, the lender loses the loan but collects the insurance.

To make things even more confusing, there are different
kinds of derivatives. Futures. Forwards. Swaps. Options.

Ever since Mesopotamians were writing on clay-tablets,
derivatives have played a useful role. But, IPD cautions, "they also pose
several dangers to the stability of financial markets and the overall
economy" because they can be used "for unproductive purposes such
as avoiding taxation, outflanking regulations designed to make financial
markets safe and sound, and manipulating accounting rules, credit ratings and
financial reports. Derivatives are also used to commit fraud and to manipulate

I guess that's why Warren Buffet (in 2002, mind
you), said derivatives were a "financial weapon of mass
destruction." He was ridiculed at the time but now even John McCain is
suggesting that people like Buffet and others tell us how to regulate the

According to Marketwatch, the derivatives market is
somewhere around $500 trillion. No, that's not a typo. That's trillion.

To put it in perspective, Marketwatch reminds us that
the U.S.
gross domestic product (GDP) is about $15 trillion. The GDP of all nations
combined is approximately $50 trillion. The total value of all the real estate
in the world is estimated at $75 trillion and the total value of all the
world's stocks and bonds is about $100 trillion. But there's a $500
trillion market in derivatives!

If you find this all confusing, we're in good
company. Because "what we are witnessing is essentially the breakdown of
our modern-day banking system, a complex of leveraged lending so hard to
understand that Federal Reserve Chairman Ben Bernanke required a face-to-face
refresher course from hedge fund managers in mid August," Bond fund giant
Bill Gross told Marketwatch.

Marketwatch goes on to observe: "In short, not
only Warren Buffett, but Gross, Bernanke, the Treasury Secretary Henry Paulson
and the rest of America's
leaders can't 'figure out' the world's $516 trillion

That's because we're talking about a
"shadow banking system," in which derivatives are not just risk
management tools but "a new way of creating money outside the normal
central bank liquidity rules. How? Because they're private contracts
between two companies or institutions."

Deregulation? Cutting taxes on the super rich? Arguing
that government "hand-outs" are a "moral hazard"
leading to "dependency" and welfare queendom? All of this
unregulated free-market ideology that has dominated American politics and the
GOP since the Reagan revolution has brought the country to its financial knees.

Could it be that in this prostrate position, enough
people will recognize that the unregulated free-market myth is dead? With Wall
Street being handed a government bailout by an administration that regards
laissez-faire capitalism as a divine elixir, the economic reality is: socialism
for the rich; capitalism for everybody else. "Compassionate
conservatism" for the wealthy. "Market discipline" for the

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