Friedman himself did little that was irrelevant. His detractors claimed he consorted with a dictator and formed a cabal of Friedmanites in Chile. When he first began working with his Chilean students, Chile was a typical banana republic. It has since survived a dictator and several leftist regimes. But it alone among Latin American countries possesses a stong economy and quality social services, largely due to the efforts of Friedman’s disciples. This was most recently evidenced by events following the earthquake in Chile. While in general developing countries collapse with a tremor as building standards are rarely honored there. But in Chile’s earthquake - 500 times more powerful than Haiti’s - less than 1000 people have perished compared to over 200,000 in Haiti. He was a small man that did great things.

There was no end to the Cold War, as Gorbachev made clear in his most recent speech. No more rubber chicken and honoraria for him.  Russia used the last 15 years to replace their failed military with a successful foreign-built energy weapon, while Gorbachev passed out platitudes. The rust will eventually set in when we pull out of Russia, but meanwhile, we’re on the defensive.

We have a few friends; some old, some new. Western Continental Europe, as usual, is too preoccupied with itself to be of any use. The Sarkozy deal with Russia was a wink and a nod that nobody took seriously.

The short term stakes are the oil resources of East Asia, Siberia and the Middle East.

It would have been lovely to have thriving democracies and peace in the Middle East, but we underestimate how much democracy owes to good luck and how little it owes to human nature.

So the Middle East will not be able to defend itself. We are going to have to hold our noses, as usual, and protect them from Russia and themselves. Give them 50 years, and maybe the Middle East will be viable. I hope so, because they are certainly going to be expensive until they get themselves in hand.

Yes, the longer term answer is energy independence and the good old Atlantic and Pacific Oceans to keep us out of harm’s way for 100 years or so. But for the next 20 years, no Middle East – no good times.

Russia sees no reason why they shouldn’t control the oil outside the Middle East. Unfortunately, they have a point. And we better do something about that as Europe hangs in the balance. If Western Continental Europe doesn’t miraculously wake up to its precarious position, we have the desperate corridor from Britain to Georgia that “gets it,” and is willing to fight, and maybe help from Asia. This sounds extreme. The problem is, it fits the facts.

And a look forward would be useful over here as well. Not even energy independence and a couple oceans is enough to protect us from a Soviet Republic of Europe. And that’s where Russia sees the future. It’s been tried before by folks with fewer resources behind them, and it almost worked.

OK, so what’s wrong with F&F?

1. F&F were chased off the Treasury’s debt roles in 1967 to perpetrate a fraud upon the American public. The taxpayer was to believe he was not bearing the burden of the agencies’ debt. As recent events have made indisputable, that belief is and always has been a corrupt deception.

2. F&F perform an undesirable function. To provide cash for mortgages that banks can buy without concern for the willingness or ability of the ultimate homeowner to pay the mortgage back is a dangerous policy. The danger is, of course, that very risky homeowners will ultimately do the borrowing. Recent events have taken that risk out of the realm of possibility and made it certainty.

3. There is no control on the size of these agencies. As a result, they now cover half the country’s private housing debt. The amount doubles the size of the Federal Deficit.

4. They are a corrupting influence. Entrepreneurs think “If we can get away with this, what can’t we get away with?” The answer, for Mortgage Sellers, Most Large US and European Banks and some Investment Banks has been, “Almost Nothing.”

5. Perpetration of corruption is among the duties of the Secretary of the Treasury and the Chairman of the Federal Reserve. Paulson understands this; Bernanke is in apparent denial.

6. The new “reform” law perpetrates the status quo. It leaves the fraudulent agencies in place, encourages them to get on with their job of subsidizing bad mortgage practices, and provides further assurance that the Treasury will bail them out. (But Secretary Paulson has hired a Goldman Sachs guy to reform all this some years from now. So all our worries are over.)

I have one question. Which of these six points is the public not capable of understanding? My answer is “None of them.” Yes, the public is fed a lot of s— and kept in the dark as though they were mushrooms. But the public is used to this. They figured out they were being treated like that in foreign policy, didn’t they? The public figured that out in health insurance, haven’t they? I think they’ve figured it out here too. F&F are going away. I just hope many, many senators and congressmen are going down with them. But America, triage is best done quickly.

What the public needs to understand about these securities, it does understand. Let me provide the obvious fact about auction rate securities. They are a way of hiding an enormous risk being passed to the Money Market Funds of US investors. This is what Washington calls “an inconvenient fact.”

First of all, auction rate securities were designed to deceive investors about their risks. Municipals, like homeowners, prefer long term debt to short. Long term debt is not acceptable to conservative investors, so the maturity had to be manipulated to get it sold. Auction rate securities were designed to permit banks to profit from securities trading without risk to themselves. This was to be accomplished by devising a way of taking all the day-to-day risk out of the business, replacing it with a risk that the method would fail, resulting in a cataclysm. (Tom Friedman’s description of how the Chinese are ruled provides an apt metaphor. As the Olympics display, it’s a great show until it all falls apart.) I hasten, along with all the bankers involved, to add that nobody claimed these securities were riskless. The approach, as usual, is to say it’s like a riskless security. The banks are being sued because some prominent brokers forgot to use the l— word. The outcome of the suit will hinge on how often the word was forgotten and whether it was in writing. (Or, if the chief executive and some other cretin had a good giggle about it over the email.)

So it did fall apart.

When bank scams fall apart, the Federal Reserve who (make no mistake) condoned the scam in the first place, makes the banks “eat their sins.” That is, the banks must repurchase all the bum securities. Since these institutions are now all wholly owned by Persian Gulf Governments (Allah be praised!) and the US government, the transaction should actually be viewed as follows.

The risky debt of municipal governments is now being assumed by the Federal Government and Governments in the Persian Gulf. This, of course, has been a plank of the Republican Platform since God was born. But there must be an easier way.

The consequences of the alternative to the act, which – make no mistake – letting the insolvent agencies and large banks fail now, would indeed be dire. But to to stick with the current plan promises to end with the failure of the US Treasury. That would be worse.

Here are the conclusions we can draw from the past few weeks. Secretary of State Paulson’s proposal to make the resources of the entire US Treasury available to Fannie Mae and Freddie Mac was rejected. As any banker knows (but none will say in print) those Treasury resources would most certainly be provided if needed, regardless of the current law. Paulson’s move was simply an attempt to allow the public in on the open secret that those resources would be available to the agencies if they were to need it. He may have hoped that this would motivate the corrupt legislators who oversee Fannie and Freddie to clean up their act – or better yet, the public to throw them out. The 900 page Obfuscation Act that was passed this week is a transparent attempt to leave the public in the dark. Fannie and Freddie are corporations who are currently paying dividends out of debt issued with an implied government guarantee, the equivalent of taxpayers paying stockholders who claim ownership of a nationalized firm. If there was ever a way to “reform” these “institutions”, it was crushed by the new bill.

The large New York Banks are, under current regulations, permitted to “sponsor” the subprime mortgage conduits that have been a focus of this crisis. What no journalists ever report is that FASB tried to make these conduits illegal under legislation following the accounting debacles of Enron. It no longer takes a genius to understand why FASB was of that opinion in 2002. Nor is there any doubt why the Federal Reserve lobbied against these reforms and successfully rolled FASB, leaving the conduits available. The word “dysfunctional” is just inadequate to describe our financial legislative process.

The reason for all the shenanigans is that the banks in New York, London and Toronto would be insolvent without major government subsidies. It should be humiliating that the form this subsidy took was an elaborate hoax. But the senators in question are beyond humiliation, somehow. The banks were given permission to buy high risk credit, then fund it with commercial paper and zero capital. This paper was sold with promises from the banks that could not be kept, which is why they are being forced to buy the commercial paper back now, returning the subprime loans to their proper home one the balance sheet of the once-again money-losing banks.

The appropriate solution to this crisis is to let these institutions die. The government’s actual plan is to expand the subsidy club, welcoming in the investment banks as well. Any real bankers interested in taking real risks in pursuit of real profits are moving to private equity. So the good news is, there will always be real bankers. The country can’t do without them. The bad news is the club of subsidized non-banking subsidized bankers is expanding exponentially along with the taxpayer’s ultimate burden when the whole house of cards comes tumbling down.

I am so bored with the current offerings of the public airways that I tuned in to the Congressional testimony of Henry Paulson, Ben Bernanke and Chris Cox to the Senate Banking Committee. Good move. I got the chance to watch a group of jackasses (the senators) tell a group of men (Paulson, et. al.) they were jackasses. Better, I got to hear the group of men agree that a jackass has two legs and an opposing thumb, while men bray and have hooves. It was reality TV taken to the ultimate.

The Chairman of the herd of senators, Jackass Dodd, kept reminding Secretary Paulson that he would soon be gone and Dodd would be left in his chair to deal with the consequences of Paulson’s “idea” to bail out the agencies. (Hint to the happy idiots. You can vote against Dodd next time he’s up. Make some somebody happy.)  True, Paulson will soon be gone – but the emphasis is wrong. The problem is that Dodd and his ilk were in their chairs, pumping up the debt of the F—-ies long before Paulson was caught holding the bag.

Poor Secretary Paulson thought he was being hired to clean up Congress’ mess. This week he had to hire another Goldman executive to whom that job will be delegated. He is charged with the duty of getting a bill through Congress that simultaneously gives the F—-ies the authority to borrow a whole lot more money and backs the whole thing with an unlimited line of credit from the taxpayer. This is being done because Paulson wants to ensure that he never needs to use this authority. And I am the Queen of England.

What is it with Goldman Executives? I think of them as smart guys. Maybe there is a hidden room in the offices of Goldman where executives are brainwashed and become The Manchurian Candidate.

First, the reason Fannie and Freddie got this big is itself criminal (before you sue, Federal Reserve, I using “criminal” in the figurative sense, of course. No reason to throw me in jail here.) So getting back to the fiction that Freddie and Fannie are government sponsored criminal enterprises, they got this big because the banks would never have been willing to buy all the mortgages they bought without a government promise to bail them out should the mortgages go sour. The government withdrew this promise (wink, wink) but to the surprise of zero bankers, is about to reinstate the guarantee (because it suddenly is possibly useful.)

Second, the “Are they too big to fail?” question is silly. IBM was once 10% of the S&P 500 index. Rome once ruled the known world. Everything eventually fails. The life expectancy of a corporation is about the same as that of a person.

But in my current offering I’m going to make a simple point. If we don’t squeeze the life out of the corrupt and ineffective Freddie and Fannie (and if t’were done t’would be best done swiftly) we will soon be confronted by the question raised by Peter Goodman (NY Times, July 20, 2008.) Is the United States too big to fail? And although I know there is many an American that thinks the answer to that question is yes, there are no students of history among them.

Goodman is no babe in the woods. He carefully counts the major costs of letting Freddie and Fannie fail. The US Treasury would need to assume much of the debt of Freddie and Fannie. The total is $5 trillion, which would double the size of the US debt. This would no doubt drive up the government’s borrowing costs and perhaps downgrade the rating on Treasury bonds, costing taxpayers some serious money. A downgrade would put US’ financial reputation in doubt. Since the reason that most other countries around the world hoard our debt is that very good reputation, other countries would be pressured to sell in favor of the Euro or, gadzooks!, the Chinese Yuan, both of whom have been flogging the dollar for some years now. The point is, every American, and many non-Americans, are going to suffer if we don’t bail out Freddie and Fannie. And sadly, not one single politician or official is going to lay out the following truth.

We said Continental Bank was too big to fail and we bailed it out. That set a precedent. We said the Savings and Loan industry was too big to fail. That expanded the precedent. We said Long Term Credit was too big to fail. We said little bitty Bear Sterns was too big to fail. Now we are saying that Fannie Mae and Freddie Mac are too big to fail. We had better get our minds around this fact. If we bail out Freddie and Fannie, the world is going to ask the question, “Is the United States too big to fail?” And if you want to know the answer to that question, just travel abroad. Ask anybody.

First there has been the way with which we have become most familiar since the crisis. Find the best scam the bank regulators are passing out and push it to the max. This was the favorite among the Large New York, Toronto and London banks, who would have faded into obsolescence long ago if the regulators had not been passing out the candy. The disadvantage of this strategy has become pretty obvious.

Be a genuine investment bank. That means living on the edge, eschewing imitation but constantly needing new and better strategies to outdistance your competitors, requiring vigilance in managing the new risks new ideas entail. Most visibly the archetype in New York is Goldman Sachs (and, yes, Lehman) but hidden “down under” are the still more creative and wisely anonymous Macquarie Group and Babcock and Brown. The disadvantage here is you are constantly being imitated and therefore need to keep creating. Something Adam Smith warned about.

Be a banking WalMart. This is Wells’ strategy as well as that of the Four Pillars in Australia. (Your bad if you don’t know who they are. See Wikipedia.)  One cuts costs to the bone, focuses on retail products only, and does not adopt the latest flim-flam out of the House or Senate Banking Committees. The strategy carries a reputation for being boring. The profits are not as spectacular as those of the investment banks. Most importantly, you have the very difficult job of balancing cheap IT innovation with the need to keep customers happy. In other words, this strategy also requires creativity of an unsung kind. But it works in good times and bad, as we are learning from the institutions’ earnings reports.

Be a Hedge Fund or Private Equity firm. This is sort of an investment banking Darth Vader. You are very cool and very successful, but nobody knows why or how. But these Darth Vaders have been the most important positive factor in banking over the past decade. In banking, “You’re Nobody Unless Everybody Hates You.”

It appears in the case of the Credit Crisis that Henry Paulson is going to lead the way out, for better or worse. There was a photo of him explaining the administration crisis plan on the steps of the Treasury in the Sunday Times that spoke volumes. No assistant secretaries, Fed leaders, politicians high or low stood beside him. He stood alone on those steps.

The reason is simple. From here on out, there are going to be no heroes. In one form or another, the taxpayer is going to bear the burden of digging our way out of this mess, and although Paulson, among the leadership candidates, is by far the least culpable in creating our unfortunate circumstances, he’s going to lead the way out. He spent his career among the leaders of an investment bank that had unparalleled success at taking calculated managed risk, rather than the government subsidized scams called banking that brought us to this sorry state.

He seems to be a person to be taken seriously. There is no preening, nor is there any shrinking away. If so, we’re lucky because there is much to be done and all of it will be criticized by the more simian of our legislative representatives.

Yet the Wall Street Journal Editorial today (July 15, 2008) raises the question whether Paulson became Secretary of the Treasury to “pad his obituary” or contribute to his country. In my mind, that question has already been answered.

Thirty years ago, that debt was a whopping amount of money. But it is dwarfed by the mortgage protection provided by these Agencies today. They protect or own over  half the US  mortgages outstanding. The amount of their exposure is in the neighborhood of $5 trillion, enough to double the existing public debt of the United States if the Treasury took the obligation onto its books. The crisis has deepened under Democratic and Republican administrations alike, and under any number of Federal Reserve Chairmen, so the politics and finger-pointing with which we will be bombarded is just so much talk.

As Paul Voelker, former Chairman of the Federal Reserve, therefore no longer prevented from telling the truth, points out that the new debt is enough added risk to threaten the country’s AAA credit rating, and that means an increase in the tax bill that I don’t even want to contemplate.

The banking system and the bank regulators, congressmen and senators alike, have been quietly letting this problem grow throughout the thirty years since Friedman made his prediction. One regulation has been piled on top of another. Loophole has followed loophole.

However, it appears that we have reached the endgame. The Crisis within a Crisis seems to have erupted when Lehman indelicately pointed out that Freddie’s assets were not of sufficient value to pay off its debt. Ordinary companies become insolvent under these circumstances of course. But investors from Joe Public to Central Banks of other countries have been treating this debt like the Rock of Gibraltar since these agencies were created and nobody seems interested in finding out what would happen if they were to become insolvent.

So what’s a regulator to do? Well, give a lot of congressional testimony for starters. And then it seems, look for a way to convince the world that the Treasury promises to see that the debt is paid without a doubt, yet without actually promising to be the one to pay it. The second part is the tricky one when the amount is $4 trillion.

The plan at the moment seems to be to put the companies into conservatorship. This is an accounting “method” (notice I didn’t use the word “gimmick.” I would never accuse our government of using accounting gimmics. No sir.) This “method” means the government doesn’t actually assume the debt of the agencies. The agencies still owe the money. But if the agencies should be unable to pay what they owe, the government would. You can see that’s not a gimmick, of course. That’s very straightforward. So different from the government accepting responsibility for paying the debt. Thank God for plain speaking bureaucrats. I bet Henry Paulson and Ben Bernancke wish they were somewhere else. Say, interred in Guantanamo Bay.