There is an excellent article today in the FT titled: Bailed-out banks eye toxic asset buys.

Here’s a brief quote:

US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system. The plans proved controversial, with critics charging that the government’s public-private partnership – which provide generous loans to investors – are intended to help banks sell, rather than acquire, troubled securities and loans. Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions ”gaming the system to reap taxpayer-subsidised windfalls”. Mr Bachus added it would mark ”a new level of absurdity” if financial institutions were ”colluding to swap assets at inflated prices using taxpayers’ dollars.

Of course the banks offer ingenuous justifications for their purchases of toxic securities, with government money, for immediate resale back to the government. And I’m sure Geithner, Obama, and Bernanke will also offer pleasant sounding rationalizations for this type of activity, as well, though it is patently the precise definition of a shell game, which used to be a crime. In any normal state of business affairs, the arrangement currently being pursued by the banks, would surely be considered an outright ponzi scheme and fraud.

More importantly, it is patently absurd. Just imagine if every single company in the US suddenly decided to recognize revenue by borrowing money from the government, to buy fake products, which it will then sell right back to the government. All the revenues would obviously be a sham and ultimately nothing would ever get produced in the economy. Markets would of course at some point completely collapse when people realized they were simply playing in a vast ponzi scheme.

So how are the banks allowed to engaged in the shell game? The only answer would appear to be that it is now become accepted wisdom, that financial fraud is the solution to the financial crisis. And interestingly the stock market is buying this solution. Presumably, those buying stocks now know this is a scam, but of course, if you can’t beat the crooks, why not join them? The justification goes something like this: The government is perpetrating a vast financial fraud and nobody is doing anything about it, as such profits at banks will be humongous, additional profits will flow into the economy etc. One only has to look at the price of Goldman Sachs to see the power of this argument in play. Goldman has of course perpetrated a huge fraud via AIG, as any rational observer can see, and yet the stock has doubled, entirely based on the meme: If you can’t beat ‘em, you should join em.

However, the question remains: If fraud is now the accepted solution to the financial crisis, how will this play out over the long term?

Government sponsored fraud has a long history in third-world countries with dire economic and social consequences.

When the entire economic system of a country is based on legalized fraud (Argentina is a good example), Markets become a giant casino where valuations are completely meaningless, since buyers have justifiably no faith in the system. In the real economy, almost nothing of value gets produced, since there is no incentive to produce anything when you can just sell garbage back to your friends in the government. Income inequality becomes vast, since with tainted money, there is an incentive to hoard it, and launder it, not share it. In other words, there is no trickle down effect.

As for investing: You cannot rationally invest long-term in countries where government-sponsored fraud is the accepted economic policy. Yes, you can trade in these markets, as long as you take your profits quickly and get your money out. Even in places, like Argentina, those who act swiftly can always make a quick buck. But with fraud, the next crisis is always right around the corner. Ponzi schemes are by nature not sustainable.

As for the social implications: There is obviously not enough space to go into the social repercussions of legalized fraud, though I suspect everyone understands why fraud on a large scale is very damaging to society. One important point, though, is that fraud increases selfishness to a large degree, since everyone becomes suspicious of everyone else. Interestingly, however, since our government was and is probably still run by Ayn Rand fanatics (i.e. Greenspan remains a huge Rand follower), it should probably come as no surprise why fraud is becoming the accepted solution to the financial crisis. Astonishingly, Rand penned a famous book: The Virtue of Selfishness. Need I say more?