In re-reading Minsky’s fabulous book of essays, “Can It Happen Again”, which deals with the possibility of another Great Depression, I came across this excellent quote which I think conveys a truth that investors need to remember:
“The fundamental instability of capitalism is upwards. “

This touches upon a deep truth of capitalism: Despite short periods of extreme distress, as we find ourselves in now, the economy and most asset prices, in due time, always bounce back.

The reason is simply because it is the job of the Federal Reserve and Treasury, the chief captains of capitalism, to ensure steady inflation, so as to enrich creditors (i.e. banks) and financial speculators, both of whom are needed for a proper functioning of financial markets.

When the current financial crisis deepened late last year, the problem was that the government simply didn’t do enough to placate creditors and financial speculators. In fact, Paulson’s actions were arbitrary and very damaging to many speculators. Both Paulson and, especially the “academic” Bernanke, were operating in the past, with Bernanke making policy decisions based on his interpretation of events from over 70 years ago! Unfortunately, the financial world is quite different now than it was in the Great Depression.

Fortunately, however, Geithner has a better understanding of modern financial markets than either Bernanke and Paulson, and hence his solution, despite its extreme social unfairness, will work over time, notwithstanding enormous short-term pain, as I’ve noted in prior posts.

Basically, as I’ve touched on in the past, Geithner understands that securitization, not classical lending, is the heart of the financial economy and the only way to get those markets humming again is to fork over trillions of dollars of free money (in fancy terms this is called: “non-recourse loans”) to the financial speculators irregardless of the moral implications.

Of course, when you’re about to receive trillions of dollars of free money from the government to speculate in securities, you’re guaranteed to make your opponent pee in their pants, until they sell these securities to you at pennies on the dollar. This explains the current market meltdown, but also provides hope for the future.

Once funds receive Geithner’s two trillion in capital, and they are able to purchase securities at insanely cheap prices, there will be an enormous amount of profit generated by these funds (my estimate is well over $200 billion). This will in turn lead to renewed speculation and a return to the fundamental instability of capitalism: upward prices.

The only issue for smaller investors is the timing of this massive transfer of wealth, which will mark the bottom of this crisis. My belief is that since the crisis is deepening by the day some major deals will happen sooner rather than later, making it a smart move to accumulate cheap equities, especially micro caps selling at negative enterprise values, at this time. I would also note that every major financial crisis ends with a crescendo of fraud discoveries. The sudden daily increase in the SEC’s ponzi scheme list, which now includes Stanford, is therefore a sure sign that the financial crisis is bottoming out.