I am For the Free Market . . . But if the Government is Going to Stick its Big Nose Into the Market, Here's What It Should Do

I am opposed to the bailout plan because it is socialism. It would deal a mortal blow to the free market and to the rule of law, as Paulson's actions are unreviewable by courts. And Paulson's plan is immoral, because its the fat cats hosing the taxpayer again.

Moreover, it simply won't work.

Why not?

Because the real crisis is the unwinding $62 trillion dollar market in credit default swaps. (See this, this, this, this and this).

A hundred billion here or a hundred billion there - while huge sums - are dwarfed by the potential of a crashing credit default swap market, which could very well take out not only the U.S. economy, but the economies of most of the world's developed countries.

I think there is a powerful argument that we should let the markets sort it out for themselves.

However, if governments are going to do anything, they should cancel all credit default swap contracts. The governments of the world should all declare that default swaps are null and void. See this.

The basis for canceling them? Fraud, for one.

People selling credit default swaps got fat and made billions of dollars selling something that no one understood, that no one was overseeing, and that is threatening to bring down the world economy. Indeed, a young, brand new graduate who knew nothing about the real world invented credit default swaps and talked her bosses at JP Morgan into selling them.

And yet they were sold as a relatively safe investment, even though the companies which sold them didn't have the assets to pay out on them. That's fraud.

Warren Buffet calls derivatives "weapons of mass destruction", and they should be treated as such.

Remember that banks and financial houses have hidden their derivatives exposure off the balance sheets. And almost no one understands derivatives:

"Not only [world's richest man] Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't 'figure out'" the derivatives market.

Indeed, the government actively helped to hide the derivatives mess since at least 2006. For example, according to Business Week:

"President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations."

Again, I am for the free market and for the rule of law. But if the U.S. government is going to stick its enormous nose into the free market, the Paulson bailout plan is not what will help. The one thing the government could do is cancel credit default swaps and persuade allied governments to do the same.

While it is solely Wall Street which would be helped by Paulson's bailout, something that addresses the derivatives mess might help the little guy, too. Remember that Orange County, California, went bankrupt in 1994 because it had invested in bad derivatives. Indeed, I heard that a small fishing village in Norway might have to file for bankruptcy because it had bought derivatives as part of its portfolio. And the pension and retirement accounts of millions of teachers and other middle class people probably contain a lot of derivatives also.