Dear Lords of the Dark Matter (Mr. Federal Reserve and Mr. Treasury): …

Dear Lords of the Dark Matter (Mr. Federal Reserve and Mr. Treasury):

Deferential to a fault, we taxpayers learned to love your bubbles and their once-harmless
aftermath. We acquiesced to your genius as Mr. Bernanke affirmed "central bankers have
finally learned how to guide economies -- not with mystique, but with economic
science". Now economic science seems to have taken us far off course.....and who could
have guessed it would turn out like this. In truth, almost anyone with a high school math
education and a little skepticism about the hubris engendered at the frequent sightings of
the once abundant Fed "put", that infamous beast that almost overnight finds itself on the
endangered species list.

We listened for a looooong time and you administered your science. Now it is time for
you to listen, because we are not as stupid as you must think and we would like to get a
few things off of our chests. We know you screwed up, we know it's pretty bad.....but we
can handle it as long as we know we are being told the truth and that justice will prevail.
Before dispensing advice however, we would like to revisit a little recent history so you
will know our anger is not misplaced because we failed to "flip" enough residential real
estate when we could get loans without down payments, jobs or earned incomes. We
passed on the chance to live out the new American dream, i. e. "get rich as fast as you can
with the least amount of work and lie if necessary in the process". Thanks to the Fed, it
did work for a while....so no complaints from those who got filthy rich from your
economic science.

As you read the quotations below, we will understand if you think they were taken out of
context or you just simply "mispoke". Since your work is "science" it will be hard for you
to comprehend how so many of your statements contradict reality, but be that as it may,
this could be the last chance for all of us to learn together....let's look under the hood.

One of the early signs your science may have needed fine tuning was a 2004 New York
Fed report on housing. It concluded "our analysis of the US housing market in recent
years finds little evidence to support the existence of a national home price bubble".
But by the time 2008 rolled around, the Executive Summary (page 2) of an internal Bank
of America (BAC) report written in contemplation of acquiring Countrywide included
this troubling information:

1. Declining house prices, higher interest rates, and a general tightening of credit have led
to rapidly escalating levels of delinquency and default among borrowers, causing many
Americans to lose their homes and the possibility that an unprecedented number will
enter foreclosure over the next several years.
2. Approximately $339 billion, or 13% of all non-agency mortgages are at high risk of
default over the next five years due to payment shock from rate reset or payment
reamortization loans.
3. $739 billion, or 28%, are at moderate to high risk or default over the same period.
4. We expect $400 billion, or 43%, of subprime mortgages, to default in the next five
years.
5. The current size of the securitized non-agency US mortgage market is approximately
$2.6 trillion.
6. We believe that any intervention by the federal government will be acceptable only if it
is not perceived as a bail-out of the bond market.

We taxpayers find it most troubling that you chose not to share this information with us
prior to your efforts at legislation. After all, we are perceivers and maybe that spooked
you a little. I believe everyone calls the Dodd Shelby bill a "housing bailout", but I think
that term shortchanges the true magnanimity of your largesse. The word "housing"
doesn't do the bill justice. Your bill's intent (I hope you don't take umbrage at this term) is
to transfer many mortgages from current owners to the guarantee of the FHA before, as
so eloquently expressed by BAC, they are subject to "payment shock" and default.
Having previously engaged the opinion of the SEC regarding assumption of Countrywide
liabilities and benefitting most from this transfer, you should not be surprised that we
question whether BAC had larger motives in mind when much of the language of the bill
was written by them and knowing how hard it is to value them in our new
"interconnected" financial system.

Since that NY Fed report, taxpayers have been fed a constant diet of platitudes,
misjudgement, misinformation and, in some cases, outright lies. William Fleckenstein has
documented much of it in his excellent book "Greenspan's Bubbles". It is amazing how
little reading is necessary to discover how infrequently words and deeds occupy the same
space. One only need take the time to read the Fed minutes, as Mr. Fleckenstein has done.
Unfortunately, his book has had no apparent impact on improving Fed clairvoyance.
Since it went into print your pronouncements seem to have taken an even more perverse
inverse correlation to reality. Let's take up where his book left off and examine what you
have said since then. Perhaps taxpayers can better remember it since it was so recent and
so delusional in its failure to recognize and comprehend a "deleveraging" of the biggest
financial bubble ever created. Where it stands in history will be revealed as we are forced
to transfer interconnected assets from Pandora's box to an exchange, i. e. mark them to
market

March 13, 2007 Mr. Paulson speech : "The fallout in subprime mortgages is going to be
painful to some lenders, but it is largely contained."
March 28, 2007 Chairman Bernanke before the Joint Economic Committee, U.S.
Congress on his economic outlook. "Although the turmoil in the subprime mortgage
market has created severe financial problems for many individuals and families, the
implications of these developments for the housing market as a whole are less clear. The
ongoing tightening of lending standards, although an appropriate market response, will
reduce somewhat the effective demand for housing, and foreclosed properties will add to
the inventories of unsold homes. At this juncture, however, the impact on the broader
economy and financial markets of the problems in the subprime market seems likely to
be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all
classes of borrowers continue to perform well, with low rates of delinquency."
May 17, 2007 Chairman Bernanke at the Federal Reserve Bank of Chicago's 43rd
Annual Conference on Bank Structure and Competition."We do not expect significant
spillovers from the subprime market to the rest of the economy or to the financial
system."
June 5, 2007 Chairman Ben S. Bernanke speech to the 2007 International Monetary
Conference, Cape Town, South Africa "The troubles in the subprime sector seem
unlikely to seriously spill over to the broader economy or the financial system."
July 26, 2007 Mr. Paulson in Bloomberg: "I don't think it [the subprime mess] poses
any threat to the overall economy."
August 2, 2007 Secretary Paulson's Press Roundtable in Beijing "I also said I thought in
an economy as diverse and healthy as this that losses may occur in a number of
institutions, but that overall this is contained and we have a healthy economy."
April 3, 2008 Chairman Bernanke to Committee on Banking, Housing, and Urban
Affairs, U.S. Senate: "Clearly, the U.S. economy is going through a very difficult period.
But among the great strengths of our economy is its ability to adapt and to respond to
diverse challenges. Much necessary economic and financial adjustment has already taken
place, and monetary and fiscal policies are in train that should support a return to
growth in the second half of this year and next year."
Lest we forget what was said about inflation, here's the record. BB indicates Chairman
Bernanke statement and Fed indicates Federal Reserve statement.
"Core inflation has been relatively low in recent months and longer-term inflation
expectations remain contained".- Fed 11/1/05

"FOMC participants project that the growth in economic activity should moderate to a
pace close to that of the growth of potential both this year and next. Should that
moderation occur as anticipated, it should help to limit inflation pressures over time...the
economy should continue to expand at a solid and sustainable pace and core inflation
should decline from its recent level over the medium term...our baseline forecast is for
moderating inflation". - BB 7/19/06

"Core inflation is expected to slow gradually from its recent level" - BB 11/28/06

"Core inflation, which is a better measure of the underlying inflation trend than overall
inflation, seems likely to moderate gradually over time". - BB 3/28/07

"With long-term inflation expectations contained, futures prices suggesting that investors
expect energy and other commodity prices to flatten out, and pressures in both labor and
product markets likely to ease modestly, core inflation should edge a bit lower, on net,
over the remainder of this year and next year". - BB 7/18/07

"The Committee expects inflation to moderate in coming quarters".- Fed 1/22/08 and
1/30/08
"The Committee expects inflation to moderate later this year and next year." - Fed
6/25/08


With a record like this, you would think a little more circumspection might be in order,
but just last Thursday (July 10th) during the House Financial Services Committee hearing
on systemic risk, Mr. Paulson demonstrated his consistent, forceful, oxymoronic
clairvoyance in opening remarks discussing financial institutions "their ability to raise
capital even during times of stress is a testament to our financial institutions and to our
financial system"....and addressing Fannie Mae (FNM) and Freddie Mac (FRE)...."their
regulator has made clear they are adequately capitalized"....and "regulators are shining a
light on our challenges" and now this gem during Humphrey Hawkins hearing "the two
mortgage giants are adequately capitalized, however weakness of market confidence is
having an effect on the companies, making it difficult for them to raise capital". Speaking
of oxymoronic....if they are adequately capitalized, then why are they raising capital? and
don't confuse your injection of liquidity as a short term substitute for capital. You are
delusional beyond belief if you think these firms will prove to be adequately capitalized
as soon as your liquidity restores confidence. They will be adequately capitalized as soon
as the collateral is greater than the debt it is supposed to secure. Little did taxpayers know
the reason for his confidence was how routinely easy it has become to pick our pockets.
While Mr. Paulson reassured us with hollow words, the stark reality that FNM stock price
was in a free fall was telling him his credibility was on borrowed time.
It is indeed a testament to our financial institutions that they have Lords of the Dark
Matter and fawning members of congress all eager to expand Fed powers even more.
These same congressman, who are afraid of their own shadows, said you have done a
fabulous job "dodging a bullet" by bailing out the BSC creditors. Even though they don't
have the slightest idea what is happening, they are only too happy to echo the praise they
hear lavished upon you by others, mostly by those who benefited the most from your
reckless policies and now need a handout. Maybe that can be explained by Sen. Dodd and
Cong. Frank receiving over half of their campaign money from the financial and real
estate sectors, the ones that stand the most to gain from taxpayer bailouts. Were it not so
serious, one might find humor in that most members of the HFSC probably saw the Fed's
balance sheet for their first time during the July 10th hearing (inquisitive journalists
might want to check their depth of "balance sheet" knowledge) and yet their knowledge
and wisdom about financial matters is the only thing standing between your power to use
taxpayer money to benefit whoever you think represents an "exigent" threat (Federal
Reserve Act 13-3) to the financial system and reward them any amount you deem
necessary to prevent a meltdown.
How did the U. S. financial system blossom into a permanent state of near meltdown?
Because regulators failed to do their jobs. It took the Fed until yesterday to use power
given them in 1994 to regulate all mortgage lenders and mortgage lending rules.
Everyone promoted derivatives ("weapons of mass destruction" - thank you Warren) to
transfer risk to "sophisticated" investors who better understood risk and said they needed
derivatives to "hedge" risk. Instead of transferring risk to those best able to bear it, the
daisy chain ended up concentrating risk in counterparties of credit default swaps (CDS).
You may already have heard of this new industry....well, actually its not a new
industry.....it's similar to state regulated insurance ...and get this....without the regulation
and capital. That is so cool. It operates similarly to a concept Jeffrey Skilling employed at
Enron to become America's "most innovative company". He always bragged of doing the
most with the least, i. e. an "asset light" company to a fault. Having watched Mr. Skilling
marshal this strategy to "meteoric" heights, except for near the end, financial institutions,
encouraged by regulators, co-opted his best ideas. Not unlike his off balance sheet
"special purpose entities" (oh how we long for the good old days of "Raptors" and "Get
Shorty" ), the opaque lock boxes of Michael Fastow, our newly flexible and innovative
financial institutions have their CDS safely tucked away in their own lock boxes. I bet
you're sorry you didn't think of this Al Gore...maybe next time....but let's take a look
inside where we can learn why financial institutions are "too interconnected to fail".
Take a peek at the Office of the Comptroller of the Currency Quarterly Report on Bank
Derivative Activities for the first quarter of 2008. Go to page 22 (top 25 largest
commercial banks in derivatives) and the column Total Credit Derivatives (OTC). These
are the CDS JPMorgan, Bank of America and Citibank are party to $8.1 trillion, $3.1
trillion and $3.4 trillion respectively. The top 25 banks are party to $16.4 trillion out of a
total of $62 trillion, $15 trillion having been added recently. Hedge funds are counter
parties to most of the unaccounted $46 trillion. These notional amounts represent the
amount of debt that has been "insured" against default. The CDS or "insurance" contract
consists of one party buying insurance from another party who is selling it. The cost is
only a fraction of the notional amount of debt being insured but the "insurer" supposedly
will pay the buyer the much higher notional amount if there is an "event", mainly a
default.
CDS become a problem because the notional amount of debt being insured is far greater
than the debt in the economy, meaning some debt is being "insured" many times over, i.
e. to gamble rather than hedge and the notional amount can only be paid once, eg. a home
insured for fire with policies from 10 companies. CDS contracts are priced by "value at
risk" models that often leave great discretion to values assigned them by buyers and
sellers on their balance sheets. Knowing the most popular model is called "Monte Carlo",
one would have to be pretty naive to think CDS are being valued conservatively.
Complicating matters further is that contracts are done on pools of debt with multiple
counterparties and noone is quite certain who owns what. When it is said markets are too
"interconnected" too fail, it means an event, such as bankruptcy of BSC, would force
insuring parties to pay off notional amounts they may not have, thereby exposing
themselves and other "capital light" counterparties having written similar contracts to a
chain reaction of "mark to market" accounting. Recent evidence indicates some parties
may have willingly entered into CDS contracts even though both buyer and seller knew
the seller ("insurer") never had the capacity nor intended to pay. Many CDS contracts are
written because, as current accounting rules permit, debt insured with CDS can be
removed from balance sheets and lessen the need for capital. This is a circuitous way to
get back to Jeffrey Skilling's "asset light" concept, crafted to perfection through the use of
CDS. At last many are calling for regulation of CDS to include capital requirements for
"insurers" and an exchange where they can be traded. Until existing CDS contracts can be
"cleared" on an exchange and priced at a market value instead of the Monte Carlo model
value, then every time a financial institution is in trouble, there will be calls for a bailout
since mispricing of CDS with its counterparties makes it too interconnected to fail. In
addition, some counterparties may be totally devoid of capital. To "protect" taxpayers
from a systemic meltdown, taxpayers are told bailouts are a better alternative than
exposing the fraudulent accounting.
This has turned out to be a little longer than I would have liked. But it's important. It may
give you a better understanding of how informed your employers are and a little sense of
their mood. I am now going to say a few things that may offend you, but don't take that as
an indication we are mean spirited, angry and inflexible......although I admit we have
reason to be tempted. We can work with you, but we need to be reassured you care about
the US credit rating and what the dollar will be able to purchase ten years from now. No
jawboning, please. We are a reality based citizenry....you know jobs, drive to work, bills,
etc. To regain our trust, minimize taxpayer exposure and begin the long process of
rebuilding our once great economy, here's what we need you to do. Now this will take
courage. It's not a job for sissies so take a deep breath, stomach in, chest out, zip up that
core ...... Here we go:
1. Be honest about the magnitude of our problems (we already know, so this will be
harder on you than us)
2. Get an honest estimate of losses owners of debt will have to take, i. e. determine the
difference between total debt in the system and the current value of the collateral
supporting it. Tip....don't hire anyone with a conflict of interest to determine current
value, especially the "consultants" FNM bestowed $1.5 billion upon to find out their
balance sheet wasn't NYSE ready (I take it you prefer taxpayers make this discovery).
3. For those pesky assets referred to as Level III, let's assume there is a clearing exchange
and what they might sell for on that exchange. You may need outside help from
derivative experts, but again make sure they do not have conflicts of interest. When they
determine these "unrealized" losses, add them to the debt owner losses. With this rough
estimate of the size of the loss, you must decide if the loss is big enough, taken at one
time, to cause "systemic" risk. In that case, do not take it all at once. Amortize it. I know,
figuring out how to do that is the hard part, but it would give all that brainpower at the
Fed something to do.
4. Admit that much of the debt origination included fraud....as will be shortly proven in
those states that have initiated legal proceedings agains CFC. Announce that you want
everyone who used fraud to be prosecuted. That would include borrowers, lenders, rating
agencies and securitizers.
5. Repatriate all income derived from fraud back to taxpayers, including compensation
and bonuses.
6. Pay congress with Level III assets and/or assets in Maiden Lane LLC. Just kidding, but
I bet the accounting would get transparent in a hurry.
If you do all that, you might be able to get us to accept, however unfair, the inevitability
that taxpayers will be stuck for part of the losses. If you want that to go down, taxpayers
must feel at a minimum there had been some justice. You would also take a small step to
regain the public trust. In case you haven't noticed, FDIC efforts to placate Indy Mac
depositors are producing the same results as the 1930's even though the runs are being
done by young and middle aged people that have no memory of that period, yet they are
acting in the same fashion. They have lost faith in what is said. No one believes lies
anymore. Until the truth be told, everything will get further and further out of control.
This lack of trust was on full display as Senator Bunning articulated how most taxpayers
feel. Here's a few of his comments that resonate with taxpayers. "The Fed is asking for
more power, but the Fed has proven it cannot be trusted with the power it has. Now the
Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Let me say a
few words about the G.S.E. bailout plan. When I picked up my newspaper yesterday, I
thought I woke up in France. But no, it turns out socialism is alive and well in America.
The Treasury Secretary is asking for a blank check to buy as much FNM and FRE debt or
equity as he wants. Given what the Fed and Treasury did with Bear Stearns, and given
what we are talking about here today, I have to wonder what the next government
intervention in private enterprise will be. More importantly, where does it stop?" I know
you would rather believe he is the exception, but everyone I know feels the same way but
is currently without representation.
Now you face the biggest challenge of your life....how to handle the FNM/FRE problem.
Finding the best solution demands that the best minds in this country be brought together
for analysis and debate, but it appears you are moving full speed ahead without that input.
It is apparently now so urgent that it cannot wait for deliberation and requires a blank
check even though just days ago taxpayers were assured by regulators and officers of
FNM/FRE that they are well capitalized and "not a problem". That is no way to gain the
public's trust and confidence. That is why I am writing this letter at this time. This is your
gut check time. You must choose who eats the losses, either FNM/FRE debt owners or
U.S. taxpayers through not only paying the difference between the value of the bonds
when transferred to taxpayers and their eventual value (by the way, will we be picking up
those unsecured loans FNM has been writing to help underwater borrowers "catch
up"?).....and increased credit and inflation costs with potential replacement of dollar as
world reserve currency.
On the morning of the hearing on systemic risk, I was thinking....I really feel sorry for the
chairman with all the problems he is already facing and now to have to testify on a day
when FNM/FRE appear to be immolating. This is really going to be a rough day, but nary
a mention of either. Instead there was a virtual love fest between congress and the
witnesses. Even though Chmn. Bernanke affirmed in answer to Cong Garrett, that barring
congressional intervention, he already had explicit authority to use taxpayer money for
any "exigency" that he thinks threatens the financial system and in whatever amount he
deems necessary, congress stands ready to transfer even more power to the
witnesses....pretty much anything they ask for.
Gentlemen, despite my empathy for your predicament, there are a lot more innocent
taxpayers in even worse predicaments because of your past and ongoing policies. Eighty
percent of the population lived responsibly within their means and had nothing to do with
your credit bubble. Now they are being asked to pay for the actions of the irresponsible
through higher costs for everything and nominal interest on their savings. Your egregious
use of our tax dollars to bail out FNM/FRE creditors may enable you and congress to
celebrate one last time what a wonderful job you have done "protecting" taxpayers from
your own malfeasance that produced the permanent state of near meltdown. But that may
be the last celebration as you will have lost the support of 80% of the population. You
will have noone to govern except those who have fleeced us royally and good luck in
collecting whatever taxes you will need for your next bailout.
Any public servants who do not have the stomach to meet this challenge in favor of
taxpayers should step down immediately in favor of leaders who can and will. This
country is crying out for leadership, not bailouts. We have no interest whatsoever of
living in a bailout nation. We have overcome worse problems than this but maybe not
worse leadership. It's time to join the 80% of this nation who had nothing to do with your
credit bubble and accounting nightmares or at least get out of the way before you make it
even worse.


                                                              Sincerely,


                                                              William P. Bennett


P.S. If the bailout fails and you need scapegoats, check the fingerprints of short sellers.
Sometimes I am remiss at having sold short Fannie Mae in 2002, thereby setting off a
torrent of careless mortgage underwriting. I heard this on the internet, so take it with a
grain of salt, it is rumored that short sellers applied for most of the "liar" loans. Had the
mortgage industry anticipated their complicity, quality control could have been reduced
to a simple question on loan applications. Have you ever sold short or thought about
selling short shares of any company in financial services? Answer "Yes" - loan denied,
answer "No" - loan approved. That one question could have eliminated from home
ownership all the varmin who ended up causing shares of FNM and FRE to fall to single
digits. I wouldn't be surprised if these same low life were buying deep out of the money
puts on Bear Stearns only days before it cratered to $2 share. You may want to look into
that. I understand there are records of who was doing it, so I would expect you will be
letting us know real soon who was involved in this chicanery so we can deport them to
France.