Credit Hedge

You may not like them and you may not understand them, but hedge funds and private equity firms are critical in restoring liquidity to the credit markets. Gone are the It's a Wonderful Life days of simple lending where your neighborhood bank issued you a mortgage and you payed them back the principal, plus interest over time.

Contemporary lending relies on securitization and shadow banking to keep credit flowing: the bank issues you a mortgage, bundles it with thousands of others and sells them as mortgage backed securities. This illustration makes it much easier to understand.

The Obama administration's latest plan (possibly to the tune of $1.9 trillion)subsidizes investments in these securities in the hopes of getting the money flowing again.

Depending on the type of security they are borrowing against, investors will be able to borrow 84 percent to 95 percent of the face value of the bonds. Investors would not be liable for any losses beyond the 5 percent to 16 percent equity that they retain in the investment.

That seems about as safe as any investment you can make these days, so what would stop funds from jumping all over this?

Add this to the Paulson bailout, the stimulus, the subprime bailout, the auto industry bailout and anything else that's floating around and the scale is staggering. When you step back and look at these remedies from afar, you get the sense that nobody knows what's going on and that we're spraying a 12 garden hoses at a house fire.