JOINING THE MASSIVE losses of taxpayer-funded investments in AIG (AIG) and General Motors is CIT (CIT), now on the verge of bankruptcy and likely taking $2.3 billion of taxpayer bailouts with it.

I suppose that, in the government’s infinite wisdom, officials thought the company was an attractive investment near $4 a share last fall, when they took a preferred stake and approved the firm as a bank holding company. Take a gander where it trades today—you need not have been a Harvard economic whiz, as Chairman Bernanke is, to have seen this conclusion coming even then. The Fed, on the cusp of being crowned a “systemic risk regulator” with virtually unchecked authority over the financial world, obviously didn’t see it coming either.

Not Geithner's Greatest


It’s a shame, because the company’s restructuring would have likely come much sooner—and less expensively, had the government permitted a free market to work and not interfered with the $2.3 billion bailout, now gone up in smoke. That’s a loss that represents virtually the entire market capitalization of Burger King (BKC).

The argument presented for saving the company was CIT’s unique niche, providing loans and financing for thousands of small businesses that is vital for a properly functioning economy. But in a capitalist economy, that’s by no means a role that only CIT is able to fill.

In fact, at the same time one major source of liquidity is collapsing, the government itself is destroying another, namely the hedge funds which regularly buy equity, debt and makes outright loans to the small companies most affected by CIT’s demise.

Just this week, SEC officials have testified over plans to make hedge funds subject to rules governing mutual funds, essentially limiting their strategies, leverage ratios and in what securities they may invest. The goal, say officials, is to “protect investors” by making hedge funds, already highly regulated, more like mutual funds. Let’s hope they’re not successful. Hedge funds have far outperformed mutual funds, even in 2008.

Moreover, officials are choking off some of the country’s most accomplished investors just as we need them the most. The best way to mitigate the effect of CIT’s bankruptcy and ease the strain on credit markets would be to deregulate the hedge fund industry, permitting investors to allocate dollars to smart money managers who would quickly fill the lending niche CIT has left behind.

Instead, our government is pushing in exactly the opposite direction, increasing regulatory burdens for funds while further limiting their ability to serve customers and assume risk. From their perspective, it wasn’t government-sponsored Freddie Mac (FRE), the Community Reinvestment Act or ultra-low Fed-manipulated interest rates that precipitated the collapse, but hedge funds, guilty of, well, actually nothing at all. In fact, hedge funds are ready and willing to make the loans customers of CIT desperately need. Why does government insist on standing in the way?

In a free economy, investors make their own decisions about the companies and firms they choose to support. The fact regulators are on the verge of further restricting hedge funds’ ability to invest just as it tallies up a $2.3 billion loss on a bailout few taxpayers wanted to make in the first place, perfectly exemplifies how far we’ve come from anything remotely resembling a free economy.

Obama Policy Odds

In blunt and unusually forthright language, Sen. Lindsey Graham (R., S.C.) told Supreme Court nominee Sonia Sotomayor that he thought her odds of being appointed were high.

"Unless you have a complete meltdown, you are going to get confirmed," Graham told Sotomayor. “And I do not think you will.”

Of course, Graham doesn’t know if she will be appointed or not. Just as a long-shot, out-of-the-money call option will often retain a nickel’s worth of value just a few days before expiration, there remains a change, albeit a slight one, Sotomayor won’t get confirmed. Improbable but not impossible scenarios are easy to imagine, either new evidence being uncovered or other emergency situations developing.

Intrade.com, the real-time, real-money futures market based on current events, is now trading a contract based on whether or not Sotomayor will be the court’s next justice. As of Thursday morning, it is trading at around 98.5, giving a mere 1.5% chance to the possibility she won’t be confirmed. The market doesn’t see a meltdown either.

Yet the free market isn’t giving as favorable odds to many of the president’s other top policy items. A contract that pays off if a government run health insurance plan is approved before the end of the year is now pricing in just a 40% chance, down from 50% a month earlier. Markets are factoring in just a 25% chance a cap and trade system for emissions trading will be established in the U.S. before December 31st 2009. Investors with Intrade.com accounts can trade these markets just as easily as buying shares of GE (GE).



Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.