The Ghost of Paulson-Past

What we saw yesterday was more of the same.

I was flabbergasted that the plan was so light on details. They have had 3 months to put something together and the best they could deliver is a 7-page fact sheet.

In addition, the plan seemed scattered. It was reminiscent of the original 3-pager for the TARP. Say you will do many things, then figure out later what to do.

I was particularly disturbed by the following remark by the Treasury Secretary: “We believe that the United States has to send a clear and consistent signal that we will act to prevent the catastrophic failure of financial institutions that would damage the broader economy.

Huh? “clear and consistent”?, you gotta be kidding.

There are two ways to translate this. First, he knows more than we do and he is telling us that our financial system is insolvent. Second, it is fear-mongering to get support for this (as well as the so called ‘stimulus’).

Here my take on the positives and negatives.

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The Positives

1. It appears as if the Fed, Treasury and FDIC are working together. This is in sharp contrast from the Paulson era where the Fed had to take matters into their own hands after the consistent bungling from Treasury. However, we have a new wild card, Larry Summers. His role in the current power structure is still evolving. After Geithner’s fiasco yesterday, I expect his role to become more prominent.

2. Banks need to qualify for additional capital. This is good news. In the past, the government doled out our hard-earned money to any bank – no matter how insolvent. We dropped $90 billion in cash and hundreds of billions in backstops to Citigroup and Bank of America – without even knowing they were insolvent.

3. Some additional teeth as a requirement for getting government money. The most important is the reporting of loan creation. I want to see the loan creation by size of corporation. We know that small and medium sized business are getting screwed because banks are rechanneling their credit to large firms. Overall, the amount of credit creations is down only slightly – but it is misleading. Jobs will be created by small and medium sized business – and they can not be the disproportionate target of banks seeking to reduce risk.

The Negatives

1. It is a disaster that the plan is so short on details. It detracts from the good things in the plan. Investors lose confidence. It would have been better to delay the release.

2. I like transparency, as you know from reading this blog. However, check out the language in the Fact Sheet: “The Treasury Department will work with bank supervisors and the Securities and Exchange Commission and the accounting standard setters in their efforts to improve public disclosure by banks. This effort will include measures to improve the disclosure of the exposures on bank balance sheets. In conducting these exercises, supervisors recognize the need not to adopt an overly conservative posture or take steps that could inappropriately constrain lending.
To me, this means they are willing to suspend mark-to-market accounting. That is a disaster for transparency. Nobody in the media picked up on this. Surely, we learned something from Japan’s lost decade where Zombie banks prevented a meaningful economic recovery.

3. The stress test as a condition for additional government equity seeming contradicts the point above — but it doesn’t. In its simplest form, a stress test is just a scenario analysis. You look at the worst scenario and see how much capital you have left. But I think they want to do the stress tests with the bogus valuation of certain assets. That is no stress test. That is a joke. That is what got us into this mess. Indeed, it is frightening to think that we dropped hundreds of billions already and didn’t require a stress test. A stress test is Risk Management 101.

4. The Private Public Partnership to deal with the toxic assets. The problem is conflicting interests. The private investors want the maximum return. The government wants to do what is best for the entire financial system.
We are short on details but one scenario is that the government lends people money to buy troubled assets. To me, this is exactly the type of action that got us into trouble in the first place. The government is taking the downside. We are throwing money away doing this.
It is much better for the government to simply buy these assets at the cheapest possible price. That way, the American taxpayer has a chance for a positive return. Why provide government guarantees to a small group of investors gain this upside? It makes no sense to me.

5. The sticker shock. $2 trillion for this. $1 trillion for the so-called stimulus. All the money spent so far. There are 154 million Americans either employed or unemployed. $3 trillion means that each needs to write a check for $20,000 to bail out the bad bets of the financial institutions? Who knows if it will work. We don’t even know the specifics. No wonder the market tanked.

The Treasury’s 7-page Fact Sheet can be found here.

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One Response to The Ghost of Paulson-Past

  1. David Gagnon says:

    Here are some of thoughts on your “negatives”…

    1. As you mentioned– they need more details. Unfortunately, it is turning into a Japan situation where almost any correct policy is oing to have a lot more short term pain (i.e. more job loss, more capital loss recognition), meanwhile the public outcry is for NOT helping the banks that got us into trouble. (I observed this problem of Japan when I lived in Japan in the 90s– in the US, 2008 was a time where the govt could have helped the banks aggressively with the public mostly on their side…that time is over now..) Obama/Geithner/Summers are going to have to draw a line of which banks/cos. survive and which do not, and then help the resulting obless make the transition to new jobs.

    2. Reversing Transparency– another Japan mistake. This could kill the markets with permanently higher risk premia.

    3. Again, policymakers need to draw a line between good banks/bad banks and then close down the bad banks and sell off the assets…this would probably include Citi, maybe BofA…the too big to fail doctrine is another thing that got Japan into trouble.

    4. The financing should be something like the RTC program in the early 90s, where private capital puts up 20% (or more) in the first loss position and the government provides low cost senior financing.

    5. Bigger is not better. Policymakers should be talking about helping the good to survive/prosper and the weak to transition smoothly. They should encourage those who still have capital to come into the markets and buy distressed assets, cheap houses, parts of bad banks, parts of bad businesses (GM, et al.) and then help job-losers re-tool for the “new” economy/reality. And breaking up a company like Citi may actually result in less job loss (especially in the long term) since the new owners would likely grow the businesses that they bought, and the new owners could be offered special govt financing that encouraged short-term worker retention.

    I totally agree on the small/medium business emphasis– but it isn’t clear whether this is just lip service or a significant policy. In apan I observed first hand the drag on job growth that resulted from tight credit for small/medium companies.

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