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Wednesday July 16, 2008 - 14:21:16 GMT
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Forex Blog - Bernanke, Paulson Need Markets to See Mama Mia and Get Happy

Rather than committing unlimited taxpayer dollars via the Treasury’s credit lines or the Fed’s discount window to the GSEs, how about the Treasury hand out tickets to Mama Mia for a far more effective mood changer?  A little Abba can do far more for investor confidence in US financials than any pocket bazooka.  Paulson’s bazooka metaphor suggests war…with traders, investors and all comers.  Why not make music instead?  Cue up Dancing Queen.  After all if SEC’s Cox is right its 90% perception and 10% reality.  Evil short sellers seem to be the focus of regulators, not bankrupt management and zero risk controls.  I also find it ironic that Paulson came into the Treasury job touting the need for less regulation of capital to better compete with other financial centers, calling the financial markets the most robust of his lifetime. 

I also could not help but see more irony at the Hill testimony Tuesday as Democrats seemed eager to extend Paulson a blank check to support Fannie and Freddie while the Republicans said not so fast.  Jeffrey Sachs of Columbia University said in a financial crisis there are no libertarians.  However Senator Bunning is surely the exception…Representative Paul however is a libertarian in a parallel universe. 

But it is also dicey if the Republicans in Congress force a delay in the Paulson backstop plan – this would put the onus on the Fed if the GSEs can’t raise funds to finance their enormous balance sheets – Freddie has about $4bln in notes to sell Thursday.  Hank, make some calls. 

What seems most surprising is that the run on IndyMac was not repeated elsewhere in the country – like in Seattle and Cleveland for starters.  Maybe Joe and Sally Public were at the premier of Mama Mia.  Nevertheless, the IndyMac Great Depression redux will show up at the very least at many regional banks.  The FDIC has 90 regional banks on its unpublished at risk of failure list…IndyMac was never on it.  And I read that the FDIC bailout of IndyMac insured deposits will use up 10% of the agencies available pool of funds to make good on $100K guarantees.  Do the math…FDIC gets emptied quickly and then we go back to the Hill for a fill up. 

It is scary that Congress is now the key player in the financial crisis…torch was passed from the Fed to Treasury and Paulson Tuesday handed it off to the Hill.  The Hill is truly the Gang That Can’t Shoot Straight.  Mamma Mia.

Which leads me to the idea of contingency planning…we are told in the financial press that US Treasury had a GSE plan ready to go for weeks if not months…hmmm.  Presumably it has a contingency plan for a run on the dollar.  What will this plan look like?

In the spirit of thinking outside the box, currency intervention is surely not the crux of any dollar contingency plan.  It may be a tactic deployed, but there has to e some other set of policy measures the Treasury, in consultations with the Fed, have dreamed up.

On a purely speculative note here are some ideas…

US Treasury issues dollar currency bills that pay 100bps over T-bills and are pitched to foreign investors, sovereigns.  The proceeds do not go to financing the budget deficit but are held in escrow for redemption at some fixed date (like CD) and the financing of the higher rate is split between US Treasury and sovereigns holding large balances of Treasuries with the NY Fed’s custody accounts…some of the interest income paid to reserve managers gets siphoned off to pay interest on the dollar currency bills – it is our currency and it is the world’s problem. 

Even more outside the box would be the government selling oil and gold…I have run this by senior officials and seems highly unlikely.  But in these times never say never.

In terms of the Fed and the dollar, there is no scope to hike now (again I think the Fed could have hike in late June tactically…but conditions have changed and this opportunity is lost).  So interest rates are off the table in the event of a run on the dollar.  In terms of the ECB and other central banks, rate cuts are off the table. 

So it may come down again to Paulson appealing to Congress for the authority to issue currency bills (or some other measure).  What scares me now is that the crisis response is now in the hands of Congress and this is the worst of all possible situations.

We read lots of references to the Great Depression – finding out what and why things like the FDIC, FHLBs and SEC were really all about some 75 years later.  So why not look at Carter bonds (marks and Swiss franc denominated bonds sold to non-domestic investors and proceeds were used to buy dollar) and gold sales as effort to support the dollar in the late 70’s as another historical precedent in terms of what surprises officials may have in mind for a possible run on the dollar?

David Gilmore



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