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Tuesday September 23, 2008 - 14:38:51 GMT
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Forex Blog - Don't Just Do Something Stand There!

This is the new mantra of central banks…like deer in the headlights central bankers are frozen on rate policy stuck between elevated commodity prices and a banking crisis come recession risk this global economy has not faced since 1929 at the start of The Great Depression.  Central banks have done one thing well in this crisis – provided unlimited liquidity to keep banks open and funded.  However, 14 months into the crisis there is no sign that banks can stand on their own and since central banks are not in the business of nationalizing bank risk, the don’t just do something stand there mantra is ever more appropriate.  This is when fiscal policy takes over for monetary policy and so it is no surprise that at the height of The Great Banking Crisis of 2008 Paulson and Bush went to mat on committing $700bln to buy bad assets from the banks, hold them and then sell them at a profit (and they lived happily ever after).


In two and a half pages of a bill, Paulson Plan gives the Treasury Secretary full discretion on the use of these funds and as we learned by Monday that foreign banks will also be included in the list of firms that can bring to Treasury all their dirty laundry…indeed the new “RTC” is a money laundering operation figuratively and literally.  And Paulson wrote in the bill no liability for anything Treasury does with the $700bln. 


Since this is an administration that cooked the Iraq war books, hoodwinking Congress in the effort, and since Congress has voters to answer to and an election weeks away, is it any wonder that both Democrats and Republicans in the House and Senate are thinking about other ways to skin the cat?  Moreover, how good can anyone feel about the Paulson plan when the strongest argument for it is Wall Street won’t wait for a better answer…?


There are no good choices in hell.  But there are choices that determine if there is hell in your future.  Congress would be absolutely remiss in not questioning and offering alternative views to the ones professed by Hank Paulson who started his career at US Treasury with a speech at Columbia University in August 2006 promising to enhance US capital market competitiveness by reducing burdensome regulatory environment (post Sarbox) that was making the US (New York) second fiddle to the more deregulated London capital market.  And throughout the crisis he has taken a case-by-case approach to the problem, often asserting the problem of the subprime market was contained.  My take on Paulson is he is either grossly naïve or grossly cynical…or both.  Each fix was enough to end the crisis because people (the markets and public) could not possibly know what the Treasury Secretary knew and each shot of penicillin would cure the patient because it was more about psychology than reality (some still trumpet this notion).  But surely Paulson and his cadre of former Goldman colleagues as well as his rolodex of every heavy hitter on Wall Street knew that this was systemic from the start and not a question of psychology as Senator Gramm claimed.  So my question for every reader is why Paulson should get a free pass from Congress or anyone else when he has demonstrated poor judgment from the outset of the crisis in August of 2007.  Why is Lehman the sacrificial lamb?  What was the thinking to save AIG but not Lehman?  For anyone who thinks the Lehman failure and its consequences are not so bad then have a look at Sunday’s news that Goldman and Morgan Stanley were allowed to create holding companies as banks, ending the investment banking model forever and bringing the two remaining investment banks under full regulatory control of the Fed.  Oh and Lehman trades and obligations in the tens of billions rest with the courts and there will be fallout for hedge funds with capital locked up with the prime broker (Lehman) and possibly forever.  Or the problems ahead for the pension funds that own loads of Lehman bonds and face seeing cents on the dollar. 


My take is that the $700bln money laundering operation being set up if Congress passes the legislation is another whack-a-mole response.  It is $700bln just for subprime (well that destination was widened on Monday to any assets of banks).  What will it take for HELOCs gone bad?  Or car loans?  Or student loans?  Or leveraged bank loans?  Or commercial real estate loans/securities?  Or credit cards?  My belief is that we can take $700bln and multiply it by 2 if not 3…yes some of it will be recoverable…to get closer to what it will take to cleanse the system.


So why pussy foot with an under funded, false solution to a banking crisis that demands a far larger response? 


My feeling is that we need a Nordic answer – government takeover of the bad banking system (good banks stay private) and government wind down of bad banks, bad assets and bad management followed by privatization.  The problem today is so much larger than an RTC-like response.  And why pretend that Wall Street is wise and deserves a second chance.  It has proven not only it is unwise but prone to self-destruction as incentives reward the riskiest behavior with no downside. 


And I do not think that if Congress commits $700bln in taxpayer money (future generations on the hook for short of an Argentina solution), the people of this country should have a claim on future bank earnings…warrants, options or outright ownership if the assets never recover in price.  And at what price does the Street get to dump the toxic waste on the taxpayer?  This is critical.  The closer to par the greater the risk to the public and the higher the haircut on future earnings for banks otherwise this is a wealth transfer from the citizens to the banks.  


I think the AIG model is the direction the government should head in – there will be plenty of unemployed, talented and honest bankers around to help run the new Federated Banks of America…no one is advocating Reps Frank or Paul will cal the shots on this nationalized entity. 


As long as markets know that a major policy response is in the works and both sides of the aisle agree to find an answer in the next two weeks, asset prices can hold together.  Making major legislation demands more than a this-or-nothing warning that Paulson is peddling.  In reality it should be this is for starters on the big response approach…which I find very problematic…an insufficient big policy response may prove worse than an overly sufficient big policy response.  It seems to me Paulson is still playing whack a mole, just on a grander scale.


David Gilmore


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