Page 2 of 2 A bedside guide for Henry Paulson
By Julian Delasantellis
sector loans. Will it work? I have no idea; what I can say is that for it to do
so it will have to buck the howling gales of deleveraging currently taking
apart and flattening everything in its path.
Once again, much as in the government's redirection of the TARP to focus on
fortifying bank capital through the purchase of bank preferred stock, this
seems to be yet another attack on the symptoms of deleveraging, and not on its
cause. Until the basic metastasis that is breeding all these opportunistic
infections of the financial system - the declining value of mortgage-backed
securities shearing away bank capital - is successfully addressed, these
hastily patched-together rescues should be
expected on a regular basis.
The same phenomenon is evident in the second half of Tuesday's announcement,
the $600 billion support package for GSE mortgage-backed securities. As the Fed
put it:
The Federal Reserve announced on Tuesday that it will initiate
a program to purchase the direct obligations of housing-related
government-sponsored enterprises (GSEs) - Fannie Mae, Freddie Mac, and the
Federal Home Loan Banks - and mortgage-backed securities (MBS) backed by Fannie
Mae, Freddie Mac, and Ginnie Mae. Spreads of rates on GSE debt and on
GSE-guaranteed mortgages have widened appreciably of late. This action is being
taken to reduce the cost and increase the availability of credit for the
purchase of houses, which in turn should support housing markets and foster
improved conditions in financial markets more generally.
The
Fed was taking these off the GSE's hands because private investors weren't;
this was what the Fed meant when it said, "Spreads of rates on GSE debt and on
GSE-guaranteed mortgages have widened appreciably of late."
It's one thing for investors to shun securitized consumer receipts lacking a
federal guarantee, but, here, GSE debt was being shunned even with the fairly
explicit guarantee provided by their de-facto nationalization in early
September. The only thing the government could have done to make the
nationalizations more explicit than it did would have been to put the loafing
brothers-in-law of Congressman into cushy no-show jobs at the banks.
Still, like an insecure young lady demanding more than just a simple
affirmation of her lover's affection in favor of fevered and continually
reaffirmed proclamations of such, it seems that investors at present want, and
are demanding, the most clear and explicit affirmations of the US government's
guarantee as a condition of opening wide their silk purses.
The pessimists' answer to the old inspirational saw that "things are darkest
just before the dawn" is that "things are darkest just before they turn
absolutely black". If you believe the former and not the latter, there was a
faint glimmer of the possibility of a gathering dawn, not in Tuesday's TALF and
GSE announcements, but in Monday's Citigroup rescue.
Even research animals can be said to possess a learning curve in that they
eventually learn, among all the other things they can do to pass the time while
in their cage, that pressing the bar gets them a treat. After doing an
innumerable number of things, from letting the crisis fester to 14 months of
ham-handed attempts to contain it, the George W Bush administration may just
have stumbled on the treat.
The press looked at the Citigroup bailout and slotted it into the familiar and
comfortable pigeonhole - big corporate bankers getting saved while the working
class (which, in the pantheon of US socio-politics, regularly reaches up to
those who make US$250,000 or more) starves. Here, as in most things, the press,
in ignoring the subtleties of the real world, missed some fairly interesting
developments.
Opinions may differ on at just what point a young person can be termed an
adult, but if you watch US television commercials, you might come to the
conclusion that adulthood commences when a person purchases his or her first
insurance policy. Prior to that point you might have been an irresponsible and
immature hellion, but once you sign on that dotted line, and write your first
premium check, you're automatically transformed into a sound and sober adult,
inevitably trading in your kick-ass, fire-red sports coupe for the light-beige
mini-van that transports the loving family you've insured to sound and sober
destinations - the church or the pediatrician's office.
In the bailout rescue deal that the US Treasury offered Citi, Treasury
Secretary Henry Paulson sold an insurance policy to the company, hoping that
it's ready to grow up.
I've written before here many times on how the core malady currently bedeviling
the financial markets is deleveraging, the continuing process that has banks
and other financial institutions withdrawing credit and liquidity from the
system. Deleveraging is being caused by mortgage securities declining in value
inside banks' portfolios, weakening their capital base and thus impairing their
ability to make new loans.
The original focus of Paulson's TARP was to buy those depreciating
mortgage-backed securities, extricating them from the bank's portfolios, and
thus eliminating the threat to the banks' capital base from any further
depreciation.
The entire world, eventually including Paulson, when he changed the direction
of the TARP on November 12, hated this idea. The Citigroup rescue may have
found a way to accomplish the same policy objective, at least initially at a
much reduced cost to the government. In exchange for Citi giving the government
$7 billion of preferred stock in the bank (in essence, the policy premium) the
government has agreed to insure losses in a roughly $300 billion package of
at-risk Citi mortgage-backed securities.
The TARP (which in this deal is also kicking in another $20 billion to bolster
the bank's capital) originally intended to deal with the threat to banks from
declining mortgage-backed securities through buying them away. By insuring
these said same securities and thus placing a government-issued floor that
supports their value, this could be doing the exact same thing at far lower
cost - at least if the policies don't have to be paid out should the securities
insured continue to decline in value.
When the TARP was first proposed in late September, conservative Republican
backbenchers in the US House of Representatives countered with an insurance
scheme something along these lines, but the Democratic leadership in the House
dismissed the idea, and threw their lot in with the TARP, when Paulson told
them that the insurance idea was unworkable.
Now, with the Citi rescue, he has essentially proposed the same thing. In this,
like in so many other responses to this crisis, Paulson's bald-faced policy
undulations are absolutely breathtaking in their guile and shamelessness. If
he's still looking for employment after January 20, I'd see if the circus has
any opening for, depending on your perspective, either the man with no spine or
the man with two faces.
Taken together, last week's rescues perfectly illustrate a key feature of the
current financial environment - the spectacular extent of government
involvement in it. After 16 months of repeated catch-as-catch-can rescues of
individual financial institutions, the US financial system seems to have been
bifurcated into two distinct parts.
One is that ever-growing part of it whose operations are, in the final
analysis, backstopped by the Federal government. That section is limping along,
heavily wounded but surviving. The other part is that section of the financial
system as of yet still traipsing across the high-wire of finance without the
government's safety net. This part of the system continues to be in complete
collapse and freefall; with every financial institution brought to its knees
and then rescued, one more player transfers from the unprotected sector to
under government's protection.
With Monday seeing basically one more vicious and bloody street mugging on Wall
Street, with the Dow Jones Industrial Average down 7.7%, and stocks of the
unprotected financial sector, banks such as Wells Fargo, Bank of America, JP
Morgan and Goldman Sachs, down in between 16% and 20% just that day, it's
reasonable to assume that soon there will be be further knocks on the door of
the government compound.
In Shakespeare's Romeo and Juliet, Juliet bemoans that she is only being
kept from her love Romeo because of his name.
What's in a name?
That which we call a rose
By any other name would smell as sweet.
Likewise, nationalization, "by any other name", maintains its odor as well.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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