Friday, October 10, 2008

When they don't 'Get it'... We do

A good workman never blames his tools
The President spoke to us today assuring us that the he has ample tools to fix the problem. But does the government know how to use those tools? Anyone can buy the tools of a builder. But does that mean that they can build a house- one that wills and be durable...pass code? What has the government shown us? Sadly it is only that whatever tools it has arranged it has not used them well.

The Mistakes By Episode----
The President's talk today is another mistake. He tries to assure us about the adequacy of the tools when we just arranged for $700 billion in Bail-Out Bucks ($700bln BOB) and have not used one penny of it. Events continue to overtake us. The tools are still in the tool kit.

The day of the coordinated rate cuts he stepped up to the mike to tell us that more banks could fail. Hey, that's a real confidence booster Mr Treasury Secretary. Any feel-good effect from the coordinated global rate cut was wiped out by his telling us it would do 'no good.'

The request for $700bln with no strings, no oversight, no recourse, no nothin' attached was a non starter and confidence-crusher all by itself. My God! Was he serious? After such a request, of course, we felt the situation was serious. But the request was a non-starter. It made us wonder about two things (1) are things really that bad, or (2) are these guys' judgment to ask for monies like this an example or proof of their poor judgment?

After the $700 Bln BOB was passed Paulson tired to re-spin his offer as a different, saying he knew all along there would be oversight. And he continued, that it would be presumptuous of him to have tried to dictate the details. But he did not offer this in his proposal he and Bernanke argued STRENUOUSLY for NO STRINGS. This sort of after-the-fact recasting of events is not healthy. We all know what he did and now in trying to say he didn't he make things worse. This kind of thing takes a toll in terms of credibility lost.

Their approach was fundamentally flawed. Put aside he bad P-R they get in asking for no strings $700bln BOB. The requested this money with no infrastructure for the program they envisioned in place. That meant that they put us on notice and Congress on notice very PUBLICLY for the need for Speed (and Size) then stuck that money in their back pocket and did nothing. Yet passing the Bill for $700Bln BOB did not have any impact on the markets or on the banks. Treasury is only now hiring staff to do the reverse auctions. They have never run reverse auctions before. Meanwhile the markets unravel. And, just to make things worse... Remember that Bernanke had argued that you need no strings to get firms participating in these auctions to make them work. NO ONE has comments on how the efficacy of this approach is now severely damaged due to the presence of strings.

The Super SIV becomes a sieve
When his whole thing broke out Paulson tried to set up a Super SIV to contain these troubled securities and the plan just could not get off the ground. It failed. The Super SIV became sieve and all the assets drained out of it.

There are other things we could add to the list. Paulson/Bernanke seem to have been unprepared to deal with the fallout from Lehman. Since it looks like Lehman actually had no value whatsoever, the decision to let it go seems vindicated. But Paulson/Bernanke seem to have been unprepared to deal with the consequences.

A Chronic Mis-diagnosis
While I generally give Bernanke good marks for his innovative and timely action at the Fed, the Fed does seem to have had one thing consistently wrong. It treated this as a liquidity problem and 'solved' the liquidity puzzle again and again. Yet we know that banks were shying away from counter-party transactions. That smacks of a SOLVENCY ISSUE. If left unchecked illiquidity can breed solvency issues so the Fed tried to make things as liquid as it could and let those who could save themselves do so: the classic Badgehot prescription. But that has not been enough. We have been here before. In the late 1980s banks got certificates of capital to allow them to continue to operate. This is the sort of problem in a period of deep shock, such as we have now, that may require the authorities to color outside the lines. But we have not seen that - yet.

Innovation out of London and From the Fed
The most innovative thinking has come from London. THE FSA (their SEC) put the first ban on short selling; our SEC followed suit. The Brits injected capital directly into banks. Now that option may move up in priority in the US since the TARP auctions are taking too long to develop. The Fed has been the most innovative central bank by far. THE ECB has been the slug of international banking. It needed the cover of a global rate move cut rates by 50bp.

G-7 meeting: low expectations
As we look forward to the G-7, it is with low expectations. Juncker of the EC Commission lauds the British for their bank bail out but said it was not for EMU. Juncker said each country had different circumstances and would need a home-grown solution. I don't see how the G-7 can come up with a plan if it is about 20 different plans that are needed. They can lunch from a Japanese Bento box but not make policy out of one. For all the troubles in the markets no one seems any closer to breaking down the regional dogmas that have stood in the way of a more aggressive approach. Clearly a more aggressive approach is what is needed.

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