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Showing posts from September, 2008

Blow It All Up; Go Back to the Drawing Board

That would be my advice to Congress after the House repudiated the $700 billion bailout plan, 228-205. I've read enough online comments to realize that Wall Street is stunned, perplexed, and not a little bit irritated. But I think that reaction just underscores a growing gulf between the two streets, Wall and Main. Joe Sixpack hated this bill with a fury, and that's what Congress has been hearing.

Now I think legislators have two choices (short of nudging 12 members into changing their votes):

Incrementalism (if you like sports metaphors, call this “going short”): Scale back the size and scope of the rescue. One suggestion floating around would provide for $150 billion in low-cost loans to companies weighted down with too many bad assets backed by U.S. home mortgages.
Advantages: Easier to marshal political support on both sides of the aisle. Sidesteps knotty questions of what to pay for hard-to-value toxic financial waste. Minimizes government involvement.
Disadvantages: May be t…

The Unraveling of the Money Markets: The Flip Side of Efficiency

To the uncritical mind of finance professors who see the markets with the eye of a P.R. agent, the changes that have taken place in the past thirty years in the financial markets were a series of inspired events brought about by visionary bankers, insightful academics and bold traders. The result, naturally, was “sophisticated” and “efficient” markets which benefited all.

In reality, finance is a dialectical discipline. Its development follows the logic of internal evolution of finance capital which turns the phenomena to their opposites – commerce to speculation, hedging to arbitrage, equilibrium to volatility, just to name a few. The most benign phenomena then reveal a hidden side that is in contrast to their docility. Such is the case with the “efficient” markets.

By efficient markets, the academics mean a market where, thanks to arbitrage, the borrowing costs are low and capital is allocated in the optimum way. In practice, this means markets in which capital never stands idle. It i…

And Poof! There Goes $700 Billion

My working title for this blog entry was “Now Serving: a $700 Billion Entrée Garnished With Political Fig Leafs.” But that was a little too long.

The storyline of the Wall Street bailout: King Henry triumphed, while politicians harumphed and bloviated and found tiny fig leafs to cover their exposure before an irate electorate (voters go to the polls in a few weeks). Paulson essentially won what he wanted, as legislators skirmished in the margins of relevance. Some highlights of what we got:

1. The Democrats can crow that they clamped down on executive pay excesses for anyone receiving bailout funds. In truth, the provisions are pretty limited in scope and meek – and don’t always make sense. Example: the CEO of a company getting rescued gets to keep his existing golden parachute, but any new CEO hired won’t be entitled to one. Come again? So the CEO who presided over a financial firm that acquired a lethal amount of toxic waste gets off scot free, while a fresh leader who works to right …

Why a Reverse Auction Won’t Work

Exhausted Congressional leaders, after hours of testy negotiating, reached a deal on the great Wall Street bailout. The devil, of course, is in the details. But from what I gather, the central feature of the plan was preserved: the Treasury will buy up to $700 billion of bad assets backed by U.S. home mortgages.

The latest version of the plan also requires financial firms to give the Treasury warrants in return for getting rescued. A warrant allows you to buy shares in a company at a fixed price. So if, say, Invest-orama receives a bailout, and then its shares soar from $20 to $40, the government can profit. That’s something at least.

From where I sit though, the troubling problem remains how much to pay for this toxic waste (see my previous blog entry). Warrants don’t eliminate that issue; they just add a complicating dimension to it. A financial firm that might’ve sold a deteriorating bond at 55 cents on the dollar might revise the price upward to 60 cents to account for the warrants.

Four Reasons to Punt on Paulson’s Bailout Plan

This weekend Congress will try to thrash out an agreement on a Wall Street bailout. Treasury Secretary Hank Paulson wants to spend $700 billion to buy distressed bonds and other assets that are backed by soured U.S. home mortgages. Okay, let’s pause and take a deep breath and look at four big reasons why NOT to.

1. There is no way to know the right price for this stuff, leaving it likely the government will overpay. The seller of a bad mortgage-backed bond may claim its “fair value” is 60 cents on the dollar. Right now, amid jitters over tightening credit and a still-deflating housing bubble, the best offer on the open market may be 20 cents. So do we trust government accountants – toiling under time pressure, analyzing thousands of different (and complex) securities, probably using vague guidelines – to arrive at the proper price?

2. The U.S. taxpayers will pick up the lousiest of the lousy, probably at the worst prices too. There’s estimated to be more than $2 trillion worth of bad…

The Sly Sage of Omaha

Sometimes, to know what a man really thinks, you need to watch his feet, not his lips. Words are the units of an often-cheap currency that’s easily manipulated and debased. And so when Warren Buffett, finance’s plain-spoken wise man, voices support of a $700 billion plan to bail out Wall Street, one might reasonably glance down to see what his feet are doing. After all, Mr. Buffett’s company Berkshire Hathaway is pretty well cashed up right now, having patiently waited on the sidelines recently while more reckless rivals dabbled in risky ventures.

Buffett’s latest bit of deft footwork: buying a $5 billion stake in Goldman Sachs. While calling any investment bank “blue chip” during this period of financial turbulence is a bit of a stretch, Goldman merits the stamp of quality if anyone does. Goldman is highly profitable, employs many of Wall Street’s smartest bankers, and – perhaps not coincidentally – was rare among peers for foreseeing troubles developing in bonds backed by U.S. home …

Hands off the Ferrari

One of my favorite Hank Paulson quotes, as he tries to drum up support for a $700 billion rescue of Wall Street, was this one. (U.S. taxpayers are preparing to buy a bunch of bad mortgage-backed bonds to clean up the balance sheets of financial firms.) Paulson was responding to a proposal by those grumpy Democrats to cap executive pay packages at companies that receive bailout money.

“If we design it so it's punitive and so institutions aren't going to participate, this won't work the way we need it to work."

Restrict CEO compensation? L’audace! Haven't the red-faced chieftains of Wall Street been humiliated enough just by virtue of having to step forward and ask for help? In all seriousness, the Democrats' pay slap-down isn't one of the better ideas to attach to this bill. Either firms will find loopholes to ladle out compensation in new, innovative ways or they’ll face a talent drain. Reforming executive pay excesses on Wall Street should be hived off from…

A Question for Secretary Paulson

I chose the wrong week to go on vacation and must now catch up with the unread papers of an eventful week.

The demise of broker-dealers was news only in the manner it played out. But the business model was doomed. I wrote on this blog that for broker-dealers “to function, the system has to be unstable”.

The wording was slightly imprecise. I meant that to function, the system needed to be balanced on a razor’s edge. And for over a decade it was. But the ongoing turmoil in money markets disrupted the shaky balance beyond any hope of restoration.

AIG, too, was an easy bet. You could see something was rotten in the state of the company from the vehemence that it attacked standard accounting principles.

What I did not know was the extent of AIG’s involvement in the troubled money market funds. Then, under the cover of arranging an $85 billion bail-out of AIG, the Treasury announced that it would also rescue money market funds regardless of their affiliation. This happened on Thursday, after…

The Big Lie Behind the Great Wall Street Bailout

At the heart of Treasury Secretary Hank Paulson's bailout plan is a Big Lie. The $700 billion plan is predicated on this Big Lie, concocted by financial firms holding a bunch of stinky investments. In brief, Wall Street claims they can't sell the investments (securities backed by deteriorating U.S. mortgages) because of the current upheaval in credit markets and nervousness about the U.S. housing market.

That's a lie. The truth is, the firms can’t sell the securities for nearly as much as they would like. So in other words, let's say they think they're holding investments worth 60 cents on the dollar, when a buyer right now might give them only 20 cents. Their argument: once the fear and panic abates in the financial markets, they'll be able to recoup the "fair value,” or the 60 cents on the dollar. But they need money now. So they're looking for a chump with deep pockets.

Enter the U.S. taxpayer, stage right. Paulson's plan would have the government…

Lehman’s Bankruptcy: An Event to Remember

The most outstanding characteristic of the “pragmatic man” is lack of conviction. He believes in no ideology, honors no conventions, adheres to no principles, follows no set rules, finds nothing per se wrong and rules out nothing categorically.

This is neither criticism nor moral posturing. It is an elaboration of what logically follows from the word “pragmatist”, what it implies. A pragmatist is ruled by the exigencies of the moment. He is a compromiser, a deal maker, a justifier, a fixer.

Central bankers are a pragmatic lot.

The news of Lehman and Merrill reached me at sea, in Alaska’s Inside Passage, to be exact. Without the phone reception and the spotty and outrageously expensive access to the Internet in the glaciated valley, I do not know the details, but the details do not matter. There is only one central question. Why was Lehman allowed to fail after long words about the systemic implication of the failure of much smaller Bear Stearns– and, if you want to go further back, Long …

Secretary Paulson Jumps the Gun – and Fires His Bazooka

Treasury’s takeover of Fannie Mae and Freddie Mac over the weekend meant that Secretary Paulson’s bazooka strategy had failed – but only because he chose to fire without having to do so. Otherwise, following his own words that “government support needs to be either explicit or nonexistent,” he could have extended an explicit government guarantee to Fannie and Freddie and achieve the same results he got with the takeover with much less suspense and fanfare. But the point, of course, was not to save Freddie and Fannie, but to bury them.

The extensive coverage of the event that followed added nothing of substance to the subject. That was par for the course for the media, as the readers of this blog know from the Destruction of Fannie Mae and Freddie Mac. A few tidbits, though, I found interesting.

One was Secretary Paulson’s using a secure video link from a bunker to brief the president. I understand the show-off, the ego trip: look Ma, I am talking to the president from a bunker. But ther…

The Critical Role of Interest Rate Swaps in Financial Markets and the Real Economy

Sometime in the fall of 1990, during a lunch conversation with colleagues in what was then Credit Lyonnais, I brought up the idea of writing a book on swaps. The head of HR who had some knowledge of the publishing industry thought I was setting myself up for disappointment. Publishers would not accept a book proposal without an introducing agent, and no agent would take a writer as a client who was not already a published author. Like first jobs and the experience requirement, it was one of those well-known catch-22s, he said.

The same evening – it was on a Thursday – I wrote a 4-page proposal and sent it to Dow Jones Irwin. On Monday they called and offered a contract.

Valuation, Trading and Processing Interest Rate Swaps came out in 1993 under the imprint of Business One Irwin – even then the publishing industry was in turmoil – and, according to the statistics of the legendary McGraw Hill bookstore in New York anyway, became an “industry bestseller”; industry meant technical books in…

(What Lies Behind) The Descent of Man

I had planned to write about this story earlier but got distracted by the events in the financial markets.

On August 6 this year, 11 climbers died on the “K2”, the world’s second tallest mountain.

Maurcie Isserman wrote an insightful Op-Ed piece in the New York Times in which he faulted the every-man-for-himself attitude of the climbers and contrasted it with the more chivalrous conduct of bygone years. I am quoting select passages here, but you should read the piece in its entirety.
WILCO VAN ROOIJEN, a Dutch mountain climber, managed to survive the debacle this week that took the lives of 11 others in Pakistan on K2, the world’s second-highest peak. Describing the chaotic events that ensued when a pinnacle of ice collapsed and swept away fixed ropes that climbers from several expeditions high on the mountain had counted on to aid their descent from the summit, Mr. van Rooijen lamented: “Everybody was fighting for himself, and I still do not understand why everybody were leaving each ot…