Tag Archives: Bailout

Yes. This Is A Bailout

Any question as to whether the government was going to use its powers to directly prop up failing financial institutions will soon be eliminated.
According to Bloomberg: U.S. Treasury Said to Invest $125 Billion in Major U.S. Banks

The Bush administration will invest about $125 billion in nine of the biggest U.S. banks, including Citigroup Inc. and Goldman Sachs Group Inc., in the government’s latest attempt to shore up confidence in the financial system.

The Treasury plans to spend $25 billion each for stakes in Citigroup and JPMorgan, people said. Another $25 billion will be divided between Bank of America and Merrill, which agreed last month to be acquired by Bank of America. Wells Fargo is to get at least $20 billion, Goldman and Morgan Stanley will each get $10 billion, and State Street and Bank of New York will get about $3 billion each, people said.

The government will obtain its stakes with a type of security designed not to dilute the value of common shares.

It is this last piece of the plan – that existing common equity holders will not get diluted by the government’s investments – that I hope is not accurate.

One of the key ingredients to getting the bailout proposal to the finish line was that any entity that sold assets to the government would have to give up equity. It seems unfair to allow existing equity holders to have a free pass at government funds in any case.

The warrant concept included in the bailout bill served 2 functions: 1) It allowed the government to participate in the upside of any plan to save these institutions, and 2) It forced existing management to take a hit, by sharing the pie with taxpayers.

Given Mr. Paulson’s sophistication and the job he has done to date, I would venture to guess that the article has this piece wrong.

But one thing appears to be clear: Mr. Fuld’s company, and my former employer, Lehman Brothers will likely be the first and the last major investment bank to fail if the government has anything to say about it. I would imagine he as well as investors in institutions like Washington Mutual are wondering why they got left out in the cold.

Warren Buffett On The Crisis By Charlie Rose (video)

A long, but worthwhile explanation on where we are…and why the bailout was necessary. Thx to ADK.

Some highlight Buffett-isms from the video:

  • I would rather be approximately right than precisely wrong
  • This is truly an economic Pearl Harbor.
  • The patient on the floor in cardiac arrest is not Wall Street, it is the American Economy
  • Everyday you don’t react to Pearl Harbor you are otherwise behind in a war that you would have fought.
  • Sheila Bear and Hank Paulson are great leaders…need more tools. They need money and flexibility.
  • Derivatives…financial weapons of mass destruction.
  • We naturally go through the 3 I’s: Innovators, Imitators, and the Idiots.
  • Leverage is a lot like Cinderella at the ball…we all know they turn into pumpkins at 12…nobody wants to leave before then.
  • Confidence in institutions is a lot like oxygen…when it is gone for 5 minutes it is the only thing you think about.
  • The American System unleashed more potential in human beings…we have all the ingredients for an incredible future.
  • Beware of Geeks bearing formulas.
  • I’m not worried about the country, I’m worried about anything that gums up the potential of the country.
  • The recession is going to get worse…best case is 6 months. Worst case is a long time….5 years.
  • It is more important who the Treasury Secretary is than who the Vice President is.
  • I would hand a blank check to someone like Hank Paulson.
  • Mark to market is a good idea. Telling the truth never hurt anybody. You get in a lot of trouble when you start putting fictitious numbers on assets.
  • I am paying the lowest tax rate in my life…and that is crazy. I should be paying more taxes.
  • We need real leadership in government. Someone who can explain things to people.
  • If AIG had tried to unwind its derivatives book, it would have hit every financial institution in the world.
  • It would be crazy not to do this….you are going to see more bad news. But over time the system will work.

Fatigue = Complacency

So the Senate passed the bill…kind of.

They passed a bailout plan, but they also included a load of pork along with the bill.

Although arguably not a bad development, the fact that a website called “Treehugger.com” is blogging about the fact that this bill has a tax credit for plug-in vehicles shows you how business really gets done in Washington (Pork-Laden Senate Version of Bailout Bill has Plug-In Hybrid Vehicle Credits).

The self-congratulatory Senate praised themselves for coming together to aid the American people in their time of need. As I have grudgingly acknowledged here, I think some kind of bailout is arguably necessary in order to keep systemic risk contained. Out of respect for someone I really admire, I wanted to acknowledge a logical counterpoint to the bailout that is probably right:

  • $700B is arguably not enough unless we do something to stem the decline in housing values and household credit which are driving the majority of this contraction.

But, even though that is likely true, I think we need to get this thing done before the glad-handers go off to parade around the nation.

Although the Senate did get something done, it is disappointing that rather than focusing on passing the bill we needed, special interests lobbed in requests to get their pet projects included in what is now an over 400 page document…this one is even too long for me to micro-analyze.

And that is part of the problem. America is so shell-shocked at considering the prospect of an economic crisis that we have complacently shrugged our shoulders as Washington jammed this bill full of pork.

Even people like me, who have been shouting into the blogosphere for the last two years on this topic, are starting to simmer with our diatribes.

I am somewhat disappointed in myself for not even mentioning it when the government slipped a $25B loan to U.S. automakers through Congress last week.

Or that the SEC is helping banks cook the books by altering Mark-to-Market accounting rules: S.E.C. Move May Relax Asset Rule:

Under pressure from banks and legislators, the Securities and Exchange Commission issued an interpretation of an accounting standard that could make it easier for banks to report smaller losses, or perhaps even profits, when they announce results for the third quarter, which ended Tuesday.

The move on Tuesday drew praise from the American Bankers Association

Can you believe the Bankers Association is happy that the SEC is going to let them manipulate their financial statements in the open and get away with it?

I think that we have collectively become so worn out with the emotional debate and dialogue around what is going on in the financial markets, that we are running the risk of complacency.

Anytime in life when fatigue sets in, it is sometimes easy to just push snooze and roll over. But I think it is important that we keep paying attention and that we keep our elected representatives accountable in the upcoming election season.

I expect the House will pass the pork bailout bill tomorrow. And hopefully that along with the SEC manipulations will help stabilize things for the time being. Unfortunately, I think the economy is going to be in for some tough times for awhile, so be careful out there if you are an individual investor with any kind of short term horizon.

Hopefully, I can turn to brighter topics sometime soon. In the mean time, I’m going to get a cup of coffee, watch the debates, and try to keep my eyes open to see what other shenanigans come across the screen.

Stop The Blame Game. Pass The Bill.

Stop pointing fingers.

A friend of mine asked me tonight: didn’t you tell me you were against a bailout a few weeks ago? 

The reality is: Yes, I was against a bailout of any kind until Congress proved they were capable of coming up with a reasonable compromise in the context of a very dire situation. As discussed, I discussed below, I believe the regulatory process is working. Whether the bill as it currently stands is the best solution is debatable, but that intervention is necessary at this point has become almost certain.

However, unfortunately, as discussed here (Barnum and Bailey Would Be Proud) today’s House vote on the proposed bailout turned into a finger-pointing session with the politics of old ruling the day: Democrats pointed fingers at Republicans and Republicans defiantly stood against supporting Democrats.

All the while, the stability of our economy is suffering. The stock market was down more than it has been in history…and this was not a matter of pointing fingers. It was the market’s reaction to the outlook for the economy if nothing is done.

So why should you care? Shouldn’t we dig our heels in and protect our “free market ideals”?

Why the Bill should pass.

1) Normal people depend on credit in a number of ways in their daily lives. From grocery shopping, to buying a car, to paying for college, the majority of Americans rely on credit to live. Although people have legitimate concerns about an over-reliance on credit over the last half-decade, we are not living in an academic textbook. We should address financial literacy with education, not with a smack to the head.

2) If we do not do something, many more banks will fail, and credit will significantly contract as a result. As you have seen, a number of banks made mistakes and lent too much money to people based on a failed economic models. If we do not do something, many more banks will fail. In fact, even if we do intervene, it is almost certain that there will be continued bank failures as the economy begins to slow and corporate defaults begin. As the credit crisis continues, the reality of credit evaporation will hurt normal people in real ways. We should seek to minimize this unfortunate reality.

3) Our economic theories have been proven wrong…why rely on them now? Those who want to take a hand’s off approach to the current situation don’t have much of a leg to stand on. If you believe in the effectiveness of the free market, how can you explain the excesses that put us where we are today? The market failed. Of course it did. It was based on models built by human beings. We are imperfect, so we built imperfect models. This isn’t rocket science. Continuing to bang our head into the wall based on economic principles that have been disproven is not only illogical, it is dangerous.

4) People are afraid. When I first started learning about economics, I remember thinking the ideas of “consumer confidence” and “economic sentiment” were wishy washy terms. Why would we care about people’s opinions when thinking about economic growth? The reason people’s opinions matter is because people are our economy. The market is comprised of millions of people, and their subjective understanding of the economic outlook can be just as important, perhaps more important, than what that understanding should be. Watching the stock market plummet today and gyrate over the last few months has made everyday Americans wary of our future. We need to rebuild confidence in our economy to keep it from slowing more than it already inevitably will.

Is the Bill perfect? No. Will it create moral hazard issues for future executives? Maybe. Will the economy really suffer if the government does nothing? Almost certainly.

The government needs to put party politics behind us.

Unfortunately, the government is facing a credibility crisis.

Sure the Bush Administration has made mistakes.  It is unfortunate that our confidence in government has sunk to such a low level that people are finding it difficult to believe how bad things will get if we do not intervene. As John Stewart cleverly pointed out in a side by-side view of Iraq and Economy announcments, President Bush’s speech last week was similar to the announcement of the War in Iraq.

However, the fact that you disagree with the President about Iraq should not lead you to stubbornly refuse to recognize how bad things are looking for our economy. No matter what some people might believe, the stock market is not controlled by anyone, and today’s market downturn showed that investors – Democrats, Independents, and Republicans - are worried about our economy. And they should be. We are witnessing an historic failure of our financial institutions the ramifications of which will be felt for years to come no matter what we do.

Now is not the time to put Party before Country.

Remember…at the end of the story of The Boy Who Cried Wolf the wolf comes. He is now standing on our doorstep. The question now is what are we going to do about it?

I remain confident that we will do the right thing.

Just One Of Those Days (Video)

As all of you are now aware, the proposed bailout Bill did not pass.

Here are some thoughts on what was a difficult day in many ways…even on a day like today, though, there were good moments for all of us. I hope we can focus on these moments rather than on the negative. I am confident Congress will come back and pass a Bill later this week…until then, good luck in the markets.

Is Mr. Bernanke A Good Artist?

Mr. Bernanke says he wants to hold the securities purchased in the bail out until maturity, but how much will they be worth at that point? Via Bloomberg: Paulson, Bernanke Put Bank Aid Ahead of Best Deal

“I am not advocating that the government intentionally overpay,” Bernanke told the Joint Economic Committee today, in response to a question from U.S. Rep. Jim Saxton, a New Jersey Republican.

At the same time, Bernanke also repeated his view that the government won’t pay “fire-sale prices” for the mainly mortgage-related securities Paulson aims to buy in a proposed $700 billion rescue. Officials want to set a long-term value on assets, holding them until they mature or markets improve.

To predict what such a scenario will look like involves answering a number of questions that are far from scientific…this is where the “art” of finance comes into play.

What will the world look like when the markets improve? Will the real estate market rebound? Will the global de-coupling thesis take hold with foreign economies pulling the U.S. out of a shallow recession? How much will losses be in the meantime? What discount rate should apply to such a set of cash flows? Just how successful will these bailout measures be if all previous actions have not slowed down the crisis?

These and literally hundreds of other assumptions will go into the valuation of the securities that Mr. Paulson and Mr. Bernanke are suggesting that we will purchase from banks at a price above the current market value.

The failure to properly value these securities by some of the smartest minds in the world and the collective wisdom of the markets has brought us to where we are today.

Why do we think Mr. Bernanke is a better artist?

The unfortunate result of the bailout will likely be losses for the American taxpayer. And without my suggestion below that we take an ownership stake in the companies we aid, the direct benefit of these purchases will accrue to the companies we aid.

However, it is important to also realize that if we can be confident that his this manoevre will avert greater financial disaster, we will collectively benefit from a shallower recession. This will provide an economic benefit to society as a whole, and this is what the administration is banking on.

One thing is clear: we should not expect to get out of this taxpayer losses if this bailout measure is approved. Being honest with these challenges is important as Americans wrestle with how they feel about the current proposals…and let’s hope that Mr. Bernanke is good at Art.