from the Thursday 25 September edition of The Financial Times:
Paulson Cannot be Allowed to Have a Blank Check
By George Soros
Paulson Cannot be Allowed to Have a Blank Check
By George Soros
Hank Paulson's $700bn [$700,000,000,000] rescue package has run into difficulty on Capitol Hill. Rightly so: it was ill-conceived. Congress would be abdicating its responsibility if it gave the Treasury secretary a blank cheque. The bill submitted to Congress even had language in it that would exempt the secretary's decisions from review by any court or administrative agency - the ultimate fulfillment of the Bush administration's dream of a unitary executive.
Mr Paulson's record does not inspire the confidence necessary to give him discretion over $700bn. His actions last week brought on the crisis that makes rescue necessary. On Monday he allowed Lehman Brothers to fail and refused to make government funds available to save AIG. By Tuesday he had to reverse himself and provide an $85bn loan to AIG on punitive terms.
The demise of Lehman disrupted the commercial paper market. A large money market fund "broke the buck" and investment banks that relied on the commercial paper market had difficulty financing their operations. By Thursday a run on money market funds was in full swing and we came as close to a meltdown as at any time since the 1930s. Mr Paulson reversed again and proposed a systemic rescue.
Mr Paulson had got a blank cheque from Congress once before. That was to deal with Fannie Mae and Freddie Mac. His solution landed the housing market in the worst of all worlds: their managements knew that if the blank cheques were filled out they would lose their jobs, so they retrenched and made mortgages more expensive and less available. Within a few weeks the market forced Mr Paulson's hand and he had to take them over.
Mr Paulson's proposal to purchase distressed mortgage-related securities poses a classic problem of asymmetric information. The securities are hard to value but the sellers know more about them than the buyer: in any auction process the Treasury would end up with the dregs. The proposal is also rife with latent conflict of interest issues. Unless the Treasury overpays for the securities, the scheme would not bring relief. But if the scheme is used to bail out insolvent banks, what will the taxpayers get in return?
Barack Obama has outlined four conditions that ought to be imposed: an upside for the taxpayers as well as a downside; a bipartisan board to oversee the process; help for the homeowners as well as the holders of the mortgages; and some limits on the compensation of those who benefit from taxpayers' money. These are the right principles. They could be applied more effectively by capitalising the institutions that are burdened by distressed securities directly rather than by relieving them of the distressed securities.
The injection of government funds would be much less problematic if it were applied to the equity rather than the balance sheet. $700bn in preferred stock with warrants may be sufficient to make up the hole created by the bursting of the housing bubble. By contrast, the addition of $700bn on the demand side of an $11,000 market may not be sufficient to arrest the decline of housing prices.
Something also needs to be done on the supply side. To prevent housing prices from overshooting on the downside, the number of foreclosures has to be kept to a minimum. The terms of mortgages need to be adjusted to the homeowners' ability to pay.
The rescue package leaves this task undone. Making the necessary modifications is a delicate task rendered more difficult by the fact that many mortgages have been sliced up and repackaged in the form of collateralised debt obligations. The holders of the various slices have conflicting interests. It would take too long to work out the conflicts to include a mortgage modification scheme in the rescue package. The package can, however, prepare the ground by modifying bankruptcy law as it relates to principal residences.
Now that the crisis has been unleashed a large-scale rescue package is probably indispensable to bring it under control. Rebuilding the depleted balance sheets of the banking system is the right way to go. Not every bank deserves to be saved, but the experts at the Federal Reserve, with proper supervision, can be counted on to make the right judgments. Managements that are reluctant to accept the consequences of past mistakes could be penalised by depriving them of the Fed's credit facilities. Making government funds available should also encourage the private sector to participate in recapitalising the banking sector and bringing the financial crisis to a close.
The writer is chairman of Soros Fund Management
4 comments:
I wish I had paid more attention in Econ 101 and 102 at UMass. I don't understand all of this, and it disturbs me.
I think this is all you need to know.
1. The US economy is designed fundamentally around everybody maxing out their credit cards.
2. Thrift, financial caution, saving are toxic and poisonous to the health of the US economy.
3. The US and every modern dynamic Western-style capitalist economy is fundamentally designed around buying Nikes and Adidas with blinking red LEDs in the heels, around ostrich feathers and caffeine-laced energy drinks, and Britney Spears music.
I've had a huge amount of fun and pleasure from
"The Great Crash" by John Kenneth Galbraith
and
"The Worldly Philosophers" by Heilbrunner (sp?)
Both are really brilliant insights into modern economics by brilliant writers.
Galbraith really socks it to poor Herbert Hoover. But a chill will go up your spine when you read about the US government's response to the '29 Crash.
And then realize who's skippering the boat through this crisis.
And then realize who *might* be the next skipper.
Amd then realize who gets to steer the boat if he croaks.
Jim- banks make money by making loans. they get the loan back plus interest (profit). businesses make money by getting loans. they use the money to buy or make stuff which they then "mark up" to pay off the loan and make a profit too. This is what makes our merry capitalist carousel go round.
2. On a bank's books a loan is treated like an asset. It's out there, but the bank is going to get paid back plus. In addition, where home-loans are concerned, the loan (mortgage) is backed up by the value of the house. So the more loans a bank has on its books the "richer" it is.
3. But what happens when the loan goes or is bad? In that case, the "asset" turns into a liability and the bank is poorer. Oh well... they can always foreclose on the house, resell it and get their money back. But what happens when the price of the house was a bubble-price anyway and it turns out that the resale value of the house was way under the amount of the loan. Oh shit....
4. Banks can only lend money in proportion to their assets. (12:1 currently I think). Because the whole system is an intricate game of musical chairs or of robbing peter to pay paul, banks can lend out more than they actually have on the calculation that not everything comes due at once and they can always spin around fast enough. But when we reach the "Oh shit" point, banks can't lend because they're aint going to be enough in-flow to cover the outflow. This is what is called "insufficient reserves".
5. Now it's a little more complicated than that because a lot of these loans were repackaged and resold to 3rd, 4th, 5th buyers down the line. The whole thing is the financial equivalent of melamine in the baby's milk.
6. The "bailout" is very simply a program of "cash for trash" Our cash to buy up all these "toxic" (i.e. no-good) loans. The idea is that if we give the banks good dollars for lousy mortagages, they will then turn around and make loans again. Of course, we'll be stuck with the trash, but the merry go round will at least start to spin.
7. But nothing in the bill requires them to make loans. Nothing stops these swine from taking the money and buying US or German treasuries, or investing in a Nigerian gold mine. It's basically just a giveaway
hiya chip --
color me surprised that Congress' voter mail about the $700,000,000,000 bailout has been so heavily NO NEVER DON'T DO IT.
this, i think, is what happens when the economy is allowed to morph from Making and Selling Tangible Things to Investment Paper.
Everybody has been in and out of JC Pennys and Home Depot and Car Dealerships.
But how often have you had any business that required you to spend a few hours or many days at a branch of Lehman Brothers or Shearson or AIG or Ing?
I know what capital is and I know how important it is to the Tangible sectors of the economy.
But we're all in Deep Shit because over the last 20 years we've allowed the Balance Thing to shift from steel, cars, factories, computers, food production, fuel to keep people warm through winter ... to stuff that Nobody Really Needs ... a gazillion tons of tradeable Paper I could never hope to read and make sense of.
(Because, as we're discovering now, you were never supposed to make sense of it. Because if you truly understood it, you'd never want it or spend real money to buy it, you'd certainly never want to have to depend on it for your Old Age or your kids' college needs.)
I believe the buzzword is "The Real Economy": corn and milk, steel, home improvement, transportation.
As opposed to securities, derivatives, super-exposed overextended credit -- a sector ultimately founded not on iron and wood and edibles, on boilers and solar panels, but on Wishing and Hoping and Fantasies of Greed.
Or, as the Butler in "Upstairs, Downstairs" explained to the working-class staff a few months before the Crash of 1929:
Wealth achieved without Work.
This kind of wealth and superprosperity are Adult Fairy Tales based entirely on Magical Beans. We chuckle at Little Kids and their imaginary fears and superstitions, their Monsters in the Closet.
But we take the incomprehensible Mumbo Jumbo of Greed Paper seriously, as if it had some sort of foundation that was Adult, Rational, Comprehensible. The Real Economy vs. the Imaginary Hope & Greed-based Economy.
The Boots and Overalls Economy vs. the Armani and Gucci Economy. This will be the Best-Dressed Depression the world has ever seen.
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