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Comment Jim was on Bloomberg TV yesterday afternoon discussing the bailout of the banking system.
If you missed the interview, you can watch it by clicking on the picture above. To see any of our recent interviews, click on the open button.
What We Said
We re-iterated our belief that this crisis was accelerated by the ill-conceived policies of the U.S. government and, in particular, Hank Paulson. By nationalizing Fannie/Freddie, letting Lehman fail, the Federal Reserve taking 80% of AIG, having the FDIC “grab” WaMu and “facilitating” a merger of Wachovia, it became painfully clear that U.S. policy was to severely punish owners of financial firms. This took a shaky situation in the banking system and threw it into a full blown crisis. Hank Paulson made it worse.
Now we have a program of capital injections into the banking system. On the surface it finally looks like Paulson “gets it” and is doing the most efficient thing possible. But, as we pointed out and is highlighted in the stories below, this money was forced upon the banks with lots of stipulations on running the company (executive compensation dividend policy) but no assurances the banks will actually start to lend.
Again Paulson is bullying the owners of financial of firms. Apparently he has not learned that this kind of behavior has made the situation worse. We don’t know if this latest bullying will backfire, but we are again operating on dangerous ground. We hope we are wrong and this will not backfire but we have no confidence in Hank Paulson given his numerous mis-steps to date.
Side Note: As we were writing President Bush spoke to the media, or should we say he was mis-speaking to the media. In a slip of the tongue, he called the “equity infusions” into the banks as “equity intrusions” into the banks. This mis-speak, we fear, might actually be correct!
Too Much Central Bank Liquidity
We also argued that the massive and numerous liquidity facilities are making things worse. The problem is more than banks unwilling to lend to each other, they are also unwilling to borrow from each other. Banks can get all the funding they need (and then some) from their central bank, so they do not need to seek a loan from another bank. We believe it has become so bad that they don’t even bother to make a decent market for inter-bank loans anymore.
Now the central banks are offering an infinite amount of liquidity which is making this situation worse. As we argued Monday, central banks might need to pull back on this liquidity to force the inter-bank market to restart, not offer more reasons to avoid interbank lending.
Is Inflation Coming?
Finally, we also fretted that the actions of the central banks have not only been inflationary, but hyper-inflationary.
That said, inflation is not an immediate problem as none of the moves by governments/central banks have worked. But when (let’s not consider “if”) they do start to work, the huge amounts of liquidity pumped into the financial system by all governments/central banks will produce massive inflation. If they do not, then deflation becomes likely. What can be ruled out is what we had over the last 25 years, low disinflation.
We worried that the last crisis might be a collapse of the Treasury market. When the credit crisis is passing, the combination of a move toward risky assets and higher inflation will destroy Treasury prices and send their yields soaring. Then we will hear stories about struggling primary dealers and hedge funds caught long Treasuries. Only then will the crisis have truly passed.
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The New York Times – Drama Behind a $250 Billion Banking Deal
The chief executives of the nine largest banks in the United States trooped into a gilded conference room at the Treasury Department at 3 p.m. Monday. To their astonishment, they were each handed a one-page document that said they agreed to sell shares to the government, then Treasury Secretary Henry M. Paulson Jr. said they must sign it before they left. … But by 6:30, all nine chief executives had signed — setting in motion the largest government intervention in the American banking system since the Depression and retreating from the rescue plan Mr. Paulson had fought so hard to get through Congress only two weeks earlier. What happened during those three and a half hours is a story of high drama and brief conflict, followed by acquiescence by the bankers, who felt they had little choice but to go along with the Treasury plan to inject $250 billion of capital into thousands of banks — starting with theirs. … Mr. Paulson began calling the bankers personally Sunday afternoon. Some were already in Washington for a meeting of the International Monetary Fund. The executives did not have an inkling of Mr. Paulson’s plans. Some speculated that he would brief them about the government’s latest bailout program, or perhaps sound them out about a voluntary initiative. No one expected him to present his plan as an ultimatum. -
The Wall Street Journal – Editorial: ‘Distasteful’ Capital
For those of us who believe in free markets, these interventions are unpleasant. These drastic steps might have been avoided had Treasury and the FDIC acted sooner, yet now they are necessary given the panic that threatens the larger economy. The goal should be to rebuild the financial system so Americans can once again trust their banks enough that government can then recede to its normal supervisory role. We are under no illusions that government will cede its new powers easily, but if it doesn’t the economic damage will be far greater than anything we’ve seen so far. -
Bloomberg.com – John Berry: Banks Need Capital, Not Government Management
Once U.K. Prime Minister Gordon Brown decided to recapitalize his nation’s banks, other European countries and the U.S. had no choice but to fall in line. That doesn’t mean the federal government should try to run the banks that join the $250 billion program. Participation was hardly optional for the nine large institutions whose chief executives were summoned to a Treasury Department conference room with Secretary Henry Paulson on Oct. 13. In short, the nine — Citigroup Inc., Goldman Sachs Group Inc., Bank of America, Merrill Lynch & Co., Wells Fargo & Co., JPMorgan Chase & Co., Morgan Stanley, State Street Corp. and Bank of New York Mellon Corp.– were told that accepting an initial $125 billion in government capital was the patriotic thing to do. “These are healthy institutions, and they have taken this step for the good of the U.S. economy,” Paulson said. And now they are supposed to do their duty by using their bigger capital base to expand lending. That’s just what the economy needs, though there’s a danger. -
The Wall Street Journal – At Moment of Truth, U.S. Forced Big Bankers to Blink
A final deal between regulators was hashed out in Mr. Paulson’s office Sunday afternoon. For Mr. Paulson, who had spent a career as an investment banker, the decision marked a reversal. Just weeks earlier, he had said that injecting capital directly into banks would appear to be a sign of “failure.” The top bankers were then told to show up for a meeting Monday at 3 p.m., but were given few details. Expecting an uproar over the plan, government officials secretly planned to break off the first meeting, giving CEOs time to vent, talk to their boards, clear their heads, and reconvene at 6:30 p.m. In Mr. Paulson’s call with Morgan Stanley’s Mr. Mack, people familiar with the matter say, the CEO asked the Treasury secretary the reason for the meeting. Mr. Paulson responded: “Come on down, we’ll tell everyone at the same time,” adding, “I think you’ll be pleased.” -
The Financial Times – Paulson at last goes systemic
The Paulson scheme has clear echoes of the plan announced in London last week. The US Treasury will buy stakes in nine large banks on terms which are open to other investors. New interbank lending – and more deposits – will be guaranteed by the Federal Deposit Insurance Corporation and the Federal Reserve will finalise a new, broader liquidity scheme. There are, however, crucial differences. The US Treasury is being more generous to banks and shareholders than its UK counterpart. The preference shares being bought in the US pay a 5 per cent dividend, rising to 9 per cent after five years. In the UK, these shares will pay at 12 per cent. And unlike in the UK, participating US banks will be able to pay dividends, albeit subject to Treasury approval. The US authorities are, perhaps, being kinder to bankers than is politically prudent.