Here we are a week later, and guess what? Armageddon is again approaching. All week long, the credit-default swap spreads on Morgan Stanley widened, until, by Friday, they were actually worse than they were at any time during the previous week. (And this time, the chief executive, John Mack, can’t blame the short-sellers for his troubles, since short-selling in financial stocks has been temporarily banned.)
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Armageddon Still Looms
By Joe Nocera
27 September 2008
Here we go again.
Just nine days ago - Thursday, Sept. 18 - financial Armageddon was warded off when word began to leak about the government’s giant bailout plan. The news first broke around 2:10 p.m., New York time, when Bloomberg News moved an article quoting Senator Charles Schumer, Democrat of New York, as saying the government was considering a “permanent” plan to address the financial crisis. (In fact, as Schumer told me later, he had not meant for his words to sound so definitive; he really didn’t know the planning was so far along.)
Then, less than an hour later, CNBC reported that a plan was being readied by the Treasury Department along the lines of the savings-and-loan bailout of the 1980s. That did it. In the time between the Bloomberg article and the CNBC report, the stock market rose 145 points. In a 45-minute burst right after the CNBC report, stocks rose another 270 points. The Dow closed up 410 points.
And by the time Treasury Secretary Henry Paulson Jr. made his big speech on Friday morning, laying out some of the details of the government’s $700 billion bailout plan, a good deal of the pressure in the markets had eased. The credit-default swap spreads narrowed on Morgan Stanley and Goldman Sachs, meaning that the credit market was less worried about the possibility that they might default.
Morgan Stanley, which had been frantically negotiating a merger with Wachovia, stopped the negotiations. Money market funds, which had been hit hard by withdrawals earlier in the week, saw an inflow of money. Other credit indicators also suggested that the credit markets were unfreezing.
Here we are a week later, and guess what? Armageddon is again approaching. All week long, the credit-default swap spreads on Morgan Stanley widened, until, by Friday, they were actually worse than they were at any time during the previous week. (And this time, the chief executive, John Mack, can’t blame the short-sellers for his troubles, since short-selling in financial stocks has been temporarily banned.)
On Thursday, investment-grade loans were trading lower than junk bonds, because investors were selling off their most liquid assets to raise capital. Wachovia, the nation’s fifth-largest bank holding company, suddenly appeared to be in deep trouble: “Wachovia is trading as if it’s going to fail,” Dave Klein, a manager at Credit Derivatives Research, said Friday. Washington Mutual was seized by the government. The markets may not be as panicked as they were a week ago, but with every passing day, the situation is getting increasingly dangerous.
Or, to put it another way, with every passing day, Congress is fiddling while Rome is burning.
Last week, I wrote a column suggesting that the Paulson plan was unlikely to fix the enormous problems facing the financial markets and the country’s faltering economy. I am still not sure it will work - or that it is the best possible solution - but this week, I have a different, more urgent concern.
Whatever its imperfections - and despite the possibility it might not work - it needs to be approved, quickly. I’m praying that by the time the markets open on Monday, congressional leaders will have reached a consensus on the bailout plan. We’re running out of time.
I know there is something tremendously galling about the prospect of Americans’ putting $700 billion - or more - of their tax dollars at risk to come to the aid of banks and investment banks whose reckless behavior has so damaged the country. They gamed the system. They lined their pockets. They made terrible, terrible mistakes. I’m as angry about it as you are.
I am also aware that there are lots of smart people who don’t like the bailout plan. On my blog the other day, I posted a letter to the leadership of the House of Representatives from more than 200 economists. They complained about what they saw as the plan’s essential unfairness (“The plan is a subsidy to investors at taxpayers’ expense”), its ambiguity (“Neither the mission of the new agency nor its oversight are clear”), and the potential that it might ultimately weaken the very markets it was aimed at saving. The objection of the House Republicans who moved to block the plan - namely, that a taxpayer bailout of this magnitude should be avoided if at all possible - also deserves to be taken seriously.
Finally, I’ve been hearing a number of interesting ideas that could well turn out to be better than the Paulson plan. One of the most intriguing ones comes from Andrew Feldstein, the chief executive of Blue Mountain Capital Management, a hedge fund that specializes in credit instruments. He proposes that instead of buying bad assets that are crippling the balance sheets of the nation’s banks, the government should establish a “good bank” that would buy only solid assets.
By setting up such a bank - Feldstein envisions having the government put up $300 billion and taking an equity stake, so that taxpayers can profit when it is sold after the crisis passes - the government would make it possible for credit to “again flow to deserving borrowers.” Bad banks might eventually fail - but they would have a place to sell their good assets as they liquidate. Healthier institutions could once again start lending. Taxpayers would face much less risk.
If the country had more time, I would argue that we put ideas like that into the sunlight and see if they flower. But we don’t have any more time. Nine days ago, the financial markets were staring into the abyss; the only thing that pulled them back was the news that the Treasury and the Federal Reserve had come up with a bailout plan.
And the only thing that has kept them from falling back is the expectation that the plan will be approved quickly. For a while, it looked as if that was exactly what would happen.
Paulson and the Federal Reserve chairman, Ben Bernanke, spent the early part of the week defending the plan before Congress. While they faced tough questioning, their main point came through: they had to act fast, otherwise the economy would crater.
Behind the scenes, congressional leaders began to hammer out the outline of a deal, with the Democrats insisting on strong oversight for the fund, curbs on executive compensation for institutions that sold off their toxic securities to the government and aid for struggling homeowners, among other things.
On Thursday, after an arduous three-hour meeting, it appeared a deal had been struck, but it quickly fell apart after House Republicans - and John McCain - objected to it. That afternoon, I had a short conversation with Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee and who had been in negotiations with Spencer Bachus of Alabama, representing the House Republicans. Frank was seething.
“Spencer was in the meeting with us the whole time,” he said. “And now here comes John McCain acting like Andy Kaufman - ‘Here I come to save the day!’ Inserting presidential politics into this is just -- “ He stopped suddenly. Whatever word he had in mind he didn’t want to share with a reporter.
There is no question that a large part of the reason the House Republicans are objecting to the Paulson plan is because of the potential loss of taxpayers’ money.
“Putting $700 billion of taxpayers’ money at risk - that’s not something we do every day,” said an aide to the House minority staff who requested anonymity because he was not authorized to speak for the leadership.
Indeed, the proposal offered by John Boehner, the House Republican leader, to create a government-backed insurance pool to guarantee mortgage-backed securities, is another of those interesting ideas that would deserve merit if there were more time.
But it is also true that much of the opposition to the Paulson plan is purely ideological: there are Republicans who believe that the bailout plan is a step toward socialism. And it appears that they would rather see the economy go down the tubes than do something they find ideologically distasteful.
And that’s what is so infuriating. Paulson is not what you’d call a socialist - nor is Bernanke nor President George W. Bush. They are all holding their noses as they sell this plan. Frank is allied with Paulson and a president he holds in low esteem because he, too, believes this is a step the country has to take.
And so do the markets themselves, which is the most important point of all. Psychology always drives market behavior, and right now, the markets are desperately clinging to the idea that the Paulson plan is the only hope of regaining the confidence of borrowers, lenders and investors. Politics is politics, but the markets are not going to wait forever for a deal to be struck. In fact, I don’t think they are going to wait much past the weekend. No deal, no credit markets. It’s as basic as that.
And if that happens, the consequences will be far more pressing than the failure of a Morgan Stanley or a Goldman Sachs. You won’t be able to get a mortgage. Credit card rates will skyrocket. Businesses will be unable to expand and grow. Unemployment will rise.
Every part of our economy depends on the credit markets. I know you’ve heard it before, but it bears repeating. If we do not claw our way out of this crisis, the country will face a severe recession.
On Friday, the German finance minister, Peer Steinbrueck, predicted that the United States would “lose its superpower status in the global financial system.” He may well turn out to be right, but let’s worry about that later, O.K.?
Right now, our elected representatives need to get down to business and agree to pass the Paulson plan. If they don’t, they - and we - will live to regret it.
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