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Friday, 26 September 2008
Paulson Just Buying Time for the Markets
There’s one glaring weakness in Treasury Secretary Hank Paulson’s plan to save the U.S. financial system: We know what the plan is. Any other problems with it are mere details. PDF
Sept. 25 (Bloomberg) -- There’s one glaring weakness in Treasury Secretary Hank Paulson’s plan to save the U.S. financial system: We know what the plan is. Any other problems with it are mere details.
Much like the credo of Brad Pitt’s character in the 1999 movie “Fight Club,” the first rule of market manipulation is you don’t talk about market manipulation.
Give Paulson a $700 billion check without asking any questions, and the former Goldman Sachs boss might have a shot at kick-starting the credit markets using some mysterious, black-box, trading sorcery. Because the money isn’t his, though, he has to give us at least a vague outline of what he’s up to. Now, even if Congress approves some form of his proposal, it’s far less likely to work because we’re all in on the deal.
The plan goes like this: Treasury will pay financial institutions above-market prices for garbage assets nobody else wants. Then, through the magic of mark-to-Paulson accounting, everybody else that owns similar stuff will use those same prices, or marks, to value the trash on their own balance sheets.
Shazam! Banks and insurance companies write up the asset values on their books. They post big profits. Their capital goes up. Everyone gets fooled. And nobody knows the difference.
Except, we do. And that’s why the plan probably won’t work.
Still, give Paulson and Federal Reserve Chairman Ben Bernanke credit for ingenuity. At the same time banks are begging regulators to suspend mark-to-market accounting rules so they can avoid disclosing more losses, Paulson and Bernanke instead devise a way to abuse the same rules for the same banks’ benefit.
Put It in Reverse
Under Paulson’s plan, Treasury would hold so-called reverse auctions for financial institutions’ troubled assets. Whoever submits the lowest bid gets to sell its junky assets to Treasury for cash.
While that might look like a competitive, free-market mechanism, it’s not. Once the first bid in the first auction is submitted, it may not go much lower, and it probably will be much higher than the true market value.
That’s because the real incentive for the banks isn’t to sell their rubbish to Treasury and get cash. It’s to watch the Treasury pay grossly inflated prices to others. That way, they can use those transactions for accounting purposes to mark their books to the Treasury’s farcical market prices.
This presents another problem. The transaction prices coming out of these auctions may not meet the accepted definition of fair value. Under the Financial Accounting Standards Board’s definition, fair value is the price “in an orderly transaction between market participants.”
Stretched Rules
A know-nothing buyer that sets up a rigged market to overpay for dreck wouldn’t seem to count as a “market participant,” under the FASB’s definition of the term. To qualify, a buyer must be “knowledgeable, having a reasonable understanding about the asset or liability and the transaction based on all available information.”
It would be a stretch to say the Treasury knows or understands anything about the swill it would be buying. Even if regulators waived the accounting rules to permit this, investors would see it as government-sponsored fraud and lose any confidence they still had about banks’ balance sheets.
So, the main hope for Paulson’s plan is that Treasury makes enough outrageously expensive purchases to spur real market participants to start buying the toxic waste from each other again, even if only in hopes of flipping it for more money to the spendthrift Treasury.
Pain Avoidance
In that case, the prices paid outside the auction process probably would qualify as “fair value.” Then, over time, maybe the prices in Treasury’s auctions would come down as competition increased.
If the prices drop too much, though, banks will wind up taking huge losses and failing anyway, which is what Paulson and Bernanke are supposedly trying to avoid. All the while, the Treasury would be spending as much as $700 billion getting us right back where we started. And a lot of Wall Street charlatans who should lose their shirts would expand their fortunes, which is politically and morally untenable.
Whatever the government proposes probably won’t work as intended. It also could make things worse. This seems to have dawned on a lot of people in Congress this week while they watched Bernanke and Paulson testify. Even if Congress fails to act, that wouldn’t mean Paulson’s plan was a disaster. In one respect, the details of his plan don’t matter.
By making it known on the afternoon of Sept. 18 that he had a bailout proposal, at precisely the moment when the financial system seemed to be tipping over the edge, Paulson bought the markets the most valuable commodity of all -- time.
Years from now, when we look back on the past week’s events, we may conclude this was his real goal all along.
Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.
1 comment:
Paulson Just Buying Time for the Markets
Commentary by Jonathan Weil
Sept. 25 (Bloomberg) -- There’s one glaring weakness in Treasury Secretary Hank Paulson’s plan to save the U.S. financial system: We know what the plan is. Any other problems with it are mere details.
Much like the credo of Brad Pitt’s character in the 1999 movie “Fight Club,” the first rule of market manipulation is you don’t talk about market manipulation.
Give Paulson a $700 billion check without asking any questions, and the former Goldman Sachs boss might have a shot at kick-starting the credit markets using some mysterious, black-box, trading sorcery. Because the money isn’t his, though, he has to give us at least a vague outline of what he’s up to. Now, even if Congress approves some form of his proposal, it’s far less likely to work because we’re all in on the deal.
The plan goes like this: Treasury will pay financial institutions above-market prices for garbage assets nobody else wants. Then, through the magic of mark-to-Paulson accounting, everybody else that owns similar stuff will use those same prices, or marks, to value the trash on their own balance sheets.
Shazam! Banks and insurance companies write up the asset values on their books. They post big profits. Their capital goes up. Everyone gets fooled. And nobody knows the difference.
Except, we do. And that’s why the plan probably won’t work.
Still, give Paulson and Federal Reserve Chairman Ben Bernanke credit for ingenuity. At the same time banks are begging regulators to suspend mark-to-market accounting rules so they can avoid disclosing more losses, Paulson and Bernanke instead devise a way to abuse the same rules for the same banks’ benefit.
Put It in Reverse
Under Paulson’s plan, Treasury would hold so-called reverse auctions for financial institutions’ troubled assets. Whoever submits the lowest bid gets to sell its junky assets to Treasury for cash.
While that might look like a competitive, free-market mechanism, it’s not. Once the first bid in the first auction is submitted, it may not go much lower, and it probably will be much higher than the true market value.
That’s because the real incentive for the banks isn’t to sell their rubbish to Treasury and get cash. It’s to watch the Treasury pay grossly inflated prices to others. That way, they can use those transactions for accounting purposes to mark their books to the Treasury’s farcical market prices.
This presents another problem. The transaction prices coming out of these auctions may not meet the accepted definition of fair value. Under the Financial Accounting Standards Board’s definition, fair value is the price “in an orderly transaction between market participants.”
Stretched Rules
A know-nothing buyer that sets up a rigged market to overpay for dreck wouldn’t seem to count as a “market participant,” under the FASB’s definition of the term. To qualify, a buyer must be “knowledgeable, having a reasonable understanding about the asset or liability and the transaction based on all available information.”
It would be a stretch to say the Treasury knows or understands anything about the swill it would be buying. Even if regulators waived the accounting rules to permit this, investors would see it as government-sponsored fraud and lose any confidence they still had about banks’ balance sheets.
So, the main hope for Paulson’s plan is that Treasury makes enough outrageously expensive purchases to spur real market participants to start buying the toxic waste from each other again, even if only in hopes of flipping it for more money to the spendthrift Treasury.
Pain Avoidance
In that case, the prices paid outside the auction process probably would qualify as “fair value.” Then, over time, maybe the prices in Treasury’s auctions would come down as competition increased.
If the prices drop too much, though, banks will wind up taking huge losses and failing anyway, which is what Paulson and Bernanke are supposedly trying to avoid. All the while, the Treasury would be spending as much as $700 billion getting us right back where we started. And a lot of Wall Street charlatans who should lose their shirts would expand their fortunes, which is politically and morally untenable.
Whatever the government proposes probably won’t work as intended. It also could make things worse. This seems to have dawned on a lot of people in Congress this week while they watched Bernanke and Paulson testify. Even if Congress fails to act, that wouldn’t mean Paulson’s plan was a disaster. In one respect, the details of his plan don’t matter.
By making it known on the afternoon of Sept. 18 that he had a bailout proposal, at precisely the moment when the financial system seemed to be tipping over the edge, Paulson bought the markets the most valuable commodity of all -- time.
Years from now, when we look back on the past week’s events, we may conclude this was his real goal all along.
Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.
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