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Max Fraad Wolff

Max Fraad Wolff

Posted: September 22, 2008 11:10 AM

Cowardly New World


I can't bring myself to join the gleeful investing masses. Watching shorting become illegal around the world and tax billions pledged, I feel an acute sense of unease. Secretary Paulson has attempted to declare himself the most equal of pigs in our animal house economy. The Treasury seeks more than $700 billion for itself under the sole auspices of the Secretary whose management helped bring us right over the brink. I say more because unlike so many commentators, I read the proposal. It only limits the Treasury to $700 billion in balances at any one time (Section 6). If they buy $700B and lose 20% of the principle ($140B), the Treasury will just buy another $140B. That restores market confidence? You can't short the 799 financial shares leading the latest faith based market surge despite a bust, bail, repeat cycle that has defined markets since July 2007. New and unspecified regulations and "help" are coming from broke Uncle Sam. Are we rallying based on the idea that strings attached help and that heavy regulation will triumph over global recession and a public no better able to pay its bills? Maybe we are just excited to have the world's first mortgage-backed security (MBS) currency? Could it be excitement at having the next president's fiscal policy set before he is elected?

The problems with this plan are myriad. Let's start with the obvious and unmentioned. The markets in Mortgage backed securities are to be replaced with a Treasury Secretary directing whatever agents he pleases (Section 2b1-5) toward whatever ends he pleases with a few months left on the job! Mr. Paulson has assured us of many things that proved false very quickly.

"Looking forward, we must balance two very important priorities -- better regulation through a more effective updated regulatory structure on the one hand and market discipline to limit moral hazard on the other. A stable system requires that risk-taking bring both reward and loss. Market discipline plays an enormous role in curtailing excessive risk-taking, a role that neither can nor should be completely executed by regulators." -- Treasury Secretary Henry M. Paulson July 22, 2008

That was before his latest proposal that he be above the law, congress and the courts (Section 8). We don't know at what price he will buy securities. We do know that he can't wait long enough to accurately value what he buys. Thus, it is the buying we have faith will raise the prices. The problem will remain what it has long been. These things are non-standardized and are hard to value. Their value depends on future repayment of loans by a credit constrained and broke public heading into a serious recession. This will help ease credit issues for the banks. It will not put money in empty pockets. Sane banks will not re-extend loans as they did in the bubble. Our underlying economic problems are not addressed. If some have access to selling to Treasury and others don't, they will buy at a discount and re-sell to the Treasury, creating a mark-up for preferential access to bail-out cash. This will weaken the economic impact.

Who will buy all the Treasuries Lord Hank will be selling? Will that money come from the usual foreign buyers? If so, what will happen to their markets, currencies and economies as they allocate much more to bail out our banks and maybe not their own (Section 2a)? How many billions in extra Treasuries can we sell while raising our debt ceiling to $11.315 trillion (Section10b)? Our debt stands at $9.7 trillion today. This act asks for twice what it purports to cost... interesting. If domestic and foreign wealth flows to Treasuries will enough flow or will rates rise? Finally, what will the final form of this bill include? How many will be disappointed? How disappointed?

In short, new assurances are seeking to direct billions back into money markets, asset backed commercial paper, financial stocks and Treasuries. All at the same time! Wow, that sounds like a tall order. Especially as banks will not be making more credit available to the broke public when they are bailed-out. They extend and global spread of excitement seems excessive. Unless we are poised to pay hundreds of billions of dollars just to kick the can a few months -- or years -- down the same road?