Day after day we get continued evidence of a major policy mistake that is costly for the average investor with a retirement account.
The Bush Administration, led by Hank Paulson, stepped in when faced with a crisis. It was courageous and correct, even if the plan was a bit sketchy.
When they finally got Congressional approval it included both additional powers and additional oversight. Paulson used the additional powers to make direct investments in financial firms, something that many top economists and fund managers thought was a good idea. This move took the "bulls eye" off of some of the top firms. It was a good step for an immediate crisis.
The Mistake
It was at this point that Paulson's effort went off the rails. We have listened and read everything on this topic. From our perspective, as experienced observers of government, we think that Paulson and Bernanke realized that it was going to take some time to establish a "reverse auction" procedure to buy distressed assets. They wanted to "do it right" as they frequently said. This meant having private buyers bidding along with the government. It should yield true price discovery. They realized that they had no plan to do this. There were a few economic papers -- more now -- but it was not like the normal Treasury auctions. They did not have the right experts on staff. Furthermore, they did not have people qualified to choose the right experts. Once these people were hired, and wrote up procedures for an auction, it would still take weeks for the legal team to write it up.
This good idea would take months to implement, and there was no time.
At this point Paulson compounded his mistake by saying that the $700 billion was enough to buy troubled assets in September, but the remaining funds were not enough now.
This is not the way to calm markets. Since no one on Wall Street seems to have any social science expertise, they do not understand the simple and obvious explanation for the delay that we have noted. Instead, traders conclude that somehow the Treasury has checked out the securities and found them worthless. Here is a simple question? Who did that? Where did they find the experts?
In fact, government is thinly staffed and does not have anyone who has these skills.
This is why it will all rest with the Obama Administration. Paulson wants to leave time and money for Obama.
The Media Makes it Worse
This is all completely consistent with what regular readers already know. Here is what we wrote yesterday on RealMoney:
While he did not use my term, "death spiral", he made it clear that the problem in financial companies is that we are chasing a moving target. They cannot reduce leverage with the new government capital when we keep writing down their existing assets. They also cannot use TARP money for lending under these circumstances. They cannot attract more private capital.
Paulsen suggested that we might suspend mark-to-market accounting. David Faber insisted that since marked asset prices have fallen, that proves that m2m was correct. Paulsen, before being interrupted yet again, tried to point out that many of these assets were performing just fine, and held by institutions that did not need to sell. The marks were unrealistic (what I call mark-to-bad markets).
He and others noted the decline in financials since the day Paulson announced that the original "price discovery" aspect of TARP would not be followed. This has merely confirmed the widely-held trader and fund manager suspicion that financial assets are all "toxic" and "worthless".
Everyone is entitled to an opinion, but that one is filed under "things people think they know, but really don't." BlackRock has reported that the original Bear Assets they are managing for the Fed (remember when that $30 billion was a big number?) are actually performing better than expected. Bill Gross has made similar comments.
Why has the market failed to generate good pricing here? The purchasers have to be investors with no fear of irrational markdowns -- investors like the federal government. This prevents the development of a real market. It is the reason that the original TARP with price discovery could benefit everyone by ending the death spiral.
Instead, we are turning the government into an investor that will meddle in compensation, lending policy, business decisions about mergers, and whether the execs fly commercial. Instead, we should be creating the right incentives to let the market work. I am continually astounded that so many who swear allegiance to markets have so little understanding of how they work, the causes of market failure, etc. Sometimes taking a course or two does make a difference.
Democrats are focused on helping people facing foreclosure. That is nice, but we should be restoring a normal mortgage market so that qualified and eager buyers can find loans. Only then will we have normal trading in those markets.
I'll leave the predictions of the trading bottom to those with technical methods. I will make this prediction. We will not see a real solution for financial companies until we do something that directly addresses troubled assets. Here are some dates to watch.
Since Sec. Paulson is saving powder for Obama, we cannot expect any help from him. The SEC's study on whether mark-to-market accounting affected bank lending is due on January 2nd. (You can still make comments on their site, and they have another roundtable tomorrow). The new Congress will be in place on January 4th. The new President on January 21st.
What to Watch
The single most bullish event would be a substantive effort to address valuation of CDO's and CMO's on the books of financial institutions. Whatever the outcome, it would be better than a death spiral where those who are pessimistic gravely intone --- every day -- that there is much more to come.
They do not really know. Neither do we. You do not either.
That is why government should address the cause of the problem.
