Monday, September 22, 2008

Paulson stops thinking, starts acting

As regular readers know I am not averse to bail-outs. The goal however is to get the best effect (ie return of normal lending, normal function of financial markets) at the least cost (bad incentives given by moral hazard).

That is hard. It requires what I would consider “constructive ambiguity”. It certainly requires that the management of the bankrupt institution are replaced and preferably humiliated. [Deny them their golden parachutes.]

The worst bailout recapitalises the institutions without imposing penalty.

And the new bailout plan looks that bad. It plans to buy mortgages from the institutions (thus injecting government money) without a change of control.

The Norwegians got it right – temporarily nationalising most of the financial system – but ensuring the crisis went away quickly. I have linked to the Norwegian history before but I still think it is a useful guide – and one that Mr Paulson should read.

Somewhere last week careful analysis got replaced with panic policy making. The short-selling rule is in my opinion insane and counter-productive. The bailout $750 billion does not contain the main necessary clauses. The government has stopped thinking and started acting.

Not good.


Anonymous said...

From what I've understood so far, the problem seems to be that a lot of institutions hold a lot of mortgage related paper that is illiquid because
- they are so difficult to value
- if they are sold at prices being offered currently would leave the financial institutions insolvent

Losses haven't been taken to the extent necessary and everyone seems to be getting stuck in a situation where liquid money is hard to get their hands on (except from temporary government facilities)

After this mess has been sorted, financial institutions should again be sufficiently capitalised, losses should have been taken by those that bet recklessly and as little banks as possible should go bankrupt.

As you have pointed out, just buying that paper at random prices is not going to solve this, and it will lead to criticism that the government is helping its friends and not the less connected (you bet they will)

I think it may work though (I think) if banks would have to agree to, alongside of the sale of their crappy paper, a bond sale to the government for the total amount they are getting for their paper, half of which would be convertible bonds and the other half would be reverse convertibles. Both at the closing price of the shares last Friday. The first would yield something like libor +5%, the second libor +7%, payable every 3 months.

It would recapitalise the financials, provide liquidity to the institutions, remove some junk out of the system, with a possible upside to the taxpayer. In this way, the prices at which the crappy paper is taken on the books isn't too much of a debate. Oh, and it would hurt shareholders, and rightly so.


The Way Rider said...

If the US and UK short selling position is "insane" then what about the blanket ASX 'no short selling what-so-ever rule'.

God help us - the politicians have taken over the markets. Prepare for an even rougher ride.

Anonymous said...

Just testing before writing. I'm from Estonia.
Everybody is talking about 700 billion or so that gets inserted in addition, maybe, most likely ...
Government took over Fanny and Freddy (or whatever their names were) whose market share was $5 trillion. Nobody is talking about the other half of the market ...
In my mind this future 700 billion with the all ready spent money seems to be rediculously small amount of money in oder to make difference ... ???
Here is one of my main worries - Is Swedbank going in to bankruptcy ? ... or should I think about buying it's shares?

Anonymous said...


HP wants to nominate a financial handout super-commisar or super-comission (presumably out of the GS stable).

You have to trust him and trust his choice - two leaps of faith no reasonable person should make.

I guess he has never stopped thinking for himself and his buddies. And now he starts acting.....

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