Bailout Mania

Okay, it took me a little longer to get to this post than I thought. And yes, I was wrong about the sustainability of the dead-cat response to the massive two-day sell-off of a couple weeks ago. But the cat's headed back to earth today.

First, I'll talk about Bailout Mania, the newest game in Washington. It's like Monopoly, but you get to print money when you run out. Then, I'll offer my take on Obama's financial/economic "dream team" - in essence, letting you know whether the team's a nightmare.

Bailout Mania kicked into overdrive last week. Let's see if we can follow the logic. Paulson, after rushing the TARP through Congress, then reversing course on how to deploy the funds, invests the first round of $125 billion in several big banks that say they don't need the capital. But Paulson shoves it down their throats anyway, to prove the markets won't punish those banks for taking it, and thus encourage other banks that DO need the capital to step up to the window.

The market punished them anyway. In the first three weeks after the intial investment, the seven largest recipients saw their share prices decline by anywhere from 32% to 71%.

The biggest loser was Citigroup, the largest bank holding company in the US, whose share price went to less than $4 - Bear Stearns territory, in other words.

So last Monday, Treasury announced it would pump another $20 billion into Citi, on top of the $25 billion injected in the first round. Hey, why not? It worked so well the first time, let's see what it can do this time. What's a 71% loss off a share price of $3.77?

Citi's market value fell $49.8 billion from the first-round TARP announcement through the Friday before Treasury announced it would pony up the next $20 billion - in other words, its value declined more than the combined infusion from the taxpayer. True, it's rebounded since then, to about $7 a share as of this writing. But that's still a loss of more than $30 billion.

And more importantly, Citi's written off $60 billion over the last four quarters, averaging about $15 billion a quarter. So the capital infusion's only going to be good for about another year or so, at best, before Citi has its hand out again.

What's even more sinister about the Citi bailout, though, is the heretofore unprecedented move of backstopping losses on some $306 billion of Citi's bad investments and loans. So those losses will accrue directly to the US taxpayer.

What? Where are the checks and balances here? This is outside the TARP, as the amount of those losses is unknown at this point. CreditSights reported the deal was "structured in a way that existing debt holders are not impaired and equity investors are not overly diluted." But the taxpayer is screwed.

The very next day, the Fed announced it would buy $800 billion in mortgage-backed bonds and consumer loan-backed bonds, in an effort to add liquidity to those markets.

Wait a minute - wasn't that the original intent of the TARP? And again, where are the checks and balances?

Let's follow the Paulson daisy-chain here:

1. Paulson asks Congress to whisk through a $700 billion financial bail-out plan, and after some initial resistance, Congress agrees, but only after adding $100 billion or so of pork. A Treasury official acknowledges that the number was pulled out of thin air, and there is no "plan" regarding what will be done with the money.

2. Paulson announces that he'll use the money to buy crap bonds from banks, improving liquidity and hopefully shoring up valuations.

3. The UK announces a plan of their own, but says they'll use the money to take equity stakes in banks.

4. Paulson decides he likes the UK plan better, and reverses course, saying Treasury will inject equity into US banks.

5. Sensing reluctance on the part of US banks to ask for the money, lest the market punish them for being the weak sisters they are, Paulson forces the first round of money on nine banks that say they don't need it.

6. The market punishes said nine banks.

7. Paulson spends the entire first round of TARP money.

8. The Fed - with no Congressional approval - commits $800 billion to do what the TARP was intended to do to begin with. (Note that the Fed is already broke and borrowing money.)

Does this make sense? More importantly, does it inspire confidence that our Treasury Secretary knows what he's doing?

No, and no.

Total Fed and Treasury commitments to bail-outs to date are more than $7 trillion, or half of GDP. And, as one Congressman said, "Whether it's lending or spending, it's tax dollars that are going out the window and we end up holding collateral we don't know anything about. The time has come that we consider what sort of limitations we should be placing on the Fed ..."

No, that time was several trillion dollars ago.

A Financial Times article today raised the question that I, and others like me, have been asking for months now: are governments around the globe going to be able to fund these commitments? More than $2.5 billion of bonds are going to have to be issued next year alone to fund this mess. And who's going to buy them? Wall Street? Nope. China? Maybe, maybe not. But if they do, they're going to want astronomical interest rates on them.

At least Congress turned down Detroit - or did they? They sent the execs back to Michigan, chastised for flying into Washington on private jets (memo: next time take Amtrak, a la Joe Biden), and told them to come back when they have a plan. So now they're talking about car-pooling.

I will die of terminal mirth if the car breaks down.

So they'll come up with a plan, Congress will add some pork to it, and Bailout Mania will continue. I'm sure of it.

On to Obama's financial team. In brief, I'm underwhelmed.

Volcker, I like. But he should be Fed Chairman. He'd know what to do, and he's tough enough to do it. I think. I mean, he used to be, but he may be going soft in the noggin, considering that he's hitched his wagon to somebody who likes bail-outs. Instead, Volcker will chair a new group called the Economic Advisory Board.

Just what we need, a new economic advisory group. Guess the Council of Economic Advisors and the National Bureau of Economic Research weren't enough (both of these will get further mention below).

As for the former, it will be headed by former Clinton Treasury Secretary Larry Summers. Summers is a very smart guy (as is Volcker). But not a great forecaster. (Does that description remind you of anyone? Hint: his initials are Ben Bernanke. Or Alan Greenspan.) Summers advocates another big stimulus package, which will only add to the effects of Bailout Mania.

But the appointment with the most teeth is Treasury Secretary, for that role - as we've seen only too clearly - carries significant power. Power enough to bankrupt the nation.

Obama's pick for that spot is current New York Fed Bank President Tim Geithner. Wall Street lauded the pick.

Anything Wall Street lauds should scare the bejeebers out of you and me these days.

Geithner is the consummate deal-maker, a guy who can bring banking and investment bank (an entity that now has gone the way of the dodo bird) heads together in a smoke-filled back room and get them to agree to anything. But the deals he brokers are of questionable value. To wit: he's had a hand in everything from the Bear bail-out to the Lehman non-bail-out to the AIG deal.

My problem with Geithner is that he's a career bureaucrat. He's got degrees in government, Asian studies and international economics. That last one is okay, but what did he do with it?

He started his career with Kissinger and Associates in DC. Then, he went on to the Treasury, where he was Undersecretary for International Affairs under Bob Rubin and Summers. After that, he went to work for the Council on Foreign Relations, then the IMF, before heading the New York Fed, where he's also vice-chair of the Federal Open Market Committee. Sounds like he'd have made a better Secretary of State, with all that foreign affairs experience.

My concern is that he doesn't understand some of the more arcane nuances of Wall Street. And even if he does, his involvement in the Bear, Lehman and AIG deals - all of which were bad deals in my view - make him a questionable pick. But he's been described as a "very unusually talented young man ... [who] understands government and understands markets."

Of course, that description came from Hank Paulson. And, like Paulson, Geithner thinks Treasury should have expanded authority. Yikes.

In closing, here's my reference to the National Bureau of Economic Research. The NBER is the official proclaimer of recessions. Today, they announced that the US economy officially entered recession last December.

In so doing, they proved my predictions of April and May of 2007 correct. Back then, I was about the only guy making those predictions, when I said we'd enter recession by the beginning of 2008. So thank you, NBER. You are now on my Christmas card list.