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This is Up, This is Dow…

By Brian | October 14, 2008 | Share on Facebook

It’s not every day that the markets provide the financial media with the opportunity to use terms like Best Day Ever!, but that’s what happened yesterday and, if the futures market is any indication, today’s shaping up to be similar.

The reason? There were three: Hank Paulson announced yesterday that the U.S. Federal Government was going to make direct equity investments in the nation’s banks, the FDIC announced that it would insure all non-interest bearing bank accounts with no maximum dollar amount, and the Federal Reserve invoked Depression-era emergency powers that allow it to buy commercial paper, providing liquidity in a market that has seized up like an engine with a giant oil leak.

This is bad for a number of reasons and good for one reason, but the one reason it’s good trumps all the others, so I’m glad to see it happen.

It’s bad because it’s a step toward socialism. The federal government now has a significant, minority stake in our nation’s banks. And it is already using the power of that investment to tweak corporate policy – executive pay and severance packages (i.e., “golden parachutes”) are already restricted, and Senator Chuck Schumer (D-NY) is recommending that participating banks eliminate their dividends and “stick to safe and sustainable, rather than exotic, financial activities,” whatever that means.

It’s bad because despite all of these restrictions, it’s only semi-voluntary. From today’s New York Times:

Mr. Paulson outlined the plan to nine of the nation’s leading bankers at a meeting Monday afternoon. He essentially told the participants that they would have to accept government investment for the good of the American financial system, according to officials.

Among the bankers attending were Kenneth D. Lewis of Bank of America, Jamie Dimon of JPMorgan Chase, Lloyd C. Blankfein of Goldman Sachs, John J. Mack of Morgan Stanley, Vikram S. Pandit of Citigroup, Robert Kelly of Bank of New York Mellon and John A. Thain of Merrill Lynch.

Bringing together all nine executives and directing them to participate was a way to avoid stigmatizing any one bank that chose to accept the government investment.

So, a well capitalized bank like Bank of America or JPMorganChase is semi-required to accept government investment in order to avoid stigmatizing less secure banks, and is then penalized for accepting that investment with restrictions on executive pay and possible restrictions on shareholder return and operational business activities.

It’s bad because it represents a change to the intended use of the $700 billion bailout plan that passed just days ago. The plan was sold to us as an authorization to buy toxic assets from banks that can’t get them off their balance sheets, and now 35% of the funds are being used for equity investments in these banks. Given the acrimony around getting the bill passed, a significant change like this just after the president signs it into law is pretty brazen if you ask me.

And it’s bad because an outgoing administration is making sweeping reforms and calling them “limited and temporary.” I think we all know how difficult it will be for individual congressmen and senators to vote for legislation that allows caps on executive compensation to expire, especially when they weren’t the ones who put them there in the first place.

But for all of those reasons why it’s bad, it’s good because it’s inspiring investor confidence and driving liquidity back into the markets. And that is our biggest problem right now. If Hank Paulson could inspire investor confidence by doing an Irish jig in front of Macy’s window on Broadway, he should do so at this point. I just hope that the kinds of things I’ve discussed above don’t become fodder for the advocacy groups and lobbyists, driving our leaders to bad mouth the plan until it crumbles and is replaced by something substantively the same, but with more oversight and pork. That’s what happened to the bailout bill, and what could have been a confidence boost became the impetus for an honest-to-goodness stock market crash.

The way out of these woods is to let good news be good news for a while, even if there are nits to pick.

Topics: Money Talk | 1 Comment »

One Response to “This is Up, This is Dow…”

  1. Jeff Porten says at October 17th, 2008 at 11:45 pm :
    Your post confused me, so I’ll start by saying that I’m asking for you to clarify my confusion rather than taking the usual “Brian is wrong, Jeff is right” argumentative stance.

    It’s bad because it’s a step toward socialism

    Um, well, my first reaction is probably akin to how you feel when I say that no-fly lists are the first step towards the Gestapo. Yes, it’s a fairly radical change in how the US government acts, but there’s still a long way from here to socialism.

    Second reaction: what, exactly, is so bad about socialism?

    Which is to say: this sounds more like a religious argument than a thoughtful one. We weren’t living in an unfettered capitalist state before — and few people support the completely libertarian government policies that would be required for one. It seems to me that taking measures to solve a crisis is what we should do, and wise societies choose the best ideas they can find, be they socialist, capitalist, what have you.

    Just as an aside: it seems to me that being anti-socialist because the government will take away our freedoms, but pro-surveillance and no-fly lists, is about as hypocritical as being pro-life and pro-death penalty. But that’s just me.

    It’s bad because despite all of these restrictions, it’s only semi-voluntary.

    Call me confused here as well. It’s not the taking of the government money that makes you stigmatized; it’s needing to take government money. Giving money to people who don’t need it only works if the financials of other banks are sufficiently opaque that when they take the money, no one can tell whether they’re in crisis. I have trouble understanding how that would be the case.

    On the other hand, I thought the deal here is that if you want to rid yourself of bailout-related regulation, all you do is buy back the government’s stake. The healthier the bank’s balance sheet, the sooner you can do that. So the “voluntary” part is whether you take steps to reprivatize sooner rather than later. And a government that wanted to encourage this would make restrictions sufficiently onerous such that banks would want to get out from under more quickly, right?

    The plan was sold to us as an authorization to buy toxic assets from banks that can’t get them off their balance sheets, and now 35% of the funds are being used for equity investments in these banks.

    Not quite — the bill that failed was the pure toxic assets bill. The one that passed included what I’ve heard called the Dodd Amendment, which specifically provided the Treasury the authority to purchase assets or equity as necessary. This was one of the points that brought in bipartisan votes from folks who bolted the first time; it would probably be more acrimonious if Treasury didn’t balance what it was doing.

    From where I’m sitting, the idea of buying equity went very quickly from being derided as a left-wing nutcase view, to being supported by Treasury and a ton of economists. I’m not sure whether I find that to be cheering or shocking.

    it’s bad because an outgoing administration is making sweeping reforms and calling them “limited and temporary.” I think we all know how difficult it will be for individual congressmen and senators to vote for legislation that allows caps on executive compensation to expire

    Yeah, you shouldn’t be concerned about this — the banking industry has had little trouble buying legislation in the past, and they’ll likely regain that ability to do so in the future. I’m curious to know how much they’re buying in the present — gotta figure that lobbyists were swarming this bill like flies. There’s a lot of this — such as giving money to banks that don’t “need” it — that sounds to me like “oh, please don’t throw me in that briar patch!”

    More to the point, I’d call this bad because we’re reconfiguring massive structures three months before we’re likely to have a huge turnover in government philosophy. Makes me wonder how much of this is to create a juggernaut to preempt progressive and populist reforms next year that the industry would truly dislike.

    I just hope that the kinds of things I’ve discussed above don’t become fodder for the advocacy groups and lobbyists, driving our leaders to bad mouth the plan until it crumbles and is replaced by something substantively the same, but with more oversight and pork.

    Here I’ll start arguing. You seem to think that “the plan” is some Platonic ideal that exists independent of advocacy and lobbyists; my guess is that the advocacy group who had the most influence over those two weeks was the banking industry. This, hopefully, will be a fascinating journalism piece in early 2009, regardless of whether I’m right.

    Likewise, “oversight” is not bad. You’ve mentioned how regulated the banking industry is — my current take on it is that this is like campaign finance, where you can’t buy a senator his lunch, but he can ask you for $4,600 a year. We’ve been regulating the wrong things, and missing the big picture.

    And, well, “pork” is planetariums and Penn Band roadtrips. Most of the time, people who argue against it are benefiting quite nicely from it, whether they know it or not.

    That’s what happened to the bailout bill, and what could have been a confidence boost became the impetus for an honest-to-goodness stock market crash.

    Since you’ve written this, we’ve had another 1,400 point oscillation in the Dow. That’s all post-bailout. In retrospect, I’m having trouble with the 1-to-1 correlation people drew between the first crash and the bill not passing. Your new thinking?

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