Monday, September 29, 2008

The End of the U.S. Financial System as We Know It?

A number of Republican House members and staff, along with others who are plugged in,
are telling me that Nancy Pelosi and the Democrats will come back with a new bill
that includes all the left-wing stuff that was scrubbed from the bill
that was defeated today in the House.

As this scenario goes, the House Democrats need 218 votes, and they have to pick
up a number of black and Hispanic House members who jumped ship because
the Wall Street provisions, in their view, were too benign. So things like the
bankruptcy judges setting mortgage terms and rates, the ACORN slush-fund spending,
the union proxy for corporate boards, stricter limits on executive compensation,
and much larger equity ownership of selling banks through warrants will all
find itself back in the new bill. Of course, this scenario will lose
more Republican votes. But insiders tell me President Bush will take Secretary
Paulson's advice and sign that kind of legislation.

Personally, if this scenario plays out, I would probably withdraw my support
for the rescue mission and switch to plan B, which would center on the FDIC
and its bank-recapitalization powers. The bank-ownership issue, in particular,
could lead to heavy nationalization of America's financial system with a
three-house Democratic sweep in November.

I'm not forecasting, because I don't know the next bill's content.
And while McCain's polls are heading south, he could still win.
But a three-house Dem sweep to implement some off the very onerous provisions
being talked about could set up the end of the U.S. financial system as we know it.

I'm gonna wait and see. Obviously, the financial markets are in total collapse today.
And the economic outlook is suffering.

Tough day. One of the worst I can remember.

Friday, September 26, 2008

Bailout-Deal Warning & Update

My latest information on executive pay-caps and government ownership warrants — which are now being called "equity protection — is that they would apply to bond sellers, not buyers. (My original warning is below). I guess that makes it only half as bad. But I must say, it still is bad.

Why should a successful bank — whether large, medium, or small — give up ownership and allow pay-caps for executives?

Even the big guys like BofA and JPMorgan Chase are still solid banks. So is Goldman and Morgan Stanley. And Wells Fargo. And many others.

Why should they agree to this? It just makes the plan unworkable. Sources tell me the Treasury is opposed. Stay tuned for more.

My earlier warning:

If the bailout bill allows executive pay-caps and government ownership warrants for all buying or selling institutions, I must withdraw my support for the bill.

There is no clear information yet on this crucial topic. CNBC is reporting that Sen. Chuck Schumer is telling people that pay-caps and ownership warrants will be included for all banks and others (Fidelity-type investment managers, KKR-type private-equity firms, etc.) that either buy or sell the toxic paper.

The Treasury Department does not want this simply because it knows it would be unworkable. In other words, giving up pay-caps and warrants would probably mean that only the most dire, down-in-the-mouth banks will sell, and they’ll sell the very worst imaginable paper. Meanwhile, no reputable institution is going to buy the paper if they have to give up ownership or compensation rules.

So it would be stupid for Congress to write this kind of thing into the bill. It would go beyond France into pure socialism. It would represent a huge first step into government interference everywhere. And it would sink New York way down the list of world financial centers. London and Hong Kong would pass us by in the blink of an eye.

I’m trying to get more information on this. But here’s a very key point: No House or Senate member in his or her right mind should vote for this bill without reading it. There’s no telling what’s in there.

The stock market is applauding the pre-announcement of a deal. The Dow’s up over 200 points. And credit-market risk spreads are narrowing a bit on the bailout hopes. But let me tell you, if the U.S. government is going to start to own all of our financial institutions, all these markets will sink like stones.

Friday, September 19, 2008

Mac Talks Up a Strong Dollar

Almost unnoticed amidst the hoopla over Treasury man Paulson's
RTC-like rescue announcement to buy toxic assets from banks and unclog
the credit system to promote economic recovery — a plan I support — Sen.
John McCain gave a thoughtful speech today before a chamber-of-
commerce group in Green Bay, Wisconsin.

The senator will undoubtedly support Paulson's plan. But he hinted at
some of his concerns about the proliferation of bailouts going on in
Washington. McCain has his own idea for a mortgage and financial trust that
would be part of the Treasury Department and help troubled institutions. But
he jabbed at both the Fed and Treasury by calling for more consistent
policies and actions. "We need to enhance regulatory clarity by holding the
same financial activity to one regulatory standard," said McCain.

But the most interesting part of Big Mac's speech was his criticism of
the Federal Reserve. And I'll quote it in full: "The Federal Reserve should
get back to its core business of responsibly managing our money supply and
inflation. It needs to get out of the business of bailouts. The Fed needs to
return to protecting the purchasing power of the dollar. A strong dollar will
reduce energy and food prices. It will stimulate sustainable economic growth
and get this economy moving again."

This is very good stuff. The senator is saying a strong dollar will
promote economic recovery through lower inflation and more consumer
confidence. He is dead right. It's the first time I can recall him being this
explicit about money.

Elsewhere in the speech McCain repeated his call to keep taxes low
and to slash the corporate tax rate. He also renewed his free-trade call and
talked about drilling for more energy supplies across the board.
I can't help but think that the more Mr. McCain talks about a strong
dollar and low taxes as an economic-recovery tonic the closer he will move
to a November victory.

Chris Cox's Terrible Idea

The decision by SEC Chairman Chris Cox to ban short selling is a
terrible idea. It is an encroachment on free-market principles. In extreme, the
absence of short sellers would inflate stock market upturns, probably into
bubbles. Short sellers keep the market honest. I know many in the short-
selling community and most of them really do their homework. They are
skeptical about puff pieces on companies and they are properly cynical about
corporate press releases.

Why Cox is doing this is hard to fathom. He is supposed to be a free-
market disciple of Milton Friedman and Art Laffer. It would have been
much simpler and much more constructive if Cox restored the so called up-
tick rule, where short sellers only can play after a share price has ticked
higher. Some academic study apparently informed Cox that the up-tick rule
was unnecessary. But virtually everyone who operates in the stock market

I'm okay with banning naked shorts, where the seller doesn't even
have to take possession of the borrowed stock collateral before the sale. But
a complete ban is just a terrible idea and sends all the wrong signals about
government interference in the market.
As much as I agree with Paulson's new RTC-type agency, which is
what I call a smart regulatory move, I disagree with Cox's action, which is
an incredibly stupid regulatory move.

Thursday, September 18, 2008

Never Sell America Short

We can fix this. If nothing else, that's the message I hope readers take away from this column.
Of course, the "this" is the run on the world banking system.
Stock markets have plunged globally, gold prices have shot up, and U.S. Treasury-bill
rates have plummeted to 10 basis points, the lowest since the 1950s.
We're witnessing a desperate flight to safety by investors. Folks are running away
from financial assets and financial institutions simply because confidence has disappeared.

This week, Treasury secretary Hank Paulson said "no" to a government bailout of Lehman.
Paulson and Ben Bernanke then took over AIG with an $85 billion bailout, with the Treasury
issuing roughly $100 billion in new T-bills so the Fed has the cash to resuscitate AIG.

All this was necessary. A collapse of AIG would have been unfathomable -- it is simply too
interconnected globally. But it turns out this rescue mission only elevated investor fears.
Shareholders are asking: "Who's next?"

The bears are now raiding Morgan Stanley and Goldman Sachs, two national treasures. Meanwhile,
the Reserve Fund -- an original money-market fund launched by Bruce Bent, a hard-nosed friend
of mine who for decades has supported conservative political causes -- has seen its net asset
value drop from $1 to $0.97. That's a shocker. And the reason? The fund's holdings of Lehman
commercial paper were unsupported by letters of credit.

Money-market funds are supposed to be safe havens for mom and pop -- for Mary and Joe in McKeesport, PA.
But everybody now wants T-bills and gold.

Well, it's time for some perspective. The world is not coming to an end. The stock market has tumbled,
but it's still over 10,000. In late 2002 it was 7,500 and in mid-1982 it was 750. Are things really that bad?

With home prices falling, foreclosures and defaults are at the root cause of the run against all manner of
mortgage-related bonds held by the banks. But as investment guru Don Luskin points out, foreclosures today
are less than 3 percent. During the 1930s they were 50 percent. Or how about the unemployment rate?
Today it's 6.1 percent. Back in 1982 it was near 11 percent and for most of the 1930s it was over 20 percent.

As the oil bubble pops the underlying inflation rate is somewhere between 2 and 3 percent -- quite unlike
the double-digit hyperinflation of the 1970s. Home prices themselves have fallen between 10 and 20 percent,
but they're still about 50 percent higher than at the start of the decade.

And there are constructive policy measures that can help fix the market's problems.

Investor Zachary Karabell writes persuasively in the Wall Street Journal that
"mark-to-market accounting in the aftermath of the Enron scandal makes no sense at all."
Many banks have taken huge losses on mortgage-backed securities and their derivatives because
the SEC insists on mark-to-market. But Karabell asks: Why knock down these bond values,
sometimes by as much as 100 percent, when the underlying home values embedded in the
mortgages have only dropped 10 to 20 percent? And in the long run, the housing market will recover, as it always does.

Bad accounting rules like this are sinking the financial system.
And why hasn't the SEC restored the up-tick rule to stem cascading share-price declines
triggered by manic short-sellers? Short-sellers are an important part of the stock market,
and they add liquidity at crucial junctures. But until July 2007, they could only short a stock
after the share price rose, not while it was continuing to decline. The SEC also should restore
the net-capital rule, which limits banks to a 12-to-1 leverage ratio governing their debt.
Over-borrowing by Wall Street is what got many firms into deep trouble.

A gathering consensus also seems to be forming around a new version of the Resolution Trust Corporation,
which effectively disposed of bad savings-and-loan assets in the early 1990s. A new RTC could purchase
underwater assets that proliferate through the financial system and are clogging the credit and loan arteries of our banks.

We clearly are in an emergency moment. But the government should opt for smart regulatory action rather
than broad-based interference that could stifle the free economy. On Thursday afternoon, as rumors spread
that Paulson was talking President Bush into a new RTC, the stock market soared 400 points.
That's what I call an endorsement.

The pessimists are now talking about the end of capitalism or a permanent decline of America.
I don't believe that for one moment. Specific regulatory reforms can get us out of this fix.
And most of all, policymakers must maintain the low-tax, low-inflation, open-trade formula
that has propelled this nation's economy and produced so much prosperity for so long.

I say, never sell America short.