Paulson’s bailout plan (with new information).

More information has come out about the plan over recent days and it’s a little different to my first impression in that I thought it was going to resemble the early 90’s Resolution Trust type set up.

It seems that Credit Suisse’s characterization that it’s a close copy of the Japanese bailout is probably pretty accuract. Seeing that they may include warrants- that is long-term options- set at favorable prices to the government shows similar characteristics to the Swedish bailout of the 90’s where the Swedish government walked away with some large profits on exercising those warrants.

People have begun to criticize the bailout for legitimate reasons while others don’t make a lot of sense.

However I want to focus on one set criticisms, which are that Paulson’s plan doesn’t offer much information, it keeps the Congress out of the picture while allowing the treasury secretary far too much power in how he manages the operation going forward.

Paulson is a trader by profession and I believe he’s looking at this problem from a trader’s perspective and that it carries numerous permutations.  He can’t legitimately explain to non-traders what he’s going to be doing because he probably doesn’t know yet in terms of the strategy as there are several different ways to proceed.

This is a very delicate trading operation. He has to be able to have free rein in terms of where he first sets the buy prices so that it doesn’t create far too much panic in case the banks stampede and begin having to mark to market downwards before they can sell the securities.

Correctly in my view he seems very loathe to set up an auction system because I think he is extremely worried about what it will do to the mark to market valuations if some banks simply crash the gates and go to the lowest possible price if they get into a panic mode. The effect of this is that it could actually cause even more severe stress and possible unintended bankruptcies all at the same time.  So I can see the reasoning of this intelligent and insightful man as to why he wants start the market above most of the mark to market valuations but not too high as his is a value judgment or a traders call.

Ideally I think he also wants to be able to create a secondary market for these securities that would allow him to set a floor when necessary rather than have to buy all the paper outstanding, as this would eliminate the need in having to use up all the capital. Even before the process starts he is possibly thinking of strategies to try and talk the market up a little that would coax private buyers to participate hoping to score a bargain. The objective is to unclog this constipated market at little cost to the taxpayer. These are things he doesn’t want to telegraph out at the moment. I certainly wouldn’t if I were he, as you want to keep all your cards close to ones chest.

Remember that paper only has to trade once and telegraphed to the market to change the mark to market for all the players.

A lot of this toxic waste is tailor made and not commoditized the way you would expect say a regular equity or the government bond. They have lots of bells and whistles and require separate and individualized valuation off synthetic benchmarks etc., so it may not be easy to mark to market. Others do of course.

My hunch is that Paulson’s prime objective would be to set a floor and subsequently begin to see a secondary market develop above current valuations where provisions have been made. This could allow banks to write back provisions thereby reducing the need for further capital infusions in to the banking system.

Seeing, as I think, he’s looking at this as a trading position the only way to be able to manage the process is to have a relatively free hand and not be second guessed by committees populated by people that have little understanding of what he is doing and why. It’s not the process that ought to be important; it’s the final outcome. Traders don’t like being second-guessed in the middle of what they are doing.

Even if you don’t agree with the bailout I think Paulson’s plan would offer the best outcome along with crossing one’s fingers and hoping it works otherwise we really do have a problem.

41 thoughts on “Paulson’s bailout plan (with new information).

  1. No John, it’s not a question of trusting him because he’s from the government. Judge him on the final outcome.

    The guy is worried that if he sets the price too low it’s all over as the bankruptcies will come at once, small and large.

    he may not actually know where to set it just yet as he needs to fiddle around and figure the lay of the land.
    Don’t trust him, trust me as I think I understand where he’s coming from. 🙂

  2. JC… So, does the bill for $700b worth of… uhm… discretionary power… end up being perpetual?

    Essentially, you are saying that you accept this particular centralisation of power, because you trust the person presently in the driver’s seat. I do not see this as a very libertarian position.

    I concede that “something needs to be done”… though only because previous government intervention has cocked things up so badly, that we need to “transition” closer to a free market, rather than simply letting things collapse… but this bill, as it presently stands, is a bad idea.

  3. Fleeced:

    if they going to do a bailout the mechanics of this deal sound okay to me.

    Paulson is going to have do some price discovery here. He may set prices up higher than required at first and bring them down or he may have to go the other way. He’s going to have to play it by ear. Either way one lot of banks are going to be pissed and may sue if they feel some others got a better price. However Paulson’s is doing nothing wrong as all he’s doing is trying to figure out where to set the market for a time see what stock is offered and then move from there.
    He may be actually thinking of offering higher prices to those in a shittier situation than other banks and then move the price down for the rest of the rats.

    Then there’s the possibility of using the price discovery to entice the hedge funds to go vulture hunting as well.

    He needs to start a market.

    That’s why he needs legal immunity is how I figure it.

    Secondly you can’t keep going back to committees and getting second guessed by them.

    I say the supervision by Congress can be worked out though and they already talking about it.

    I wish I was doing the trading it would be absolutely fantastic fun.

  4. Fleeced – why shouldn’t JC push the “nobody understands but my industry is special” line. Everybody else does it. 😉

    To be fair however there is going to be an intervention so I do appreciated the analysis on where it could be done better and where it is being done poorly. In particular I have so far been reasonably pleased that the bailouts have tried to discourage further moral hazard.

    What it would be nice to see, if somebody has the time and inclination, is some analysis of why the USA is in the systemic poop and Australia isn’t. As alluded in my post about “Price Fixing and Credit” I think the USA does an inferior job of managing monetary policy and whilst it kept the dollar too strong in the late 1990s and early 2000s it has held interest rates too low since then. Maybe they are corrupt, maybe incompetent, maybe they have poor governance but either way I think the US Fed does a poor job.

  5. jc

    i believe Paulson’s plan in its original form absolutely sucks.

    hence i am mighty relieved to see he has seen the suckiness of his original plan and addressed two key areas;
    i) placing restrictions on executive pay of those banks who apply for a bailout and
    ii) taking an equity stake in these same banks.

    i appreciate your arguments about the need for an above market purchase price for the crap assets but there must be trade-offs in return.

    otherwise Wall St gets bailed out and there will be one almighty backlash against capitalism and the free market when the average punter on Main Street figures out what has happened.

  6. charles – I’ve explain this to you before, but listen again.

    Some of us are professional economists and it reflects poorly on us to let you repeat some of your misconceptions here.

    The US never “defaulted” on it’s debt – the Bretton Woods system was simply unworkable if America had a sustained balance of payments deficit – which in itself is not a necessarily a bad thing – but under the postwar arrangement, the US was forced to basically give away gold to arbitraguers who could use a fixed dollar price against a realistic valuation of the dollar vs gold.

    Nixon more or less shut down a Government sponsored gold giveaway. Devaluations and revaluations were common, but infrequent during the postwar period. They were not considered a “default”. You are falling into the trap of faulty thinking engendered by economic nationalism, which is rooted in misunderstandings of basic economics and the basis of national income accounting.

    Your money is still backed by gold – but the growth rate of money supply isn’t.

    Please discontinue your missives of you choose to remain ignorant of the facts.

  7. September 22, 2008 – Washington D.C. – Today, U.S. Senator Jim DeMint (R-South Carolina) announced his opposition to the $700 billion plan proposed by the Bush Administration to bailout Wall Street.

    “After reviewing the Administration’s proposed bailout plan, I believe it is completely unacceptable. This plan does nothing to address the misguided government policies that created this mess and it could make matters much worse by socializing an entire sector of the U.S. economy. This plan fails to oversee or regulate the government failures that led to this crisis. Instead it greatly increases the role for Secretary Paulson whose market predictions have been consistently wrong in the last year, and provides corporate welfare for investment firms on Wall Street that don’t want to disclose their assets and sell them to private investors for market rates. Most Americans are paying their bills on time and investing responsibly and should not be forced to pay for the reckless actions of some on Wall Street, especially when no one can guarantee this will solve our current problems.”

    “This plan will not only cause our nation to fall off the debt cliff, it could send the value of the dollar into a free-fall as investors around the world question our ability to repay our debts. It’s also very likely that this plan will extend the cycle of bailouts, encouraging other companies to behave in reckless ways that create the need for even more bailouts, triggering an endless run on our treasury. This plan may make things look better for Wall Street in the next couple months, but the long-term consequences to our economy could be disastrous.

    “There are much better ways of dealing with this problem than forcing American taxpayers to pay for every asset some investor doesn’t want anymore. We should start by reforming government policies and programs that created this mess, including the Federal Reserve’s easy money policy, the congressional charters of Fannie Mae and Freddie Mac, and the Community Reinvestment Act. Then Congress should pass a number of permanent and proven pro-growth reforms to encourage capital formation and boost asset values. We need to make permanent reductions in the corporate tax and the capital gains tax rates. We have the second highest corporate tax rate in the world, which encourages companies to take jobs and investment overseas.”

    “It’s a sad fact, but Americans can no longer trust the economic information they are getting from this Administration. The Administration said the bailout of Bear Stearns would stop the bleeding and solve the problem, but they were wrong. They said $150 billion in new government spending using rebate checks would solve the problem, but they were wrong again. They said new authority to bailout Fannie Mae and Freddie Mac would solve the problem without being used, but they were wrong again. Now they want us to trust them to spend nearly a trillion dollars on more government bailouts. It’s completely irresponsible and I cannot support it.”

  8. Pom
    You know what will happen. the management forgoes big comp for a year and then claw it back after they get off on life support.

    I think they will take an equity stake through options.

    I see these as minor issues compared to the rest though. The dude can’t be second guessed every time he does a trade by those numbnuts in Congress.

  9. Charles:

    For Lords sake. The US HAS NOT DEFAULTED on its debts. Will you please stop this nonsense as you’re giving Mark Hill heart burn every time he reads one of your comments.

  10. Mark Hill – you assume that selling the gold was the wrong course of action. In my view they should have sold the gold rather than devaluing the dollar.

  11. First off, Paulson was an investment banker (corporate financier) not a trader. And this process is not about price discovery or encouraging vulture funds back into the market (they don’t need any encouragement if there’s a deal worth doing). Its about purchasing impaired assets at inflated prices in order to recapitalise the banks, and indeed the entire financial system. The system is at risk of being insolvent by virtue of having purchased assets at speculative prices with borrowed money. The prices are crashing and no one wants to lend anymore, increasing the cost of borrowing, so the system is stuffed. There’s a very small chance the program could make a profit, but much more likely it’ll make a huge loss. But that is the point, the government wants to take the loss to prevent the financial system going bust.

    Its a shame the US is turning to socialism to fix its financial system, but the free market option would be a very, very painful catastrophe. There will probably still be a painful catastrophe anyway. The ultimate ramifications of this plan will be immense and unforeseen.

    Have you noticed the irony of the editorial stance in this post and the first of your quotable quotes?

  12. Yes, that’s right, me, As CEO of GS Paulson wouldn’t have had the first clue about trading, placing stock and underwriting.

  13. me,

    How does a financial system “go bust” and what exactly does this mean? Is this preferrable to the Japanese situation America is wallowing into where banks never worry about solvency and continually get bailed out, recpaitalised over and over again at the expense of taxpayers and private credit prices?

    Why is a decade long recession preferable to some incompenetent bankers losing their jobs and everyone else keeping theirs?

  14. Of course he has a clue. But proprietary trading is quite a different activity to placing stock and underwriting. All I’m saying is he hasn’t spent his professional life as a trader – he’s not a Jon Corzine or a Gus Levy.

    Not that its a substantive point. Your argument is flawed regardless. How is the government over-paying for a whole bunch of crappy assets going to induce a market for them? They’re not worth what the government is going to pay for them. The goverment can hold them, take the risk and in a decade if it turns out better than anyone expects, perhaps the government will make a profit. If, as the market currently believes (granted, perhaps irrationally driven by fear and paranoia), using these notes as toilet paper would increase their value, the government is going to the cleaners. Frankly, Paulson knows it, Bernanke knows it, Rove knows it, Bush knows it, you would have to expect Congress knows it…

  15. Me:

    Thanks for giving me a lesson on what prop trading is all about. I didn’t know 🙂

    The point your trying to avoid is that Paulson, as former head of GS would know. He would also know things such as how to start a market in securities that haven’t traded before such as an IPO and where to set prices.

    Frankly I don’t know what they are worth. You don’t, Nancy Pelosi doesn’t and Barney Frank doesn’t.

    This is why I have been saying that he needs to be able to move the price around a bit to establish optimum pricing in terms of obtaining his objectives.

    Ideally and I suspect it is his intention, he would probably want to see a secondary market develop and use the reserves as a floor.

  16. Mark Hill I agree all the way.

    Letting the situation work itself out wouldn’t be the end of the world, or “armageddon”.

    Watch this youtube – as the narrator points out, an economic crash doesn’t involve factories exploding and people dying on a mass scale.

    I’m quite convinced there are only 2 feasible options. One is short, sharp and painful.

    The other is a prolonged, painful, politically uncertain, recession brought about by new regulations and bail-out packages, which will have an immense number of unwanted consequences. (e.g the Dems want a moratorium on foreclosures inserted into the bail-out, they want a lowering of repayments for home owners).

    None of the dozens of measures have worked in the last year. As each new measure is announced, each new power grab and bail out is debated in Washington, the markets wait nervously and there will be a lot of uncertainty from investors. This is not a good situation.

  17. Jono

    The last major short sharp fall the US experienced was in the early 20’s, when Cal Coolidge to his credit left everything alone. Industrial production fell about 40% i believe and despite his treasury sec asking to intervene he stayed out. 18 months later the economy righted itself.

    However the world was a lot different then than it is now and you just didn’t have all the government entanglements.

    My humble view is the we should look to remove a great deal of the moral hazards and regulatory crap later rather than right now. I think the bailout could work, but I’m not sure. However as far as bailouts go Paulson’s plan (adding a few things to it) doesn’t look horrendous. That’s been my point.

  18. No bailout. Let the businesses fail. So long AIG, and thanks for all the fish.

    There are two problems. One, businesses made bad decisions. Yes, this was somewhat due to government intervention (implicit backing of F&F, dumb lending laws) but bad decisions still need to be punished.

    Two, there’s a liquidity problem. This is the fed’s responsibility. Bernanke has done the right thing to sell down his Tsy bonds and buy up corporate bonds, so as to add liquidity to the market. If the “hiding money under matress” mentality continues, the fed might need to cut rates or find some other way of pumping short-term money into the system.

    That is the legitimate area of fed action. Not asking for $1 trillion of taxpayer money. No bailout.

  19. Well this is all redundant now it seems as there doesn’t look like there’s going to be a bailout. It’s over by the looks of things.

  20. My humble view is the we should look to remove a great deal of the moral hazards and regulatory crap later rather than right now. I think the bailout could work, but I’m not sure. However as far as bailouts go Paulson’s plan (adding a few things to it) doesn’t look horrendous. That’s been my point.

    You are entitled to your own views, but this is really not convincing. I actually can’t see this ending the credit squeeze and I know its going to be a deathblow for the US taxpayer and their currency. Even I’d support the bail out too if I thought it cost nothing and the only risk was on the upside.

    Why do libertarians or free-marketers seem so sympathetic to this rushed bail-out ? Did any of you oppose the other failed attempts that led up to this point, e.g nationalisation of Fannie and Freddie ?

    jc, at the moment, I can’t accept your description of this plan. There is no sophisticated rationale to this that only Hank Paulson, super-genius, master of the free markets can unravel.

    I’m not saying that he isn’t intelligent, but many other intelligent people are dead set against it, and they’ve done a wonderful job of elaborating all the hazards and pitfalls of the plan. 190 top economists just signed a petition opposing any bail-out.

    I’ve got a similar scenario for libertarians to consider.

    If a massive university, or say, a private hospital, were about to declare bankruptcy, and leading academics/medical administrators were to propose a nationalisation of those institutions, I don’t think a single free-marketer would approve on any terms.

  21. Jono:

    I have said all along that I am ambivalent about the plan. i simply hope it works. However as far as plans go. it’s not bad and I think the guy doing it would do a good job.

  22. I hope its dead in the water. Time for me to head off, but I’ll provide some linkage to intelligent people a bit skeptical of the bail out:

    Dallas Federal Reserve Bank President Richard Fisher said the proposed $700 billion rescue of financial institutions backed by Fed Chairman Ben S. Bernanke would plunge the U.S. government deeper into a fiscal abyss.

    The plan by Treasury Secretary Henry Paulson to buy troubled assets from financial institutions would put “one more straw on the back of the frightfully encumbered camel that is the federal government ledger,” Fisher said today in the text of a speech in New York. “We are deeply submerged in a vast fiscal chasm.”

    And the petition of 190 top economists:

    “As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:”
    1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

    2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

    3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

    For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

    Acemoglu Daron (Massachussets Institute of Technology)
    Adler Michael (Columbia University)
    Admati Anat R. (Stanford University)
    Alexis Marcus (Northwestern University)
    Alvarez Fernando (University of Chicago)
    Andersen Torben (Northwestern University)
    Baliga Sandeep (Northwestern University)
    Banerjee Abhijit V. (Massachussets Institute of Technology)
    Barankay Iwan (University of Pennsylvania)
    Barry Brian (University of Chicago)
    Bartkus James R. (Xavier University of Louisiana)
    Becker Charles M. (Duke University)
    Becker Robert A. (Indiana University)
    Beim David (Columbia University)
    Berk Jonathan (Stanford University)
    Bisin Alberto (New York University)
    Bittlingmayer George (University of Kansas)
    Boldrin Michele (Washington University)
    Brooks Taggert J. (University of Wisconsin)
    Brynjolfsson Erik (Massachusetts Institute of Technology)
    Buera Francisco J. (UCLA)
    Camp Mary Elizabeth (Indiana University)
    Carmel Jonathan (University of Michigan)
    Carroll Christopher (Johns Hopkins University)
    Cassar Gavin (University of Pennsylvania)
    Chaney Thomas (University of Chicago)
    Chari Varadarajan V. (University of Minnesota)
    Chauvin Keith W. (University of Kansas)
    Chintagunta Pradeep K. (University of Chicago)
    Christiano Lawrence J. (Northwestern University)
    Cochrane John (University of Chicago)
    Coleman John (Duke University)
    Constantinides George M. (University of Chicago)
    Crain Robert (UC Berkeley)
    Culp Christopher (University of Chicago)
    Da Zhi (University of Notre Dame)
    Davis Morris (University of Wisconsin)
    De Marzo Peter (Stanford University)
    Dubé Jean-Pierre H. (University of Chicago)
    Edlin Aaron (UC Berkeley)
    Eichenbaum Martin (Northwestern University)
    Ely Jeffrey (Northwestern University)
    Eraslan Hülya K. K.(Johns Hopkins University)
    Faulhaber Gerald (University of Pennsylvania)
    Feldmann Sven (University of Melbourne)
    Fernandez-Villaverde Jesus (University of Pennsylvania)
    Fohlin Caroline (Johns Hopkins University)
    Fox Jeremy T. (University of Chicago)
    Frank Murray Z.(University of Minnesota)
    Frenzen Jonathan (University of Chicago)
    Fuchs William (University of Chicago)
    Fudenberg Drew (Harvard University)
    Gabaix Xavier (New York University)
    Gao Paul (Notre Dame University)
    Garicano Luis (University of Chicago)
    Gerakos Joseph J. (University of Chicago)
    Gibbs Michael (University of Chicago)
    Glomm Gerhard (Indiana University)
    Goettler Ron (University of Chicago)
    Goldin Claudia (Harvard University)
    Gordon Robert J. (Northwestern University)
    Greenstone Michael (Massachusetts Institute of Technology)
    Guadalupe Maria (Columbia University)
    Guerrieri Veronica (University of Chicago)
    Hagerty Kathleen (Northwestern University)
    Hamada Robert S. (University of Chicago)
    Hansen Lars (University of Chicago)
    Harris Milton (University of Chicago)
    Hart Oliver (Harvard University)
    Hazlett Thomas W. (George Mason University)
    Heaton John (University of Chicago)
    Heckman James (University of Chicago – Nobel Laureate)
    Henderson David R. (Hoover Institution)
    Henisz, Witold (University of Pennsylvania)
    Hertzberg Andrew (Columbia University)
    Hite Gailen (Columbia University)
    Hitsch Günter J. (University of Chicago)
    Hodrick Robert J. (Columbia University)
    Hopenhayn Hugo (UCLA)
    Hurst Erik (University of Chicago)
    Imrohoroglu Ayse (University of Southern California)
    Isakson Hans (University of Northern Iowa)
    Israel Ronen (London Business School)
    Jaffee Dwight M. (UC Berkeley)
    Jagannathan Ravi (Northwestern University)
    Jenter Dirk (Stanford University)
    Jones Charles M. (Columbia Business School)
    Kaboski Joseph P. (Ohio State University)
    Kahn Matthew (UCLA)
    Kaplan Ethan (Stockholm University)
    Karolyi, Andrew (Ohio State University)
    Kashyap Anil (University of Chicago)
    Keim Donald B (University of Pennsylvania)
    Ketkar Suhas L (Vanderbilt University)
    Kiesling Lynne (Northwestern University)
    Klenow Pete (Stanford University)
    Koch Paul (University of Kansas)
    Kocherlakota Narayana (University of Minnesota)
    Koijen Ralph S.J. (University of Chicago)
    Kondo Jiro (Northwestern University)
    Korteweg Arthur (Stanford University)
    Kortum Samuel (University of Chicago)
    Krueger Dirk (University of Pennsylvania)
    Ledesma Patricia (Northwestern University)
    Lee Lung-fei (Ohio State University)
    Leeper Eric M. (Indiana University)
    Leuz Christian (University of Chicago)
    Levine David I.(UC Berkeley)
    Levine David K.(Washington University)
    Levy David M. (George Mason University)
    Linnainmaa Juhani (University of Chicago)
    Lott John R. Jr. (University of Maryland)
    Lucas Robert (University of Chicago – Nobel Laureate)
    Luttmer Erzo G.J. (University of Minnesota)
    Manski Charles F. (Northwestern University)
    Martin Ian (Stanford University)
    Mayer Christopher (Columbia University)
    Mazzeo Michael (Northwestern University)
    McDonald Robert (Northwestern University)
    Meadow Scott F. (University of Chicago)
    Mehra Rajnish (UC Santa Barbara)
    Mian Atif (University of Chicago)
    Middlebrook Art (University of Chicago)
    Miguel Edward (UC Berkeley)
    Miravete Eugenio J. (University of Texas at Austin)
    Miron Jeffrey (Harvard University)
    Moretti Enrico (UC Berkeley)
    Moriguchi Chiaki (Northwestern University)
    Moro Andrea (Vanderbilt University)
    Morse Adair (University of Chicago)
    Mortensen Dale T. (Northwestern University)
    Mortimer Julie Holland (Harvard University)
    Muralidharan Karthik (UC San Diego)
    Nanda Dhananjay (University of Miami)
    Nevo Aviv (Northwestern University)
    Ohanian Lee (UCLA)
    Pagliari Joseph (University of Chicago)
    Papanikolaou Dimitris (Northwestern University)
    Parker Jonathan (Northwestern University)
    Paul Evans (Ohio State University)
    Pejovich Svetozar (Steve) (Texas A&M University)
    Peltzman Sam (University of Chicago)
    Perri Fabrizio (University of Minnesota)
    Phelan Christopher (University of Minnesota)
    Piazzesi Monika (Stanford University)
    Piskorski Tomasz (Columbia University)
    Rampini Adriano (Duke University)
    Reagan Patricia (Ohio State University)
    Reich Michael (UC Berkeley)
    Reuben Ernesto (Northwestern University)
    Roberts Michael (University of Pennsylvania)
    Robinson David (Duke University)
    Rogers Michele (Northwestern University)
    Rotella Elyce (Indiana University)
    Ruud Paul (Vassar College)
    Safford Sean (University of Chicago)
    Sandbu Martin E. (University of Pennsylvania)
    Sapienza Paola (Northwestern University)
    Savor Pavel (University of Pennsylvania)
    Scharfstein David (Harvard University)
    Seim Katja (University of Pennsylvania)
    Seru Amit (University of Chicago)
    Shang-Jin Wei (Columbia University)
    Shimer Robert (University of Chicago)
    Shore Stephen H. (Johns Hopkins University)
    Siegel Ron (Northwestern University)
    Smith David C. (University of Virginia)
    Smith Vernon L.(Chapman University- Nobel Laureate)
    Sorensen Morten (Columbia University)
    Spiegel Matthew (Yale University)
    Stevenson Betsey (University of Pennsylvania)
    Stokey Nancy (University of Chicago)
    Strahan Philip (Boston College)
    Strebulaev Ilya (Stanford University)
    Sufi Amir (University of Chicago)
    Tabarrok Alex (George Mason University)
    Taylor Alan M. (UC Davis)
    Thompson Tim (Northwestern University)
    Tschoegl Adrian E. (University of Pennsylvania)
    Uhlig Harald (University of Chicago)
    Ulrich, Maxim (Columbia University)
    Van Buskirk Andrew (University of Chicago)
    Veronesi Pietro (University of Chicago)
    Vissing-Jorgensen Annette (Northwestern University)
    Wacziarg Romain (UCLA)
    Weill Pierre-Olivier (UCLA)
    Williamson Samuel H. (Miami University)
    Witte Mark (Northwestern University)
    Wolfers Justin (University of Pennsylvania)
    Woutersen Tiemen (Johns Hopkins University)
    Zingales Luigi (University of Chicago)
    Zitzewitz Eric (Dartmouth College)

  23. jono:

    this looks awfully like one of those concerned economists for global warming petitions. calls to authority without detailed reasons don’t sway me one way or another. In fact I become a little more questioning when I see crap like that.

  24. Jono — there’s no need for publishing all the names in this comments section. Use a link.

    And there is no reason to believe this will be the “deathblow for US taxpayers and the US currency”. The US taxpayers have (unfortunately) put much more money than this into many other stupid projects, and yet survived. And if the bailout really is being paid for by US taxpayers, then it should have little impact on the US dollar.

    I am opposed to the bailout. But my reasons are long-term… not a prediction of immediate danger.

    Having said that, I don’t think the fed should do nothing. It is their responsibility to manage the US dollar, and currently there is a sharp (albeit, probably short-term) decrease in the amount of broad money in the economy, as people are hording.

    I think the fed has been too lax over the last 10 years with their monetary policy, but this situation calls for their quick action to temporarily increase base money supply.

    Such action would minimise the economic impact of this crisis, while still allowing some banks to fail.

  25. We haven’t seen dollar deposits trade below 7% going as high as 11% this week. US dollars are really as scarce as hens teeth.

  26. John H

    I have seen countless interventions in the FX market. Some have worked whereas some haven’t in terms of changing the markets direction.

    To simply argue (not that you have) that this won’t work is not supported by the raw facts of governments acting in the FX markets to get the desire they want.

    The prime reason I see some benefit coming out of this is that if Paulson is smart he could actually start the secondary market up in this stuff as too few people are prepared to put their hand up and take a risk.

  27. “The point your trying to avoid is that Paulson, as former head of GS would know. He would also know things such as how to start a market in securities that haven’t traded before such as an IPO and where to set prices.”

    I haven’t avoided this point at all, I’ve been quite direct and said its just not what’s driving this plan. Paulson is an incredibly intelligent, successful man and of course he knows more than the average bear about securities and markets. But these are not securities that haven’t traded before – they are securities that have stopped being traded. Why have they stopped? Prices were unrealistically high in a frenzy of borrowing and speculation. But when the quality of certain of these assets in the subprime sector became apparent, the credit boom came to an end. Demand for a range of asset classes has fallen through the floor, and prices promptly followed. As you say JC, the banks who hold these assets can’t sell them at current prices because to do so would crystallise their losses and their insolvency would be bared to the world.

    The fact of the matter is that there are tens of thousands of smart people (not as smart as you, obviously, JC – after all you ARE a trader) in New York, Boston, London, Frankfurt, Tokyo, Hong Kong, etc, who are analysing these securities constantly, searching for a good buy. Their bids are not matching the banks ask, because the banks can’t go that low or they’ll be bust.

    You’re right though, I don’t know what they’re worth, you don’t, no one does. It depends on events that are uncertain. But do you think these vulture hedgies are going to be sitting by their Bloomberg terminals, slapping their foreheads saying “Gee whiz, the governments buying these things, now I want to get my hands on these hot buys”? I think they’re probably going to be sitting their saying, “Now we might have a seller who can give us a realistic ask without going bust.”

    “How does a financial system “go bust” and what exactly does this mean?”

    Sorry, I guess what I meant was widespread failures amongst financial institutions to such an extent that the complete loss of confidence causes the financial system to haemorrhage and cease functioning. We’re in a diabolical situation already judging by LIBOR, but I think it must be able to get much worse?

    “Why is a decade long recession preferable to some incompetent bankers losing their jobs and everyone else keeping theirs?”

    I don’t have a view on the merits of the bailout plan and I have no idea what the best way of dealing with the current situation is. Never purported to. But as a classical liberal, I am dismayed to see the largest and most successful capitalist society ever nationalising mortgage originators, insurance companies, badly impaired financial securities, etc. Even if this is the best course of action based on all currently available information (and it may well be), I think its ramifications will be immense and it will undoubtedly have important effects that we are not even conceptualising today.

    The only reason I posted is because I disagree with JC’s view that this is a liquidity problem that will be solved because Hank Paulson was CEO of GS. The reason we have such a diabolical liquidity problem is because the market is afraid that there is a diabolical underlying solvency problem. There may not be, it is possible the bailout will work exactly as envisaged and no doubt JC would take it of affirmation of how smart he is (he IS a trader, after all), however market participants currently believe there is a real risk of systemic insolvency. I believe that is what everyone on Capitol Hill is trying to respond to, not market-making baloney.

  28. Me:

    Look I’m sympathetic to a lot of what you say. And no I certainly don’t think I’m anywhere near being very smart. I’m a little worried at the moment: actually more than a little worried, I am a little panicked.

    The stock market isn’t the thing that worrying me, it s the credit markets have, made me more than a little concerned. I’m looking around and I see so much complacency from people here, elsewhere and especially with the Congress and don’t believe what I am seeing.

    Short-term money, that is day-to-day dollars in Asia haven’t been lower than 7% and on some days trading as high as 11%. The TED spread which is T-notes against the comparable LIBOR term is trading at 300 basis points. I’ve never ever seen a situation like this. Add the fact that the large global central banks have turfed in about 200 billion in the system hoping to liquefy it and we still end up with rates like that is a real, real cause for concern.

    People look at the US Stock market and think things aren’t as bad as they are. I’m not so sure when I see evidence of the credit markets seizing up like that. Be worried, be really, really worried if this package, which despite the grandstanding, goes through and doesn’t work because then it will be full on and will resemble the 30’s in lots of ways especially with the ascension of the left in the US.

    Look, I believe that the cleansing mechanism of the market would see us though. However I’m not so sure we would be allowed to have an Austrian cleansing that should be allowed to happen. There will be all sorts of hampering and shackles put on the market in the US from next year by both the candidates in an effort to prevent things falling further (and therefore making things worse). This is why I’m partial to the bailout, simply because I see this as the least worst alternative. This is just a simple judgment call on my part and respect most of the things you say.

    For instance Citigroup is a monster that’s been wounded by the mess. If they go under it’s a $2 trillion balance sheet if one includes the off balance sheet crap they are running. This isn’t chump change, me.

  29. JC, I would say we agree almost completely then. Things are grave in the credit markets to a completely unprecedented extent. I also am panicked. I bank with Citigroup and I transfer my salary out of there immediately every payday, and as you say, this is one of the biggest financial institutions on the planet.

    I speak to Australians who say, we’ll be right mate, property will be a buy with a 5-10% drop, our borrowings have been invested in productive capacity, mining boom, etc. I think they are completely deluded. Australia is not isolated from this. The world has to deleverage to the extent of Lord knows how many trillions of dollars following the most enormous, unprecedented credit super-cycle ever. There is a distinct possibility that it is going to be very, very ugly, make the Great Depression look like a picnic at the beach on a nice sunny day.

    I may be paranoid or we avoid whatever potential catastrophe may be lurking, but just the possibility and the way things are heading, LIBOR, etc, makes me very, very anxious.

    Incidentally, Paulson is only in the job for a few more months, right? So if he sets up this plan, he may not be the one administering it in the long run in any event?

  30. JC,

    Re: 34

    Excuse the ignorance, but can you explain some of the jargon? e.g. LIBOR, TED spreads, etc.? And what exactly is the significance of those percentages?


  31. Libor

    London interbank offered rate.

    Very common benchmark used by banks to set loans and loan rollovers. So common that even US banks can at times use it to set loans in the US domestic market.

    Terms, 1wk, 1 mth…. out to 24 months if I recall.

    Very Short end really only trades a few ticks over the Fed funds rates if the Fed is say neutral on rates (no tightening or loosening bias).

    TED spread.

    The spread 3 month US Treasury notes over the Euro dollar futures contract.

    Carefully watched indicator during times of tension

    300 basis points is unheard of. Shows people aren’t lending to each other and money is really tight.

  32. To add a little bit more info, LIBOR is determined every morning by the London Bankers’ Association calling around a sample of banks, say 15, and asking them what interest rate they will charge to lend to a hypothetical leading bank in a number of different currencies for various different terms, 1 week, 1 month, etc. They ignore the highest and lowest one or two and average out the rest. This is taken to be representative of banks’ cost of borrowing – i.e. if a bank needs 1 million euros for 3 months because it promised to lend them to a client, it should be able to borrow them in the interbank market at the relevant LIBOR.

    LIBOR is used, as JC says, as a benchmark for a huge amount of lending around the world. I don’t know exact figures, but by way of example, BHP might have a loan of AU$10bn from a syndicate of banks (like Goldman, Morgan Stanley, RBS, CBA, NAB who all put in a fraction of the total AU$10bn) and the interest rate they charge will be LIBOR plus a margin of, say, 1.5%.

    Problem is, at the moment, banks are afraid to lend to each other, even overnight, because they’re worried the counter-party is going to pull a Lehman on them and they won’t be repaid in the morning. As a result, the cost of borrowing (LIBOR) has not only shot up to unprecedented levels – i.e. LIBOR has NEVER been anywhere near the same ballpark since it first started. That’s how scared the people who are familiar with the situation are, they don’t want to give their money to certain banks even overnight. Now, doesn’t that fill you with confidence?

    There are other things that demonstrate how bad it is out there, but its depressing to go into them. Thinking about CDSs sends a shiver down my spine – if AIG had gone under, it would have been all over…

  33. Some other shit that’s happening:

    When Lehman filed $63 billion of commercial paper simply disappeared. Now firms are worried and are drawing down on their CP paper programs. This hits the banks very badly because CP paper facilities aren’t heavily counted in their capital adequacy requirements. However when the lines are drawn this hits the capital chain all the fucking way up and forces banks to restrict their lending even more to other areas. So the friggen credit multiplier simply stops like a pump that is supposed to be pumping out water has air going through it. The banks simply don’t have any money to lend as they don’t have the funds for other things. This could be one of the reason dollars are so tight.

    This is where we get to Armageddon and we see wholesale firings as firms can’t meet payrolls simply because the banks can’t get the cash. Some of you guys think this shit isn’t serious but it is. If they don’t get the support package, its over guys. The world as we know it will change forever.

    I don’t normally make these comments and I always wanna see markets do all the work. But this is so friggen serious it scares the shit outta me.

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