Sunday, September 21, 2008

Dictator Paulson's Bailout

The Treasury issued a "Fact Sheet" yesterday which shed a little more light on its proposed $700 billion bailout. Although the fact sheet was fairly brief, I'll quickly summarize it for those of you who don't have the time to read my full write-up.

I, Hank Paulson, will be granted absolute dictatorial control and power over $700 billion to buy whatever assets I damn well please under the terms of my choosing from any U.S. or foreign financial institutions that operate in the U.S. I will personally select which of my friends get to manage these assets, and you should consider yourself lucky that I intend to give you an update in a few months.

Let's look at some of the details that are coming out more closely. For starters, according to the fact sheet:

"The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets."
We're first told that the intent is to purchase residential and commercial mortgage-related se
curities, but then we read that the Treasury can also buy other assets. So, that really means that the Treasury can buy pretty much whatever it wants.

"To qualify for the program, assets must have been originated or issued on or before September 17, 2008."
It's been incredibly clear for at least 6 months to even the most ignorant observer that the housing bubble was imploding, deleveraging was underway, foreclosures were rising, risk aversion was increasing, and credit quality was deteriorating. Why in the world are we going to bail out those who were foolish enough to continue gambling these past 6 months?

"Participating financial institutions must have significant operations in the U.S., unless the Secretary makes a determination, in consultation with the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively stabilize financial markets."

This makes it abundantly clear that U.S. taxpayer dollars will be going to help support foreign-owned financial institutions. Why are we bailing them out with our money? Why aren't their own governments bailing them out? Are U.S. financial institutions with an international presence being bailed out by the foreign countries in which they operate? This looks like yet another gift to our foreign benefactors upon whom we're dependent for funding our ever-increasing debt.

Moving along:

"The assets will be managed by private asset managers at the direction of Treasury to meet program objectives."

Private asset managers? I wonder how many companies who will be benefiting from this bailout will also be benefiting from the fees they'll earn managing these assets. The Treasury could have at least mandated that no firm that participates in the bailout will be eligible to manage the Treasury-purchased portfolio.

Other details of the plan have begun emerging as well. One of the most disturbing is that Paulson is asking that no court or government agency be able to review any of his decisions. I'm sure Paulson is a nice guy and all, but I wouldn't trust him to cat-sit for me, and I don't even have a cat. I imagine even Chavez of Venezuela and Ahmadinejad of Iran are subject to some oversight.

I still haven't heard about any protections being given to U.S. taxpayers who are the ones incurring all of the risk in this bailout. I've heard no discussion of the Treasury being given equity for access to its funding. This is even more disconcerting given the issue of bank capitalization. As I highlighted a couple days ago ("The Ugly Step-Mother of All Bailouts") the only way this bailout can really help out the banks is if the Treasury buys their distressed securities at well above market prices. Selling at a true market clearing price would likely lead to immediate insolvency for many banks. Of course, buying their toxic securities at a premium would lead to an immediate loss for the U.S. taxpayer. We should be compensated for the immediate loss we'll suffer as well as the risk of significantly larger losses down the line. When we bailed out AIG, at least we were given some consideration in the form of majority ownership and a respectable yield on the debt.

This bailout is terribly flawed. What's worse is that there is a very high likelihood that it won't ultimately save the financial system. There is no guaranty that banks will start lending again. To what degree banks will still need to be recapitalized is unclear. It doesn't improve the financial condition of the U.S. consumer/homeowner. To the degree that it slows or stalls the process of actual market price discovery and deleveraging, the downturn will be strung out over a longer time period.

The market could certainly rally into quarter-end as fund managers are desperate to salvage their performance this quarter, but once the broader implications of this bailout are appreciated, there is a good chance that the market will roll over once again. Should the market begin to doubt and question the effectiveness of this huge comprehensive bailout, we could certainly experience a new high on the VIX (fear index) and a meltdown in confidence.

We have begun to increase our short positions and anticipate building them further should the market continue to rally in the coming weeks. We also anticipate further building our gold, silver, and/or junior mining equity positions.

Buckle up.

Disclosure: The Rubbernecker is short dictators and long transparency.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.