Economic crises need bold, strategic decisions not desperate measures to start healing them. Amid the cacophony of financiers, politicians and corporations calling for adoption in the US of the $700bn ‘bad-debt’ bailout package, it’s tempting to plump for the quick fix to stem stock market woes. But if Congress decides tommorrow, as many now expect, to row back on last week’s veto, it will still be left holding an economic bomb, just with a longer fuse. Instead, what Congress should do is demand a swift, but thorough rewrite of the bill and push the US to become an activist investor in those banks that need their balance sheets propped up. The US government should follow its European counterparts by taking equity stakes on favourable terms in ailing financial groups and then demanding board positions to guide their future business policies and ensure they support US economic growth. Apologies for bringing Warren Buffet back into a second consecutive editorial, but he’s shown Hank Paulson and the US Treasury a clean pair of heels by taking a $5bn stake in Paulson’s ex employer Goldman Sachs on eye-wateringly lucrative terms.The US government would do well to copy Buffet’s strategy with banks that need capital infusions. At the same time, it should start applying concerted pressure on banks to start lending to each other or face the consequences. No lending? Well no short-term loans and no equity then! In short, the government should be looking for the best deal both economically and socially for its stakeholders. This bailout isn’t it. There are several key reasons why the current proposal is bad legislation, bad economics and bad politics. First, US taxpayers should not be on the hook for a conservatively estimated $700bn as a result of legislation rushed through in a matter of weeks via a document that started out as three pages but has ballooned to a complex two hundred plus page opus.
An initial reading of the bill shows it claims to protect US homeowners, but it’s difficult to see how? The wider debate really should be about whether a short to medium-term ‘shock’ cut in interest rates would better alleviate mortgage debt, reinvigorate consumer confidence and revive the economy.
The bill also raises the prospect of highly complex reverse auctions to price the bad debts before they can be taken onto the Treasury books. There is scant indication how this would work. One danger is that the government overpays on assets the market won’t touch and can’t recoup its money in a politically or economically expedient timeframe. Another, as Steve Niven, head of asset allocation at UK manager F&C, points out, is that the government underpays for the bad debt, forcing further write-downs and further undermining the financial system. That sound likes a deal which sticks the US Treasury between a rock and a hard place. The ‘theory’ of the bill is that the removal of toxic waste from banks’ balance sheets will remove counterparty risks and stimulate lending. A plausible alternative reality, bearing in mind current market panic, is that banks continue hoarding assets, despite the bailout, and that more of the money that has fled the money markets will go, as it has been, into short-term US treasury bonds. That is not going to un-gum the market.Regarding the bailout, US taxpayers should also ask themselves why in return for a lifeline they are being offered bank warrants for non-voting stock. The least they should expect is a future voice in those banks in exchange for their money. They might also ask whether the much talked about abolition of ‘golden parachutes’ – AKA rewards for failure – for executives, is really all it’s cracked up to be. My reading of the bill suggests the parachutes will only be zipped up in firms that have passed on bad debts to the government, and then only for the duration of the government’s holding of that debt. In reality, it’s disappointing that the debate on excessive executive remuneration has only come this small distance, despite many respected market professionals acknowledging it has played a poisonous role in the market’s short-termist mania. Finally, the US Congress, and the rest of us involved in financial markets, might want to ask whether the outcome of not passing this flawed bill will be worse than passing it, only then to find it doesn’t work.
Now that’s a scary thought!