Thursday, October 16, 2008

a possible improvement

we might be stepping back from the abyss. after flailing around and trying everything else first, hank paulson might have hit the right button.

this idea about the FDIC insuring bank debt might work... at least for a little while. bank spreads were generally tighter and libor declined. bank of america and credit suisse are now recommending financial bonds. furthermore, california succeeded in selling $5bln of its muni debt.

the sp-500 is hugely oversold. I think the risk to reward now favor buying stocks and credit now.

in the meantime, some issues with the paulson plan to use the FDIC to ensure bank debt incurred through the middle of next year ...

once banks are insured, what kind of incentive do the banks have to fix their books?

under my plan, they still have credit ratings and differential borrowing costs according to basic credit fundamentals. my idea is less intrusive.

paulson's plan will create a legal link between the govt and corp bonds. over time it could create unpredictable negative outcomes. if the govt is a buyer of corporate bonds, it just phases itself out of the market when needed. the current plan could create greater tensions as june 30, 2009 approaches and the coverage nears its end.

banks might profligately issue large amounts of publicly backed debt. this is hardly the way to hold the banks' feet to the fire. many of these companies were completely irresponsible and need to be unwoundnd tranquilly.

by owning their bonds, the government has true control. financials need constant access to liquidity, and washington will be their lender of last resort, as long as they maintain the right credit ratings.

this would be also allow them to raise new PRIVATE capital, which is what regulators would force them to do in a situation like this in normal circumstances. paulson doesn't seem to get that just because we're in a crisis, we don't need to swing all the way into the socialist camp. we're still americans.

once the credit backstop exists, liquidity will return. equity investors will look in and realize things still aren't so bad and the worst of the writedowns are over... knowing that the bank has access to real financing, they will buy the stock. the govt could work with moodys and s&p along the way to influence the credit ratings, and thus the fate, of each bank. this would give control without ownership. now the government has overpaid for partial ownership, and has no clear methods of control -- aside from paulson's menacing tea parties.

I think the treasury secretary doesn't realize that in the world of finance, creditworthiness is an asset. these guys have seriously damaged theirs. they need to earn it back before responsible adults will trust them again. forcing them to take cheap money and have their debt guaranteed, paulson is mixing incentives. it's like giving them a sour apple candy, deciding to call it yucky medicine, and washing it down with a 5-pound bag of sugar.

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