Excerpt from the Hussman Funds'Weekly Market Comment (4/6/09):
Last week saw a continuation of the impenetrably misguided policy response to this financial crisis, which seeks to address the downturn by encouraging more of what got us into this mess in the first place. The U.S. Treasury's toxic assets plan, for instance, looks to "leverage" public funds (with the FDIC providing the “6-to-1 leverage”) in order to defend the bondholders of mismanaged financials who took excessive leverage. At the same time, the Treasury plans to limit the “competitive bidding” to a few hand-picked “managers” who will be encouraged to overpay thanks to put options granted at public expense. This is a recipe for the insolvency of the FDIC and an attempt to bail out bank bondholders using funds that have not even been allocated by Congress. The whole plan is a bureaucratic abuse of the FDIC's balance sheet, which exists to protect ordinary depositors, not bank bondholders.
Look. You can play hot potato with the toxic assets all day long, and only outcome will be that the public will suffer the losses that would otherwise have been properly taken by the banks' own bondholders. You can tinker with the accounting rules all you want, and it won't make the banks solvent. It may improve “reported” earnings for a spell, but as investors who care about the stream of future cash flows that will actually be delivered to us over time, it is clear that modifying the accounting rules doesn't create value. It simply increases the likelihood that financial institutions will quietly go insolvent. I recognize that the accounting changes may reduce the immediate need for regulatory action, since banks will be able to pad their Tier 1 capital with false hope. But we have done nothing to abate foreclosures, and we are just about to begin a huge reset cycle for Alt-A's and option-ARMs. As the underlying mortgages go into foreclosure, it will ultimately become impossible to argue that the toxic assets would be worth much even in an “orderly transaction.
I have no idea how long investors will remain enthusiastic about trillion dollar band-aids and eroding the integrity of our accounting rules. I do know that at the end of the day, what matters is the long-term stream of deliverable cash flows that investors can actually expect to reach their hands. It's exactly that consideration that makes it clear that we will sink deeper into this crisis until we observe debt restructuring on a large scale. If we don't restructure the debt, the debt will fail, because for many borrowers, the cash flows aren't there, and it is not possible to service the debt on existing terms.