What is Hank Paulson Thinking?

Includes: C, DIA, QQQ, SKF, SPY, WFC, XLF
by: Roger Ehrenberg

It's only Monday morning and two items have already hit my BS detector:

1. The ability of the SEC to suspend mark-to-market accounting rules on a case-by-base basis. From today's New York Times:

While the bill does not drop the accounting rule that requires banks to report on the market value of their assets — a rule that some banks believe has forced them to report excessive losses — it gives the S.E.C. permission to suspend the rule for any individual company if it thinks that is in the public’s interest. That is likely to lead to intensive lobbying of the commission.

2. Citigroup's (NYSE:C) acquisition of Wachovia (NASDAQ:WB) assets with the FDIC's assistance. From this morning's Wall Street Journal:

"The FDIC has agreed to provide loss protection in connection with approximately $312 billion of mortgage-related and other Wachovia assets," Citigroup said in a statement.

The Federal Reserve and Treasury Department were also part of the effort, another sign of how proactive the government has been in preventing ailing financial firms from failing and instead pushing for stronger firms to acquire some assets of the weaker companies.

I am a detailed-oriented transparency junkie who believes that aligned motives are always essential for success. Unfortunately, these three elements of goodness are not present here.

Suspending MTM accounting. I know, let's commit $700 billion to doing the right thing and undermine the entire program by sewing seeds of doubt. There is absolutely no reason, logical or otherwise, for why the Government would fund or buy assets at prices other than at market clearing levels. Because you can't fake solvency. As I've stated, ad nauseum, long-term asset values are meaningless unless you have the capital structure to hold it for the long term. And, sadly, it is all too clear that few institutions have a liability structure that matches their asset duration. If you make your bed you should lie in it, which means moving busted assets off the balance sheet, cheaply, at market value, and filling in the capital gap with a senior convertible instrument that sits above current debt and equity holders. Net net, the same liquidity profile as if Hank bought the assets at carrying value (a fiction, to be sure) but with a shift in economic ownership from current debt and equity holders to the U.S. taxpayer. Seems fair and proper given that it is our money doing the propping up. I am just aghast at the insistence of keeping such a conflict-laden provision in the bailout bill. This isn't a feature of a Splurge - it is out and out theft. For the sake of credibility and integrity of the entire program, this little tidbit has got to go. Otherwise, there will always be questions of who got a sweetheart deal. And Secretary Paulson doesn't want that as part of his legacy, does he?

Helping Citigroup buy Wachovia. So let me get this straight; we (the collective We) and providing a subsidy to Citigroup to better manage the assets of Wachovia than if Wachovia itself were buttressed through the new program? It seems to me that the decision should turn, first and foremost, on the strength and credibility of management. Are we really comfortable that Citigroup's management, which has made perhaps one good decision in the last five years (raising $50 billion - and fast), has the wherewithal to manage this even larger Goliath? What evidence have we seen that this might be the case? Now, if you told me that Wells Fargo was the buyer, I might feel differently. But this seems like the case of consolidating a bunch of crappy assets under a decidedly mediocre management team in order to claim a win for the current Administration and the U.S. taxpayer. Bull*@%^. All we're doing is potentially upping the cost of a subsequent bailout instead of taking care of Wachovia cleanly and in a straight-forward manner - now. Why make the hard choices now when you can punt for another day? It feels like Social Security all over again.

Snatching defeat from the jaws of victory. Nice job, guys. Let's hope there is some more astute decision-making as this bailout takes hold. Because so far, I am anything but impressed.