Paulson's Poker Face: A Bluff by Going All In

Treasury Secretary Hank Paulson and Fed Reserve Chairman Ben Bernanke went all in by putting chips on the table. When this measure was proposed, the markets reflected the notable expectation by “banking in the numbers” ahead of the legislation’s passage. This is a dangerous way to play a poker hand because there is absolutely no room for error, and it becomes an all or nothing gamble with people’s pension funds, retirement accounts, IRA’s, 401k’s, money markets, and savings accounts on the line.

Now, I fully support the Paulson plan, but it was a weak hand to play from the onset, mostly because the success and failure depended exclusively on Congress to pass legislative action. And such preconditions ultimately mean you are not in control of your own destiny. We saw “the flop” last week in the first wave of capitulation and the political muddling that occurred as a result of too many cooks in the kitchen. Monday’s reaction saw “the turn” as the House Congressional members were unable to pass the desperately needed legislation.

Folks, we are now waiting for the final card known as “the river.” There are no more cards to be dealt from the deck and you can’t take your chips off the table now because it’s way too late. This is it, all in, the critical nexus point where you have no choice but to play the hand out in its full entirety.

Wall Street waits with nervous tension as Congress reconvenes to rework the legislation and appease bruised and battered egos. The casino lights are dimming because the House is about to go bust. We are all positioned to sit on the sidelines of the table as spectators, while Congressional members play political calculus by sticking their fingers in the air to see which way the wind is blowing–one might suggest a better place they could stick their finger if they really wanted to plug the leaking sieve of pork belly spending and earmarks.

This plan was never perfect to begin with and there are many measures that I would like to see, but the crisis demands and necessitates action, not empty rhetoric. I don’t understand why there continues to be this fundamental and irrational disconnect on explaining this crisis and why it matters to everyone now. You don’t punish the innocent people just to get at the few that are responsible.

I had an argument with a friend of mine because he, dismissively, presumes this crisis doesn’t effect his family. And I explained, even though he is actually gainfully employed, don’t think that your employer keeps your checks from bouncing by stashing a huge wad of cash in a safe somewhere. If employers can’t fund payrolls due to a freeze in the credit markets, every working family will, unfairly, feel the direct connection to this Wall Street bailout.

Everybody likes the ideological rhetoric of “free markets,” but nobody likes the harsh reality of “markets in free fall.” There’s a difference and ideological rhetoric is a luxury we can’t afford to have when markets are crashing all around us. Most people hate the police when they don’t need them, but when an emergency crisis occurs, the police are the first ones that people call for help because they are the only ones that will come to the rescue.

The idea of bailouts incites a vomit inducing aversion to the prospect of cleaning up someone else’s mistakes. It’s like going on a date with a bulimic person to a restaurant, and having to foot the bill on the taxpayer’s dime after they just returned from regurgitating the meal in the bathroom.

POLITICAL POSTURING

They either pass this legislative vote or they don’t. I’ll say this, if those pandering Congressional members worry that their constituents wouldn’t vote them back in their respective offices if they supported the bill, I can damn well guarantee they won’t vote them back in if they don’t pass legislation and the markets collapse sub-10,000 on the DJIA and S&P 500.

Senator Christopher Dodd summarized it correctly, and I am paraphrasing here, but essentially his point was astute to point out that voters are angry and don’t like the idea of a bailout bill, but they will be angrier if nothing is done and things worsen due to the direct consequences by this failure to act.

In shameful contrast, you had Richard “freedom fries” Shelby publicly chastising the Paulson plan as a Wall Street bailout, while he held up 5 pages of nameless “leading economists” who opposed the action. He couldn’t help himself to excoriate and compare this to “socialism like the French.” Get off your high horse, Mr. Shelby, and stop pretending you’re so noble when you consider this is the same man who derailed Boeing’s (BA) tanker refueling contract to, instead, offer it to a French subsidized Airbus. And for a person that says he doesn’t believe in bailouts, was it any coincidence that the award to Airbus that was, thankfully, rescinded by the GAO, was going to build an assembly plant in his home court of Alabama? Hmmm, smells like a pork belly earmark to me.

I mean, for all the talk of not wanting to spend $700 billion, the non-action by the majority of the House ended up costing 1.4 trillion in losses to the S&P 500 which, essentially, are the strongest corporations and primary employers for American job creation, as well as the underlying stability of our economy. What Paulson and Bernanke accurately forecast in their dire warnings, was that the consequences would cost more if the unwanted, but necessary action in the intermediate solution didn’t pass successfully.

I really don’t respect people that criticize others without offering real solutions first. If you don’t want to pass this bill, fine, but you better come up with an alternative plan that is better. You can’t be in a position of power and simply stand by and watch the house burn down completely. You obligate yourself to work toward a solution the moment you open your mouth to offer an opinion.

CRISIS MAKES STRANGE POLITICAL BEDFELLOWS

I’m pleasantly surprised, actually, that the Democrats have worked in conjunction with the current administration to bail out, what they feel is inconsistent, Republican policy that helped to precipitate this mess. Let’s be clear, both houses have their share in the blame game but, honestly, I can’t believe that Democrats are pushing this bill more than some Republicans. I’ll make a prediction here, if this passes and the markets stabilize, it greatly increases McCain’s chances of winning.

The economy is only a major mainstream political hot button issue when it’s not functioning correctly but, when it is working, no one thinks about it either because it bores them or they fail to understand how it really works. Otherwise, politicians can go back to distracting their audiences by debating non-issues like gay marriage and gun rights.

If Democrats were playing politics with this issue, they could stall for time and allow the markets and economy to falter further and guarantee a win in the fall election a little more than a month away from now.

I mean, these very same Congressional members just passed last Wednesday a “stop gap” spending bill of $600 billion dollars that included $25 billion allocated toward automakers. Yeah, while everyone was focused on the Paulson plan, nobody criticized this spending plan which is just about equal in amount of taxpayer burden. Where was the outrage in that? Where was all the concern for the taxpayers dime that seems to be pinned on this legislative action?

In my last article, I closed with the idea you could never underestimate the stupidity of Congressional leadership to politicize a crisis and posture rather than work toward a solution. I even went so far to dare Congress not to pass the Paulson bill. But never did I actually believe they would call the bluff of Paulson and Bernanke.

I’ll tell you, I mistakenly assumed Congress wasn’t as stupid as I thought, and boy, was I wrong.

I will offer credit to those both on the Republican and Democratic sides of the aisle that stood up in a bi-partisan fashion and constructed the architecture of the bill for the good of the nation and American people. No one wanted this bill to become necessary just as no one wanted a deleveraging crisis to unfold, but this situation is upon us and the consequences of doing nothing is self-evident by Monday’s record breaking selloff in the markets.

To those that voted against this bill, they have clearly put, for the most part, politics before their country. It is utterly shameful and disgraceful that there are those that cling to the very same ideology that helped facilitate this event, will now rely on it to be the excuse on why they aren’t responsible to act.

I’ve written earlier about how much I respect Ron Paul and fully anticipated that he would be one of the people to vote against the bill. To him, along with the select few, I grant exception to criticism because he is consistent and truly practices the convictions he preaches. But to others that only play for political survival at the expense of innocent people, something is wrong.

I consider myself to be far more conservative on many issues, but this debacle, if not resolved, will turn me to vote for a Democrat out of spite, and especially for a person that I really don’t believe is qualified for the job either. Please, will someone step up and reshuffle the deck and bring a legitimate third-party candidate forward? I can’t be the only one with buyer’s remorse, can I?

I saw those first debates and while most analysts couldn’t decide who the clear cut winner was, no matter how much they spun it afterwards, I absolutely know who the loser was–it was us, the American people, because neither party candidate had a clue on how to describe the current events of the economy beyond more empty rhetoric and, even worse, not one valid plan to solve the problems at hand.

BREAKING THE MYTHS

It’s not fair to put this cost on taxpayers. Really? Tell us something we don’t know. But if we don’t have careers, jobs and the ability to earn income then paying taxes is the least of our worries. If Congress wants to be setting standards, they could stop voting for their own pay raises and health care coverage while denying our citizens of the same standard of care.

And since when have taxpayers ever had to pay for our deficits? In fact, tax rates have continued to draw down over time despite budget deficits continuing to be rolled over like consumer credit. We all know the tagline of how politicians make it seem like deficits are, literally, putting a tax on you or your family. We’ve all seen the ads that tell us how each child comes into the world owing money from the moment they are born.

Here’s the thing that people don’t seem to understand. If we don’t restore confidence to the credit markets and the willingness for banks to lend money, guess what? Then we really will have to pay for this mess and you might make that non-credible scare tactic of taxpayer burden become reality. Why? Because what other country will want to continue to buy our debt and keep funding our deficits if our economy is unstable and not credit worthy?

This is an old Ponzi scam we’ve been playin’ on the rest of the world. We borrow money by issuing guaranteed debt and yield, in return, we help police the world and help support global stability and development. But, our ability to continue rolling guaranteed debt depends exclusively on the trust of the world economies and our best allies believing that the United States is the strongest player on the Monopoly table.

The rest of the world needs our solvency, strength and leadership to be the beacon of light that leads others into safe harbor. Ironically, those that really don’t understand the markets and how they function, irrespective of ideal classroom scenarios and economic models, are imposing market manipulation by virtue of being obstructionists.

By preventing those that have the power to act, you are essentially taking action which is the complete contradiction of free markets because such action causes a reaction, as demonstrated by Monday. This is serious market dislocation and a panic selloff where rhyme and sense of reason don’t exist. That’s not a free market as much as it is a broken market.

I’ll tell you what would effectively communicate how serious this issue is to those that don’t get it, banks should immediately freeze all credit lines and allow everything to come to an absolute grinding halt short-term. Call it a “fire drill” and let Main Street understand the connection to Wall Street in very real terms before it’s too late. When people can no longer shop at the store because their credit lines and credit cards have been frozen, let’s see who flinches first. Then all these Congressional leaders on the list of “nays” will be facing a whole new paradigm shift in sentiment.

The problem with fixing this credit crisis without the dramatic downside, is that uninformed people will criticize this as a bailout for Wall Street without ever taking personal responsibility or fully comprehending how it has extended to everyone. This is why some people in Congress are scared to support a bill they know may cost them their political future. The political calculation is to pretend to take a stand against this Wall Street bailout, and hoping that everyone forgets that these same leaders were in office on both sides of the political parties when these events unfolded. No one is willing to own this mess and very few are willing to clean it up…

THREE QUICK FIXES:

1) Mark-to-market accounting rules need to be repealed immediately to stop the downward pressure on balance sheets. In conjunction, credit rating agencies need to be on par with creating stability, they were complicit on the way up, they might as well be complicit on the way down.

2) As many others have pointed out correctly, you must maintain liquidity in financial institutions by drawing down the run on banks and by raising the FDIC deposit insurance limits from $100,000 up to $500,000 and more. Restore the confidence in bank deposits and reduce the risk of under capitalized institutions. Also, it would be worthwhile to increase brokerage insurance through SIPC from $500,000 up to $1,000,000 or more as needed.

3) Shore up the biggest and strongest balance sheets in the financial system like a fortress and allow the others, outside the protective moat of the castle, to float freely or fail without resuscitation. I think this is already happening as discussed previously, because the “too big to fail” writing is on the wall as the Fed is stepping in to keep JP Morgan Chase (JPM), Bank of America (BAC) and, most likely, but not necessarily, Citigroup (C). Goldman Sachs (GS) and Morgan Stanley (MS) will also survive this crisis in their new incarnations as commercial banks.

All small regional banks are clearly sacrificial as equity can be wiped out to zero, bank deposits bought out and the debt back stopped. Not to incite a panic, but if you have your savings in a small local bank or a regional one, transfer your account and assets to one of the aforementioned institutions that are too big to fail and will make it through this crisis.

If Congress fails to act, the Federal Reserve should just step in with massive liquidity injections directly into these major “too big to fail” banks and simply start, in conjunction with the FDIC, closing down all the other riskier over leveraged financial institutions and allowing JPM, BAC and C to step in and buy franchises at fire sale prices. They need to do this in conjunction with all of the world banks to stabilize the financial markets and deal with the problem simultaneously on the idea of containment before it spreads out of our control.

Just start liquidating and zeroing out the equity of these much weaker financial institutions that remain on the verge of insolvency, and bring whatever retrievable assets or deposits are left under the protective umbrella of the few remaining conglomerate banking institutions anointed by the Fed to emerge as the preeminent financial power brokers of the future.

Look what happened with the collapse of major financial institutions in Europe such as Fortis bank that had occurred overnight and, in addition, the washout of Wachovia (WB) as the assets were acquired by Citigroup in coordination with the Fed as the backstop.

This may not be right or fair, but it is the action that will be necessary to stabilize the credit markets by removing the viral and toxic assets that are causing ripple effects and fear in the markets. The Fed, unlike this Paulson plan, does not require Congressional approval to take action to save our economy, financial and monetary system.

REASONS TO BE OPTIMISTIC

As bad as it looks and feels right now, if you are already invested in the market I would not advise selling good positions that are falling with the decline of the overall market for reasons unrelated to fundamental stability. What you do need to do is reduce your leverage risk, so that you can sustain further market shocks if and when they happen. Honestly, I’m shocked that the market has fallen to where it has but, more importantly, you must always be prepared for unexpected moments like these.

Let this heavily data driven week continue the selloff so we can find a declarative bottom before passage of the Treasury plan. If there are those that intend to bring this market lower no matter what, then just do it now. Push it down a thousand points or more if that is what it takes to find the absolute bottom and change the vote of Congress by demonstrating that Paulson was not bluffing after all. The sooner, the better, so we can truly begin to consolidate around stability and move forward.

This has been the most exhilarating and exciting ride I’ve ever been on over the last several weeks. Like a roller coaster, it’s the ride down that scares the living daylights out of you when, in fact, it should be the ride up, in anticipation of what is to come just as all asset bubbles seem calm before they pop.

The VIX hit a high of 47%+, true fear in the markets and ridiculous implied volatility in option contracts. 777.68 down on the DJIA is a record, officially worse than ‘87 Black Monday. What next?

I continue to be optimistic but maintain the discipline of being risk adverse so that there are no forced liquidations. As we close out the month of September, remember that it is also the end of the quarter and major portfolio rebalancing is occurring along with hedge fund redemptions which tends to exaggerate the selling pressures. There are simply no active volumes of buying pressure to absorb a declining ask price for securities.

I actually sold more long put protection into the last 30 minutes toward the close. It’s not that I think the markets can’t continue lower, but when premiums rise to levels that demand you take profits simply to offset equity losses in the portfolio, you must not leave money on the table for someone else to pick up afterwards.

Remember, with this almost 800 point wash out, simply making it back to 11,000 would have the appearance of a major rally and the market will set up nicely for a recovery.

I think this show by Wall Street was a very orchestrated and grand performance which may be convincing enough to “sell the Paulson plan” after all. So, there is good reason to believe that the plan will be passed in some form or another by the middle or end of the week and, unlike Monday’s events, there won’t be selling on the news. If not, rinse and repeat the same sell off over and over.

The evaporation of wealth is real and the effects are not fully felt throughout the Main Street economy, but the lingering consequences will steadily appear if this crisis is not resolved. It’s scary and I sympathize with the amount of pain that has been caused on retail traders. I have no tears for overpaid CEOs and executives that precipitated this debacle, but, as always, the rich will remain solvent while the average hard-working American suffers.

The disconnection that prevents very effective marketing of the Paulson plan fails to protect families who are dependent upon stability in housing prices and the security of their pension plans, retirement accounts and savings. My concern is for all of us. While most of us aren’t privileged to ride on the upper decks of the luxury suite, we are all on the same boat, sink or swim.

Comments

[Shinjimas:]

Loooong article good on the economic side, but off-base on the political side. The "Republican policy that helped to precipitate this mess"? More than anyone, Congress bears responsibility for creating this mess. They created a system where loans were encouraged for those who couldn't pay even to the point where banks were punished for not making those loans. The "republican" administration was blocked from fixing this problem by a democtatic congress.

2008 Oct 01 05:31 PM

[Rolland:]

You are obviously drinking the cool-aid that the president, Wall Street, and the totally corrupt arm of congress is feeding you. This is a bailout of Wall Street, plain and simple. Sure, in the short term, it will effect a lot more people than just Wall Street, but the market will take care of itself if left alone. Also the idea of the Fed interjecting and printing more money to solve the crisis is a completely wrong approach. Let the dishonest/incompetent go under before they take everyone else down with them when the dollar becomes completely worthless.

2008 Oct 01 06:11 PM

[JPDD:]

"I can damn well guarantee they won’t vote them back in if they don’t pass legislation and the markets collapse sub-10,000 on the DJIA and S&P 500."

And what do you think will happen when they pass the bill, and the DJIA drops, say, just after the election?

2008 Oct 01 06:36 PM

[stark naked:]

Oh shut up already! All you guys are just trying to protect your own butt and dont really care about joe on the street!

2008 Oct 01 07:10 PM

[changeisreal:]

Just wanted to let you know that I originally wrote this article and submitted it after the markets closed on Monday, September 29th although it was published today.

Obviously, the 400 point window dressing and technical bounce on Tuesday didn't occur yet.

As I write this, the Senate did the right thing and passed their branch of Congress by an overwhelming and convincing approval rate of 3:1.

Like many of you, I don't like how we are in this mess but I strongly believe that action must be taken to prevent a complete market meltdown.

The consequences of what may portend would only punish the average retiree, investor, small business person and, eventually, job cuts would follow in a dangerous deleveraging process.

It seems to be that the choice is either a protracted recession that is workable or a depression that cleans people out. Neither choice is what we want but one is clearly much worse than the alternative.

I don't think this plan is perfect but it is better than simply doing nothing and standing by with a bucket of water in your hand while the house burns down.

How successful or not this plan will be depends entirely on the very select few that will attempt to facilitate liquidity in the markets. I will write further on this later once the bill passes with my own criticisms, but imperfect as it may be, it is better than nothing.

As for the first comment posted, you may have misunderstood what I was saying. I was stating that I am surprised that Democrats are supporting this bill when their entire political platform is on the basis of accusing Republicans for being the ones held responsible.

I think with so little time until election, Democrats could have easily stalled the ball in the fourth quarter and allowed markets to collapse to play politics and win an election. I am relieved that they didn't and decided to take action by putting country over politics first and foremost.

I think blame is to be attributed to both parties because none of this mess happened over night, this was long in the making and now the consequences are being felt.

2008 Oct 01 10:53 PM

[lonie:]

Jefferson:

Good article,i mostly agree with you . Now is not the time to quibble .
I don't think most people understand monetary affairs and are leary of what we have . Credit is money,money is debt needs to be changed or at least controlled better. Now is not the time to build a new system. Get this one back to working for now and when the good times arrive again ,if ever, then start making purposeful changes slowly that don't wreck the financial system again.
What we have now has operated fairly well and we don't want to plunge headlong into another system that is mostly unproven.
Most blame this on the housing situation but the root cause is the cost of energy. The way America is set up it is almost more important to have a car than a house. No car, no job ,no eat , no house . The choice was made, i keep the car, job and eat, hell with the house.
Yes, people were over extended in overpriced home and other items.
That is a failure of our education system. It spent 8 years trying to teach me fractions many years ago and not one damned thing about finances ,i had to teach myself.
The money centers are also at fault for ever extending so much credit . In past 15 years i have probably received 300 sign here you are pre approved for credit. Buy a house , "dollar down and dollar when we catch you " . The scheme finally imploded.

2008 Oct 02 11:15 PM

[lonie:]

This finance situation reminds me of living in Kunming,China in the wild wooly growth days before traffic controls.
Fender bender at intersection, 500 people gang around pointing fingers and yelling ,i know who was at fault . Police come,get out of here, clear the intersection and clean up this mess and get traffic flowing again ,we will figure out who the culprit at fault was later.
Here on Seeking Alpha is similar to a fender bender in Kunming.
By a philisopher ,who i do not know :
" So the thousands of men of America disputed loud and long. Each in his own opinion , exceedingly stiff and strong. Though each was partly in the right , and all were in the wrong."

2008 Oct 03 12:41 AM

[iNVestorUnrest:]

PANIC has wrecked our market

2008 Oct 08 10:56 PM