Paulson in a State of Panic

Bloomberg sums up the disorientation of the Treasury in two articles: “Paulson Indicates Need to Purchase Bank Equity `Soon as We Can'” and “Fannie, Freddie to Buy $40 Billion a Month of Troubled Assets”. In "Paulson/Bernanke: A Conspiracy of Dunces", I wrote that the dynamic duo has shown no consistency in their rescue methodology and sent the markets into panic with the Lehman failure and doomsday predictions related to the $700B package. Thank God they are now looking to the British for inspiration. Trouble remains in that neither the Treasury nor the Brits are giving details on bank equity purchases and the associated punishments.

If the Treasury learned its lesson regarding the market’s reaction to excessively punitive help, will they retroactively ease up on the 79.9% solutions to American International Group (AIG), Fannie Mae (FNM) and Freddie Mac (FRE)? Monday (10/13) Paulson’s TARP manager Neel Kashari is scheduled to give a way forward speech. The question of fairness will surely come up if Morgan Stanley (MS), Goldman Sachs (GS) and the four anointed mega commercial banks (BAC, C, JPM and WFC) are able to sell equity to the Treasury on less onerous terms than AIG and the GSEs.

I have not heard either Paulson or Bernanke utter the words moral hazard for the last two weeks and they continue to struggle to explain the benefit of Lehman bankruptcy. Now that they know they failed, and the bank equity purchase program cannot be unduly harsh, it’s time to revisit AIG and the GSEs. CEO Edward Liddy alluded to this in AIG’s most recent conference call. He said that if AIG behaves well and pleases the Federal Reserve, the Fed might ease up on the equity conversion.

But clandestine activity persists. The government is forcing Fannie and Freddie to buy $20B each per month of subprime, Alt-A and non-performing mortgage securities. This program is in addition to the $700B TARP, but the GSEs can sell their existing $210B of toxic mortgage to the TARP. Talk about twisted logic. As usual, sources were not revealed because the plans are supposed to be confidential.

Even though Paulson clearly stated the GSEs will not be run “to maximize shareholder returns”, they should not run for shareholder annihilation either. Paulson has not laid out a clear direction for the GSEs and loading more toxic mortgages on their books will not return them to health. If his objective is to use the GSEs to cleanse mortgages (buy cheap and modify or foreclose), than Paulson must state whether the operation will be for profit or charity. Here again, we need to know what the plan is or even if there is a plan.

As Paulson shifts the TARP to purchasing bank equity, it appears that he is using the GSEs to pick up the rear. Even in conservatorship, shareholders have a right to know how their company is being run.

Disclosures: Author is long AIG, BAC, C, FNM, FRE and WFC.

Comments

[madasiwannabe:]

AMEN!!! Conservatorship doesn't give Paulson the right to wipe out the GSE's to save the other mortgage holders. The laws are very specific about the charter of a conservator, and unless there's more to the purchases that secures the current company value, this goes against that charter.

We all know the takeover had nothing to do with the solvency of the GSE's. If it did, why haven't they used any of the 200 Billion to stabilize the GSE's. Paulson knew all along that at some point he would use the GSE's to buy up toxic assets to clean the books of his buddies. I find it interesting that every time Goldman Sachs or Morgan Stanley stocks take a dive, Paulson comes up with another plan. Time to get the FBI and supreme court involved to stop this madness.

2008 Oct 12 12:52 PM

[PastTense:]

1. If firms are basically worthless because they decided to make massive amounts of poor investments and bad loans there is no reason whatsoever for equity owners to receive anything at all. This is true for massive numbers of businesses of all kinds--and the answer is the same for all of them--let the investors lose all their money. Don't you understand the basic fundamental concepts of capitalism?

2. The only reason for the government to engage in any bailouts is the effect of financial failures on the broader economy. So any government programs should be totally oriented toward this. Thus a total guarantee of deposits or goverment loans or equity investments is a much, much better proposal than the government buying junk assets from banks. The original bailout proposal was simply a proposal to move the losses for the banking industry's bad loans from the banks (where it belonged) to the federal government.

2008 Oct 12 02:30 PM

[who:]

shorts aren't the culprits, but taking advantage of the situation. a certain way shorts are wake up call otherwise the situation could have even snowballed bigger.

policy and policy banks is what caused the current crisis. Chinese banks used to run on policy and lend blindly to comply with policy hence massive looses.

2008 Oct 12 03:14 PM

[turkeyeyes:]

Shorts bring no value.
They destroy companies and the economy.

2008 Oct 12 05:36 PM

[little sid:]

GSE shareholders (both common and preferred held by individuals and banks have devastated by the conservatorship created by the Treasury. The Federal Reserve recognizes this and according to a report on MSNBC will act to protect banks that are hurt by this action.
One news service reported that " Banks and insurance companies have
typically purchased the two companies' preferred shares. The Federal Reserve and other bank regulators said that they will work to ``develop capital restoration plans'' with the ``limited number'' of smaller institutions that hold Fannie and Freddie stock as a significant portion of their capital. Smaller institutions are those with less than $2 billion in capital.

This is understandable, but raises an important question. What will the
Federal Reserve do to protect retired individual investors whose IRAs and 401Ks hold a "significant portion of their capital" in GSE preferred and have been wiped out by the this action. Are individual investors
who qualify under the less than two billion rule unworthy of the protection and “capital restoration” the Fed will provide for the banks?

The latest bizarre command that Fannie and Freddie buy $20 billion of sick mortgages a month is another step to guarantee that the GSEs will never survive.

Sidney

2008 Oct 12 05:53 PM

[poncawolf:]

~ Financial House of Cards ~

Wish I will - Wish I Might – Blow - blow – The Joker is next.

All the Kings - men and women – Could not put the house of cards - back to there greed again

One by one – Those cards of greed – shall fall from this simple house of greed.

Look low and look high – The joker is next – The winds shall blow – the Joker card shall spin – and fall away.

Wish I will - Wish I Might – Blow - blow – Who shall be next?

You should Have known – The anger of the Son and the Father – Has always been roused to respond – When greed has taken the lead.

2008 Oct 12 06:20 PM

[hkn:]

I am disgusted with the pick and choose who is to fail. They know they made a mistake with Lehman. Who is making the decision. The Goldman people who have been selected to "help". That is why Citi did not get the Wacovia deal and Goldman got it. The exclusivity clause was ignored. I have no respect for greedy Buffet. He came in a few days later when the rules were changed and he saw he now could make money on the deal and his people were in charge. The bull that was passed around was too much. When ciiti made the deal Buffet did not want it then. Our government was not fair. The Goldman people hired by Paulson influenced the decision. I wont forget what is being done behind our backs by this bunch. I have lost in these people. I was taught honesty and fairness and ethics. They forgot about these values that made out country great.

2008 Oct 12 09:31 PM

[A819:]

the failure of lehman was unprincipled because there was no basis to distinguish it from BSC. I was appalled at the time, and still am, that they let it fail. IMO its failure is the reason for the current giant margin call that is currently being labeled "panic selling."

this whole ad hoc way of dealing with the crisis is emblematic of bernanke. i felt in January that the prior august (2007) he failed to lower interest rates enough. the guy is bright but overthinks.

my retirement plan has always been to own my own home and keep working. recent evens have made clear my fears were justified; there is not such thing as retirement anymore.

2008 Oct 12 09:51 PM

[A819:]

p.s.... when you have system-wide collapse, moral hazard is not relevant.

2008 Oct 12 09:52 PM

[A819:]

p.p.s. warrant buffet is loaded down with hubris. his is coming.

2008 Oct 12 09:53 PM

[little sid:]

The Treasury has not been unethical, it has been ignorant. Our governments "unfairness" stems from its lack of real knowledge of what was happening in the banking system. If Paulson knew what would happen when he let Lehman collapse the Treasury would not have allowed that disaster to happen. Your information is incorrect. Wells Fargo got Wachovia, not Goldman. Buffet bought into Goldman and Wells Fargo, before, not after, Wachovia walked away from Citi. Wells Fargo was not interested in Wachovia until the IRS issued new regs that gave it a megabillion tax break if it merged with Wachovia. I do n ot know which is worse - unethical behavior or ignorance if you are running the world's largest economy.

2008 Oct 12 09:57 PM

[A819:]

little sid... agree it's ignorance. please excuse typos in my prior post, in this day and age a glass of wine is needed.

2008 Oct 12 10:41 PM

[poncawolf:]

Nothing but a bunch of fee driven pricing.

Now is the time to put the pricing - at the right price - your house is worth 30% less then they said - it's time the refi - to that.

Least we forget the JOKER.

2008 Oct 12 11:46 PM

[Fish Gone Bad:]

Take a look at Paulson's face. See the fork mark scars on his forehead? When he was a little kid, he did not know how to eat. That is a sure sign of a retard.

Okay, that was mean.

There is no way that anyone this important can be doing something this stupid unless he is doing it on purpose. ** God that sounds like conspiracy theory **.

Give this some thought: If you wanted to destroy all the money in the world, how would you do it? Seriously. This is a good way to do it.

If you take a look at YouTube's "Money is Debt", you will understand why money blows up.

Clark Jenkins
FishGoneBad.com

2008 Oct 13 12:58 AM

[pathwhisperer:]

Of course he (and Bernanke) are panicking, they thought it was a game of bluff and they'd never get caught. Reality has a way of smacking people upside their heads. Look at their inconsistency, they're like trapped rats running this way and that.

First they (the Greenspan Fed) think they've spread the risk to the point that they've created riskfree capitalism. Now they're taking the taxpayers' money to ensure it. Law enforcement should look at these two conartists.

pathwhisperer.wordpres.../

2008 Oct 13 06:09 PM

[JKA:]

Why are the authorities being so secretive about the whole thing?
Why are they handpicking a few?
Why not just copy the British version?
And then Wall Street worries that a guy like Obama will win the elections!
A bit of transparency will go a long way to restoring confidence, otherwise they can give away the billions to whomever they like and the market will still nose dive again.
Look at RBS shares' performance today after the market finally managed that a potential (not a definitive one) does not necessarily mean loss of equity value.

2008 Oct 13 11:22 PM

[JKA:]

Sorry, read the last paragraph:
Look at RBS shares' performance today after the market finally managed to understand that a potential (not a definitive one) dilution does not necessarily mean loss of equity value.

2008 Oct 13 11:24 PM