The title of the diary comes from the title of an article by John Hussman of Hussman Funds. Hussman is a very "reasonable" commentator that I have followed for some time. He puts out a weekly market discussion that is always well worth reading.
Tonight he takes on the financial bailout...and, NO, he does not agree with the chosen method.
However the final legislation is written, the Troubled Assets Relief Program (TARP) being rushed through Congress will evidently be built around its single worst provision, which is that the Treasury will have authority to purchase distressed mortgage securities from U.S. financials.
Hussman provides simple numerical examples to show how the proposed solution fails to solve the underlying problems. He gives easy to follow balance sheet examples of what happens to a bank as even a small percentage of its assets go bad.
Its crystal clear from Hussman's basic examples that what is proposed will simply not work.
Yet Hussman is not just a critic. He provides an alternate method that could help achieve a measure of stability. Let's start with what has already worked.
Buffett's investment may reflect confidence in Goldman, particularly with a government backstop on whatever questionable assets it does own, but if anything, it suggests that the government should have gone the same route – namely, provide capital in return for a financially viable security that is senior to common shareholder equity, have it accrue a relatively high rate of interest, and allow it to be repaid early (Buffett's preferred is callable by Goldman) as soon as the financial institution can secure cheaper financing.
So the idea is that government would provide a "super bond" to financial institutions (that would not exceed its existing bond totals). This bond would act as capital, essentially temporarily recapitalizing the banks that needed it. This loan would have priority over shareholders AND bondholders, but not depositors in the case of a failure. So in a failure, depositors would get paid, but the government would be in line before bondholders and shareholders to get repaid. The idea is that this super bond would carry a high rate of interest to make sure that companies only used it as long as they needed to.
Instead this is what the government is proposing:
the government is taking on financially non-viable securities and warrants on common equity, while failing to improve the capital position of these financial companies at all (unless it overpays). Taxpayers will not make money here.
This is not a good deal, because it will waste taxpayer money without addressing the fundamental solvency problems.
Unfortunately the whole process has been dominated by Paulson's original insane proposal. Instead of standing back and looking for viable alternatives (there are several out there) all the attention has been put into finding a way to modify Paulson's proposal to get enough people to vote for it. This is NOT the way to solve problems. It is a way to screw things up though.
Let there be no misunderstanding. We are in the middle of a bloody serious international financial crisis, and one that has been made worse by some of the Treasury/Fed actions so far. Unfortunately we are using the John McCain "drama king" style of problem solving, instead of the Barack Obama strategic style of operation. This proposal will buy a few more weeks, but we will be back here again soon enough.