STATICRHETORIC

by C.S. Jefferson

THE $700 BILLION DOLLAR DISCONNECT

There is a serious, fundamental disconnect between the reality and the perception of the Hank Paulson plan. Treasury Secretary Paulson, who I admire along with Chairman Ben Bernanke, are not politicians. Make no mistake about it, their stature is enormous, but their ability to “sell policy” like a used car salesman to the public is second-rate at best. By comparison, Congressional leaders who stay in perpetual office by peddling themselves every election year on empty rhetoric, are much more able to convey sentiment but often fail in delivering real solutions.

Lack of eloquence does not mean that Paulson and Bernanke are wrong in what they are proposing. In fact, I truly support what they are trying to accomplish here, but the risk of allowing this political posturing by Congress to continue only exacerbates the problem in the economy because time is running out and we are deep in this mess, so check your shoes just so you know what we may have stepped in.

This is the reason that the power of language and the ability to communicate effectively matters and why, unfortunately, the most qualified people for the job are often passed by for the most personally appealing. Most people have no idea of how the economy and financial system functions beyond payment of basic bills and the tangible reality of how much, or how little money they have in their wallets. And even more scary than that could be what was made patently clear, that most Congressional leaders, even those in the Senate banking committee, have less understanding of the economy than their constituents.

Never underestimate the stupidity of Congressional leaders to play political football and grandstand once the lens of the camera turns in their direction. Their inane line of questioning revealed how little they actually know, and I was truly frightened by the fact these were the people in charge and tasked with the responsibility to effect change or confidence at a time when it is needed most of all. Seriously, folks, is it too much to ask Congressional leaders to stand in unison, a bi-partisan consolidation, and tell America they will do whatever is necessary to save our economy and instill confidence in the markets?

Not to mention, the most obvious hypocrisy of all, was that Treasury Secretary Paulson and Chairman Bernanke are relatively new and have been in their appointed positions of authority less than any of the elected officials trying to blame them as being responsible for the origins of this particular crisis. In fact, attempting to humiliate in public the very people that have been the most actionable persons motivated to fix the problem at hand, and remain the very last guardians of our global financial system, really demonstrated a lack of class.

I really found it personally offensive that Congressional leaders, who have the power to legislate and presided over the creation of this potential and looming debacle the past several decades, want to blame the two individuals such as Paulson and Bernanke that seem the most committed to saving and fighting to defend the American way of life.

LOST IN TRANSLATION

In my own frustration of describing how serious the problem is to friends of mine, I finally came up with the best way I can break down the proposal so that it makes sense. Perhaps, it was because I was writing about subject material on liquidity providers in the stock and options markets that it became clear.

Essentially, Paulson’s plan is about stepping in to a very opaque, non-transparent market for mortgage and debt securitization and providing the absolute floor in price discovery. This is about the Treasury actually being the world’s largest “market maker” and liquidity provider, so that the clot in the arteries of the financial system can be removed and the money can begin to flow again.

They don’t want, or intend, to spend $700 billion recklessly or blindly throw into a black hole of bad mortgage debt, in fact, they want the show of force to absorb and maintain the bid and ask to facilitate transactions in the financial sector. And they need the flexibility to demonstrate confidence, trust and solvency in the financial markets.

I use the analogy of a market maker because think about the role and function that is performed in the stock markets. They essentially create the underlying bid and ask, or buy and sell points of the trade. Market makers provide the necessary transparency to order flow by absorbing the volume as a counter-party which creates liquidity. They carry the trade on their own accounts and books temporarily, and begin to trade out of their held positions into the continued demand or order flow. The very reason the Treasury is right to ask for $700 billion up front is the same reason a market maker has enormous margin capabilities, so that they can be a liquidity facilitator.

By not having an active market maker in the markets, the bid and the ask spread widens and, potentially, order flow could freeze up just like our credit markets are doing now. This is exactly what has transpired in the mortgage market meltdown. Mark to market accounting rules make holders of these securitized assets incapable of selling into the open market without serious devaluation and risk of insolvency to their own institutions.

The problem with stigmatizing this Paulson proposal as a bailout is that there is a misconception that the Treasury or governing entity will become a giant cesspool for toxic paper that no one wants in the private and financial sector. This simply isn’t true.

The Paulson plan, and this is a crucial point to emphasize, doesn’t have any interest in holding these securitized assets indefinitely, but the Treasury must absolutely be willing and capable of holding them as long as it takes until our economy recovers. And this is where confidence matters most in effort to both stabilize and create a viable market for complex assets and derivatives.

And by virtue of an economic turn around in the future, those assets that were bought at discount will be write ups for the American taxpayer. You see, if the Treasury steps in and creates the absolute bottom price that they are willing to pay for securitized assets, then the competing bids from the private sector and, potentially, sovereign wealth funds will step in and buy the collateralized debt instead because there is an immediate “risk arbitrage” opportunity.

Think about it, if you were a private equity or hedge fund and you knew the absolute price or bid the Treasury was willing to pay for mortgage papers, which is obviously at a discount and much lower than the price held to maturity, then you would be enticed to pay above what the Treasury was offering to hold that securitized asset. Why? Because the risk of insolvency is gone since you know, if necessary, you could, in turn, sell it back to the Treasury. Essentially, it becomes “risk free arbitrage.”

Private equity and capital in flows would risk adding money because the spread between the discounted price above the bid from Treasury was well below what the asset would be worth if held to maturity. And, yes, the potential rewards for private equity and hedge funds is tremendous upside and the very incentive needed to step in and stabilize the credit markets, especially with the confidence of the backstop by Treasury.

And how do you know that private equity and hedge funds will step in to bid? Because they will do what is known in the stock market as “front-running,” or stepping in front of a large block transaction to ride the momentum. This is the dramatic effect that Paulson is looking for, in truth, by creating liquidity and pushing prices up to normal stable areas.

In effect, not much different than the biggest “short squeeze” ever in history last week. Paulson knows there is a lot of capital on the sidelines but they just need the sign or green light to hit the accelerator. Look what Warren Buffet did with Goldman Sachs (GS) yesterday, he put capital to work on the premise that this bill would be passed to inject liquidity into the markets.

This idea of Paulson bailing out the markets is ridiculous. Remember, Paulson let Lehman Brothers go into bankruptcy–there was no bailout, and as for the collapse of AIG, he diluted shareholders significantly and restructured management. Fannie Mae and Freddie Mac almost zeroed out the equity of shareholders by crushing them to the point of oblivion. So, to be fair, Paulson is definitely not bailing out Wall Street.

Listen, the wealthy players of Wall Street will survive financially no matter if any action is taken or not. But the crisis is now a main street problem and this effects everybody. It’s not fair, it’s not right. But the problem is among us and we need to solve it now.

STOP POLITICIZING WHAT NEEDS TO BE DONE NOW

I heard Senator Chuck Schumer, who for the most part is a reasonable pragmatist, but when he suggested to piece meal out and parcel the required money he is wrong. Creating tranches or splitting up the capital commitment is not practical, because the crux of the problem is instilling confidence without the reluctance of leadership.

Even more ridiculous, is the fact that Congress is pressed to resolve this and suggested instead to give something now before leaving, and the rest later next January when they come back from another “vacation,” ironically funded and paid by the taxpayer that they so often claim to be protecting. If Congressional leaders don’t act now, there might not be a market to come back to in January.

In fact, let me go a step further and put it in terms that people should understand. If the credit markets truly freeze up and the financial system collapses, pension funds, retirement accounts, 401k’s, IRA’s, money market funds, credit and debit cards and, yes, even FDIC insured savings accounts will disappear in a puff of smoke. Sounds scary? It should be.

And it’s a shame that Paulson and Bernanke don’t put it in those exact terms, so that main street America does understand the extensions of this crisis and how it directly effects everyone beyond the extraneous complexity of Wall Street.

I did hear one Congressional leader ask for such a bold statement and both were very reluctant to say it themselves. But when the Congressional member phrased similar comments about how not acting could mean parents couldn’t send their kid to school, or that they would lose their job, house and car in a yes or no question, the answer by Bernanke was a very disquieting, “we wouldn’t disagree with that.” That, to me, was a stunning, jaw-dropping moment that many people may have missed amid the parade of showboats shaking their finger in the air.

Paulson and Bernanke’s plan is to stop being put in this difficult position of being forced to bail out one failing institution after another, once the problem erupts. This plan is directed not at bailing out individual institutions like domino theory, but bailing out the entire financial system before it becomes systemically dismantling to the global economy.

Paulson and Bernanke should call their own press conference and publicly challenge the entire body of Congress by saying, very matter of fact, if you don’t authorize this plan, let your name be known on record as the person that failed to act and save America.

They need to put it in the vernacular of most ordinary people and explain while Congress will be away on holiday until next January, imagine if this bill isn’t authorized and you don’t have money to buy basic necessities. Your home will be foreclosed and your job will disappear. Can you imagine a holiday Christmas season with massive unemployment and soup line kitchens?

There is a very common saying that “those who can, do; and those that can’t, teach…” Well, as a person with great respect for many scholars, it’s an insult to the tutelage and profession of teaching to belittle them in that way. However, I would change that theme and argue: those that can, do; and those that can’t, become elected officials.

COULD THIS BE THE GREATEST TRADE IN THE HISTORY OF FINANCE?

If you don’t do this plan it will become a bailout down the road, but we are not there yet, not just yet…

Many people characterized this inaccurately as RTC action, or a Resolution Trust Corporation type bailout that occurred from the savings and loan crisis of yesteryear. This is different because at this point in time, none of the targeted institutions are insolvent or bankrupt. And the more I listened to Paulson and Bernanke’s testimony, I realized it’s not an RTC scenario, in fact, it’s more about being the potentially greatest trade in the history of finance.

We all know the old stock investing adage of “buy low, sell high,” right? In truth, that’s what is actually being proposed here. These are equity investments into real assets, not an expenditure as Bernanke accurately stated. At some point, the actual underlying real assets will be worth something at the end of the day and much more than they actually paid. Did Congress hear and understand that differentiation? Or were they too wrapped up in their own vanity as they bloviate about empty rhetoric and failing to comprehend the meaning that this proposal isn’t a bailout?

The reason they need 700 billion is to show the global markets they have enough resources to maintain an orderly market and absorb the bid and ask prices of distressed assets. Let’s say Bernanke’s fire sale of pennies on the dollar will happen. Once that absolute price is established at the very bottom of the market, then other private equity buyers will come in and raise the bid, simply to arbitrage the situation.

I don’t think they should be buying any unsecuritized debt like depreciating auto loans or credit cards, but the only exception could be at the discretion of decision makers if they are related in the form of attachments, like liens on home equity which may be the only way to unhinge existing mortgages and rework the paper.

I absolutely do agree on Congressional oversight because it is essential that people aren’t allowed to game the system on the taxpayer dime.

COULD THE AVERAGE AMERICAN BENEFIT IF THEY RAN “U.S.A. INC.” LIKE A HEDGE FUND?

What if you actually had the Treasury operate like a hedge fund for the benefit of the American people? And who better than former Goldman Sachs CEO, Hank Paulson? That is with the intention to make real profits for the benefit of the taxpayers and shareholders in U.S.A. inc. Long term fundamentals, all of these distressed assets will rise appreciably in value over time. If you don’t believe the American economy and, yes, even the dreaded real estate market will recover, then you should move somewhere else. It won’t happen this year and probably not next, but the American economy is resilient and still the most viable economic power in the world.

Technically, it’s not a “bailout” which would imply subsidies to cover losses, good money thrown away to cover bad debts. We haven’t reached that point yet and that’s the reason timing is critical. This is, in fact, an investment into distressed assets at bargain basement prices. Remember, most of those securitized mortgages are not in foreclosure, the majority still collecting interest bearing payments. But the paper has been depleted in terms of current market value because there is no market to speak of. If you were a hedge fund with liquid capital, you would be doing the very same thing by buying at the bottom. The upside to all of this is incredible over the long term yield curve. So, yes, our Treasury will be the largest hedge fund in the history of the world.

But the only entity that can hold distressed assets until economic recovery or maturity is our government, any private equity fund by comparison would be illiquid and insolvent long before maturity even, if ultimately, the trade was correct. But by the Treasury stepping in and creating a floor in price discovery, you add stability to the capital markets and what was deemed as risk for private equity now becomes viable with a liquid and transparent market.

Now, I will suggest something that I know will never happen because, honestly, it makes too much sense as logic and reason seem to be scarce. The upside on all this could actually fund every single program that Democrats and Republicans promise but will, we all know, not be able to fulfill beyond the empty rhetoric of change.

Health care–not socialized, but actually paid for by the investments of the American taxpayer! Now, tell me, is that not the definition of Capitalism? A return on your money? And not standardized health care created by lowering the bar for treatment, no, a fully paid health insurance program that allows you to stay with whatever provider you choose and receive equal or better treatment than privately paid health care.

And let’s say you decide you don’t want health care in return for your investment. Ok, what if you could turn that taxpayer investment into shareholder equity in the form of a tax free Roth-IRA like program–and then you decide what to do with your money upon retirement? You’d never need social security again. But for those that are still staunch supporters of social security, the upside to this action by our Treasury Secretary’s hedge fund could fully pay all social security for everyone.

But, sadly, we all know that even if there were upside from the return for taxpayers, most would be wasted on typical pork belly spending like $500 toilet seats or $2,000 hammers. Oh, well, it’s nice to dream…

I LIKE PANCAKES FOR BREAKFAST IN THE MORNING, NOT WAFFLES

I like pancakes for breakfast in the morning, not waffles…

One thing we all want when we vote a politician in power is the belief that they are incorruptible, that they are willing to stand up for what is right and moral, not what is most politically expedient. What we can’t stand is a politician that sticks his finger in the air to see which way the wind is blowing before making a decision.

Ron Paul, I admire and respect the man, but I don’t agree with him on specific issues. Obviously, I am in support of the Paulson plan but I am quite sure that Ron Paul will not vote for this bill. But that doesn’t bother me because I trust that he is doing it based on the convictions he truly believes and adheres to. Having said that, I respectfully disagree but I understand that he is sincere about what he believes. And being a man of conviction, even if I don’t agree, is more important to me when it comes to trust.

However, many of his colleagues in Congress are playing a shell game here by ducking for political cover–they are trying to hedge their bets by publicly going on record showing their disapproval to appeal to their voting constituents even though they know they have to vote for this policy, like it or not, behind closed doors. Now, others will try to game the vote by waiting once the resolution is a comfortably vast majority, so then they can safely vote against it without risk of the measure clearing the house.

There is more “waffling” going on here than common rhetoric and ideology can usually support, made even more ridiculous by the glaring hypocrisy, but this is not a time to play the partisan politics and show us how publicly objectionable it is to “bail out Wall Street”, or how this is akin to socialism and we are like France. Please, stop the unnecessary noise, and get behind this Paulson plan and instill confidence in the markets to make the economy function again.

Because, if you really want to be honest, you can’t just point the finger at Wall Street. You need to be truthful with your constituents and tell them unless they could have put 15-20% down on a home, they aren’t entitled to the American dream. You have to say that buying a new $50,000 suv and rolling a depreciating asset into a ballooning debt of another car loan 2 years later to have the newest model car is not an entitlement. And you would have to say that buying clothes and shopping at the local mall on a credit card and borrowed debt you can’t afford to pay back is not your right, it’s a privilege.

Now, if these politicians can be actually up front with America and explain how we all share in the blame of this mess on one level or another, without creating this mythical villain of Wall Street, then maybe we can fix the real root of this problem. Of course, if you start talking about responsibility to your constituents, politicians would have a hard time getting elected.

If you truly think this is wrong or, perhaps, you want to insert other appendages to the proposal, then stand up on your convictions and come up with a better plan. But you better do it fast or, as Bernanke and Paulson made with dire warnings, the consequences of inaction will be far worse than the cost of a short term remedy. There is plenty of time to enact real legislative change once the markets calm down. Play the blame game afterwards, not now.

Look, if impenetrable ideology matters more in principle than the risk of what we face in reality, then go ahead and vote against the Paulson plan. In fact, I dare Congress to vote against this proposal. I don’t believe Congress could be that reckless to risk the future of our economy at this critical juncture, but I remain fully hedged, not because I want to be, but because I can’t afford to be wrong.

Paulson clearly lacks the political eloquence of Obama, for instance, because he stammers and stutters a little bit in his speech and that may incorrectly be interpreted as a lack of conviction about the success of his policy proposals. But, unlike Obama and McCain who have been curiously missing from attendance and are running on platforms on how the are the right man for the highest office in power, Paulson is one of the few people in public office that has been present to actually address the real crisis with, most importantly, substance over style.

I’ll tell you this, instead of the usual questions asked in the debate such as appointing Supreme Court judges, I know America wants to know who either candidate is going to appoint, if necessary, to the Treasury and Federal Reserve. And I would take it a step further by making my vote conditional based upon their promise to keep both Hank Paulson and Ben Bernanke in their appointed positions into the new administration. As we know now, experience does matter when it comes to the real engine that drives our economy.

You can elect a puppet in office, but you better put someone you trust and knows what they are doing to control the strings. And, folks, make no mistake, this is a 3 a.m. moment and as far as I can tell, Hank Paulson and Ben Bernanke are the only ones picking up the phone…

This entry was posted on Wednesday, September 24th, 2008 at 10:03 pm and is filed under POLITICS, DIATRIBES AND EDIBLE RANTS, TRADING AND INVESTMENT STRATEGIES, U.S. MARKETS AND THE GLOBAL ECONOMY. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.