Paulson Speaks!

Treasury Secretary Paulson had a press conference after the G7 meeting and discussed his plans to spend $700 billion.  Direct equity purchases are highlighted, and his statement includes an interesting twist:

As we develop plans to purchase equity, as in the approach we are taking to broad mortgage asset purchases, we are working to develop a standardized program that is open to a broad array of financial institutions. Such a program would be designed to encourage the raising of new private capital to complement public capital. Consistent with the legislation, any equity the government purchases through a broadly available equity program would be on a non-voting basis, except with respect to the market standard terms to protect our rights as investors.

How do they intend to promote the raising of private capital?  May I answer a question with a question?  Does this blog post by Greg Mankiw represent a classic trial balloon?

Here is an idea that might deal with these problems: The government can stand ready to be a silent partner to future Warren Buffetts.

It could work as follows. Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date.

This plan would solve the three problems. The private sector rather than the government would weed out the zombie firms. The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control.

Why would an undercapitalized financial firm take advantage of this offer? Because it would need to raise only half as much capital from private sources, that financing should be easier to come by. With Warren Buffetts in scarce supply, the government can in effect replicate them, by pigging backing on what they do.

Dr. Mankiw has the government matching private investment dollar for dollar but that ratio is somewhat arbitrary; I assume a two for one or even three for one match would work as well.

The obvious follow-up question is, what sort of games might this structure encourage people to play?  If current owners believe their shares are over-valued, they would benefit by buying more shares themselves, thereby drawing the Treasury in at the same too-high price  (Obviously that ploy is foolish if bankruptcy is likely).  However, I doubt whether the sort of rights offering needed to execute this idea would count as the "new private capital in an arms-length transaction" that Dr. Mankiw described.  And there is an obvious coordination problem - all the current owners would want the other owners to be the ones that pitched in their cash to attract the government's money.

Time will no doubt tell, but this may be a sneak preview of the next Paulson plan.

LEST WE FORGET:  This previous post also tackled bank capital.  Yeah, we have fun around here day and night.

Comments

[clarice]

You don't trust anyone, do you TM? Sheesh

[Pofarmer]

Would the House have ever passed the Bill with this spelled out????

I rather doubt it.

Tricks and lies boys, tricks and lies.

[Rick Ballard]

Pofarmer,

I believe that Paulson would be operating under the auspices of power granted in the 1930's, not 'new' power granted under recent legislation.

The logjam will not clear until the CDS business is resolved. What difference does dumping capital into a bank make unless you have some certainty that there isn't a wad of CDS stuck in a bottom drawer somewhere in the bank? The same goes for the banks largest customers as well. How does anyone know whether good ole Bob (CFO of Bigco) sold a little synthetic CDS just for fun.

So many people have become so truly proficient at moral relativism and situational ethics that banks playing Scrooge McDuck and filling their vaults with cash makes very good sense. For a little while anyway. Then they go broke due to lack of income.

[Charlie (Colorado)]

Maybe it's just been too long a day, but this sounds pretty good, honestly. I don't like the idea of the goernment owning voting stock, and this avoids that one at least.

[Pofarmer]

What difference does dumping capital into a bank make unless you have some certainty that there isn't a wad of CDS stuck in a bottom drawer somewhere in the bank?

Which is why this thing has been so bass ackwards from the start.

So, how do you get rid of the CDS?? Of course, it could expire, I suppose, depending on what it is, but that could take??? These auctions don't get rid of it, just attempt to value it, whatever "it" is. Can the various entities invovled just release all parties from CDS obligations? They've got themselves in a dogknot situation here they can't get loose from.

[R C Dean]

Maybe it's just been too long a day, but this sounds pretty good, honestly. I don't like the idea of the goernment owning voting stock, and this avoids that one at least.

The fundamental conflict of interest arises from the government having any financial interest in a bank. Whether its voting stock or not doesn't make any difference.

Big corporate boards are basically self-perpetuating anyway - the current board nominates the new members, and they get voted in at a rate even a gerrymandered Congressman would envy. The boards with fed ownership will know who is buttering their bread, and make sure to give the fed all the board representation it wants.

[Rick Ballard]

"So, how do you get rid of the CDS?"

You don't have to get rid of them. You just have to set up a registry and make "all party" consent forms mandatory at registration. No consent from the party being covered - no coverage. The continued liquidation in the market implies a much higher CDS exposure than the Lehman and WaMu totals would seem to warrant. There has been a couple of trillion in cash raised in the past two weeks (not counting commodities) and Lehman's deal "only" involved a face payoff of $280 billion.

CDS do have a term - generally five years. There is an up front premium paid with quarterly payments thereafter.

[Tom Maguire]

Maybe it's just been too long a day, but this sounds pretty good, honestly.

Maybe it did not shine through but I like Mankiw's suggestion. And the only game I could think of probably can't be played, which is good.

[Rick Ballard]

Slapping a gov issued WE'RE TOO BIG TO FAIL sign on the bank when Uncle Sugar buys in would definitely inspire confidence. Maybe they could color coordinate the signs with the Fed issued wooden legs? Just to make it easy to pick out the Fed runners in the race.

[kim]

Well, it violates one share equals one vote but I guess that happens anyway with various classes of stock. It's not as if a share has God given rights or anything.
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[JJ]

CDS do have a term - generally five years.

About the time it will take to recover the lost value of my IRA?

I love all the econ jargon, boy, I love this jargon. Worse than computers. My portfolio of code words and acronyms runneth over. It's what kept me out of econ classes in college.

[Rick Ballard]

"About the time it will take to recover the lost value of my IRA?"

That's a really good question, JJ. Let's say we have had a $2 trillion liquidation event so that sellers of CDS can pay for their amputations and new prosthetic devices. That $2 trillion didn't evaporate, it's just going to move from Dumboy's account to Smartboy's account. What is Smartboy going to do with the money? Especially with the market just a tad oversold? Delivery of proceeds (settlement) on the Lehman auction occurs a week from Monday.

Now, there's definitely an economic contraction occurring, freight shipments really don't lie. But it's really no big deal to this point and a 40% decline from the year high is a little ridiculous.

I've been wrong a lot lately so take that into account but I'm looking at SP500 funds. Shoot, the Dow is currently yielding almost 4%. If all dividends were cut 25% you would still be getting 3%. The SP500 is selling at a PE of 11.42 - it spends most of its time hanging around 16 so there is a tremendous amount of bad news priced in already.

[Pofarmer]

Two things Rick.

Value of the $ and Foreign markets. The U.S. ain't the only game in town anymore.

[Mustang0302]

Mr. Ballard:

Very OT...but I would like to ask a favor of you.

I am engaged with the forces of moonbattery elsewhere on the web, in my own small way.

I would like to ask if you would be so kind as to review a post on made on another board, and my own meager response to that post, for your general observations and comment. Time and interest permitting, of course. Nothing at all earth-shattering.

Thanks in advance for your consideration, and if possible, I can e-mail them to yargbies, if that is satisfactory.

Thanks, once again.

[Rick Ballard]

Pofarmer,

Here are the world markets. Try and find one which is significantly outperforming the US and has the ability to absorb any where near that much money.

What did your cost per bushel run this year? How much less will it be if oil stays at $80?

[Charlie (Colorado)]

The fundamental conflict of interest arises from the government having any financial interest in a bank. Whether its voting stock or not doesn't make any difference.

That ship sailed in the 30's. Any time a bank is taken over by FDIC the government has a financial interest.

And kim, you're exactly right; the notion of "non voting common" and "non-voting preferred" is all over the place.

Not to mention really complicated things, like the way the Sulzbergers control the NYT.

[Rick Ballard]

Mustang0302,

Sure - click my name at Flares and send it direct.

[Charlie (Colorado)]

Po, Gold is down $100 today, the Euro is down by about 15 percent against the dollar, and the pound sterling something similar. Money is flooding into the US.

[Jim Ryan]

I'm going to tell my company's payroll lady to increase my biweekly 401K contribution by 50% for the next few months. Bargains. When the market is back up, I'll bring the contributions back down.

[Mustang0302]

Mr. Ballard:

Thanks. On its way.

[Pofarmer]

What did your cost per bushel run this year? How much less will it be if oil stays at $80?

If commodity prices keep dropping we'll be wanting for $150 oil again.

And, correct me if I'm wrong, but if the FDIC takes over a bank, isn't it just untill a suitable "partner" can be found? Then it's back into the woodwork?

[Pofarmer]

Po, Gold is down $100 today, the Euro is down by about 15 percent against the dollar, and the pound sterling something similar. Money is flooding into the US.

Ag commodities are down the limit, pretty much across the board, as well.

So, with all that money flooding in, the best we could manage today was a 200 point loss on the Dow?

[RichatUF]

Pofarmer-

And, correct me if I'm wrong, but if the FDIC takes over a bank, isn't it just untill a suitable "partner" can be found? Then it's back into the woodwork?

They can also liquidate a bank like what they did with IndyMAC.

[RichatUF]

So, with all that money flooding in, the best we could manage today was a 200 point loss on the Dow?

Not when it is sitting in bank vaults with management playing Scrooge McDuck. That was one of Rick's points-this is a massive liquidation of anything of value far outside what would be expected with the Lehman payouts and the soon to settle WaMu and AIG payouts.

[kim]

Pofarmer, 7-10 % losses on other bourses were rolling toward the West. The Dow, or Bush, or America, or maybe topsecretk9 stopped the tsunami.
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[clarice]

I keep thinking how much gold Chaco could be buying me if he hadn't made that disastrous bet with Jim.

[Pofarmer]

bourses?

[Pofarmer]

Not when it is sitting in bank vaults with management playing Scrooge McDuck.

This really is a puzzling little ditty. I've tried to avoid the conspiracy theory nonesense. I suppose those players are just waiting to pick up the morsels after the lemmings have gone over the cliff?

[Rick Ballard]

"I suppose those players are just waiting to pick up the morsels after the lemmings have gone over the cliff?"

Nah. Remember, we're talking about people who lunch at "Where the Effete Meet the Elite". Wall Street wizards run in herds too. It's like missing the signal of what WE'RE TOO BIG TO FAIL actually means - WE'RE TOO F'N STOOPID TO BREATHE WITHOUT PROMPTING.

It will do real wonders for capital formation at Citi when they sign up for their welfare check. I just can't wait to throw money at people that stupid - can you? We're not talking cattle here - we're talking domestic turkeys.

I can't go for conspiracy when collective stupidity and willful ignorance will answer. We're not talking about independent thinkers or the sharpest knives in the drawer - just elite cliques with a modest gift for bafflegab.

[kim]

Sorry, Pofarmer, francophone for stock markets. Don't I sound so Euro?
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[George G]

"So, with all that money flooding in, the best we could manage today was a 200 point loss on the Dow?"

Late to the party here due my timezone. To add to Charlie, Rich and Kim's observations. Watching the day closely some notable data was:

1) Foreign Exhange Real Time indicated strong flows of funds to the US and that accelerated in the afternoon.

2) Notes, Bills and Bonds were positive on yield throughout the day - so the money was not getting parked or seeking safety.

3) The activity between 3pm and 4pm showed heavy buying throughout, almost as if players were waiting the opportunity highlighted by the previous day's heavy sell offs in that period (which of course occurred)

4) Yields have remained positive since close of market so no movement back to there.

A lot of money came into US equities yesterday. To Po's point, it looks like that money is taking advantage of bargains and the DJIA close was quite good, actually looked like closing positive right up to 4pm. Simplistic I know and no offense will be taken if more knowledgeable folks demolish this.

[George G]

"So, with all that money flooding in, the best we could manage today was a 200 point loss on the Dow?"

Late to the party here due my timezone. To add to Charlie, Rich and Kim's observations. Watching the day closely some notable data was:

1) Foreign Exhange Real Time indicated strong flows of funds to the US and that accelerated in the afternoon.

2) Notes, Bills and Bonds were positive on yield throughout the day - so the money was not getting parked or seeking safety.

3) The activity between 3pm and 4pm showed heavy buying throughout, almost as if players were waiting the opportunity highlighted by the previous day's heavy sell offs in that period (which of course occurred)

4) Yields have remained positive since close of market so no movement back to there.

A lot of money came into US equities yesterday. To Po's point, it looks like that money is taking advantage of bargains and the DJIA close was quite good, actually looked like closing positive right up to 4pm. Simplistic I know and no offense will be taken if more knowledgeable folks demolish this.

[George G]

Apologies for the double post. I made the mistake of flicking back using the "Go back one page" Firefox button. That resubmitted the posted data - sigh!

[kim]

Well, George G, that was encouraging. The only thing simplistic about your comment was to lump me with the knowledgeable. I was optimistic, though. Scared as Hell, sturdy withal; it's a great country.
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[Pofarmer]

Thanks George G.

What concerns me now is that Commodities and the stock market seem to have divorced.