Category: Henry Paulson

Paulson’s gift to the bears

It’s official: The U.S. economy is headed for its worst recession in three decades. Henry Paulson’s scheme to keep Fannie Mae and Freddie Mac on government life support and bail out its creditors (i.e. Wall Street, Big Banks, and Bill Gross at PIMCO) removes any doubt. The only question remaining: Will this downturn rival the Big Kahuna of the 1930s?

Paulson was interviewed today on Bloomberg. Here is the money quote:

“No one likes to put the taxpayer into situations like this. No one does; I certainly don’t. Government intervention is not something I came down here wanting to espouse, but it sure is better than the alternative.”

The alternative, of course, is that Paulson’s friends are actually forced to take huge losses on their reckless, ill-fated loans to Fannie and Freddie. Unthinkable! Paulson assures the naïve interviewer that the taxpayer will come before the shareholder, forgetting to mention the shareholder has already been wiped out, putting the taxpayer last in line behind the creditors. Under Hanky Pank’s scheme, the taxpayer is simply the bagholder of last resort. Paulson was obviously a quick study under former Goldman Sachs CEO and Treasury Secretary, “Mr. Bailout” himself, Robert Rubin.

The initial reaction of the stock market was to celebrate with a 300 point rally in the DJIA. Our guess is the euphoria will fade quickly as investors realize bailout money does not grow on trees, and the cash will either be taxed, borrowed or printed. The only question: How much will the final tab run?

The more pressing concern, however, is the economy. This economy needs to break its addiction to cheap credit, remove the waste of the previous credit binge, shed its political parasites (e.g., friends of Hank), and rebuild on a solid foundation. Every intervention prolongs the process and deepens the malaise. A wholesale government takeover of the mortgage market virtually guarantees the economy will be mired in deep recession for years.

The only winners (besides whiners like Bill Gross)? Those who are short the market.

Note to self: Move those inflation hedges from the attic to the front hall closet.

Super SIV to the rescue

The three amigos, (Citibank, JP Morgan and Bank of America), have agreed to support Treasury Secretary Paulson’s Super SIV fund by the end of 2007. Details to follow but it seems the $75 billion fund will purchase any type of SIV collateral.

The fund could start operating before next year, the person that the newspaper cited said, and the banks could be asking financial institutions to contribute as soon as Friday.
The fund could restore some liquidity to the market for asset-backed securities by establishing a buyer, even if no SIV uses it, the newspaper said. The proposed still must obtain the approval of credit-rating agencies.

Can a $75 billion fund stop the bleeding in the $320 billion SIV market?

The average net asset value of SIVs rated by Fitch fell to 73 on Sept. 28 from more than 100 in July. A 0.5 percent drop in value of assets is equivalent to a 7 percent decline in the so- called NAV, Fitch said.
Once an SIV’S net asset value falls below 50, a clause is typically triggered requiring the fund to liquidate.


My Comments: The rapid decline of SIV net asset values since the credit crunch began in July may put most of this asset experiment in liquidation mode just in time for Christmas. Of course, Bernanke assured the markets last week he would offer 90% financing to the banks participating in this Super SIV. Can Bennie and the Jets prevent the unwind of insolvent structured finance “securities”?

Paulson to the bat phone

Returning from New York this past weekend I opened the Wall Street Journal on Monday to discover yet one more chapter in the structured finance shell game. Evidently Treasury Secretary Henry Paulson picked up the bat phone to several of the largest US banks, begging them to work together in order to facilitate an orderly unwind of numerous off balance sheet structured investment vehicles (SIVs). The proposed Super SIV will try to float one year capital notes with proceeds earmarked for the purchase of SIV assets originally created by Citigroup. Thus Citi avoids two problems, an increase in reserve requirements from assets returning to their balance sheet and ongoing reputational risk.

At this point, the rational investor is throwing up his hands, and why not?

“I have never seen Treasury play this kind of role,” said John Makin, a visiting scholar with the conservative American Enterprise Institute in Washington and a principal with hedge fund Caxton Associates LLC. The banks made “riskier investments that didn’t work out. They should now put it back on their balance sheet.”

Paulson and Co have their hands full lately as trust and confidence in structured finance have been waning. Apprehension and/or the inability to mark securities to market have sent a shock wave through the credit markets. More recently we witnessed the following acts of desperation:

  • Increased injections of liquidity by the Fed
  • Broadening the collateral accepted (to include asset-backed commercial paper) and terms (from 7 to 30 days) of the repo market
  • 100 basis point cut (two separate actions) in the discount rate and 50 basis points to fed funds
  • Encouraging use of the discount window (formerly stigmatized) because banks no longer trust collateral being posted when lending to each other
  • Proposed Super SIV whereby roughly 20% of the total SIV market is re-tranched

Clearly the credit markets are faced with unprecedented circumstances due to countless players and massive leverage. Unlike LTCM which required a NY Fed bailout, the credit markets today have grown incredibly opaque while derivative exposure has gone parabolic.

It’s obvious the SIV assets won’t be priced at market rates because there’s not much of a market to begin with (and why the super SIV exists in the first place). But where exactly do they get priced? To whose benefit? And by which standard?

Unlike the Bernanke induced rally two months ago, Paulson seems to be striking out in spades. The banking index is probing 52 week lows while Citigroup has dropped over 6% in 3 days.

This latest scheme, to which the ex-Goldman Treasury Secretary gives his blessing, attempts to put off the structured finance day of reckoning even further. Could the Super-duper SIV create the inevitable mark-to-market across most aspects of the securitization world leading to a run on the bank? Note to Hank: Beware the law of unintended consequences.

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