April 14, 2009
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This essay is excerpted from the most recent version of the HCM Market Letter. To subscribe directly to this publication, please go here.
“I think you are dead while you are alive. More and more I think society is made up of people like you. You take risk unconsciously. When you are in the town, or driving your car, you take risk but you don’t think about it. Now you are with me, and this is a conscious risk, you say you will not take it. But if you do not come, you will feel bad. Will you take it?”
Charlie English1
The inmates have taken over the asylum
It is going to be virtually impossible for anyone, including the Chinese who hold our debt or the investors that the government wants to start taking risk, to regain confidence in American capitalism as long as the American Congress continues to act like the inmates of Bedlam. It is one thing to express moral outrage at the excesses and abuses that brought the economy to its knees, but quite another for legislators to completely disregard the law or suggest that the targets of their wrath commit suicide. Yet members of Congress did both when they learned that AIG was paying bonuses to the individuals who were largely responsible for blowing up the insurance giant. Senator Charles Grassley’s suicide call will undoubtedly go down as proof that just when you think public discourse in this country can sink no lower, a prominent public servant or personality will prove you wrong. At the rate we are going, President Obama will have to establish a line item in the budget for a staff psychiatrist to be put “on call” for Congress. Congress is as responsible as any entity for the regulatory policies and lapses that led to the current financial collapse. Instead of trying to divert attention from its own failures, it should be apologizing to the American people and moving with all deliberate speed to implement responsible policies to move this nation forward. Such policies do not include an earmark-laden stimulus bill, a confiscatory ex-post facto tax on financial executives, or a continuous trail of show trials intended to publicly humiliate men and women who are no more culpable than the members of Congress of creating this mess. It is time for Congress to take a deep breath, man up, and start solving problems instead of creating new ones.
The Fed steps up
Nobody can complain that the Federal Reserve isn’t manning up. On March 18, 2009, the Fed announced that it would begin quantitative easing (the outright purchase of government securities), which triggered a sharp drop in the dollar and U.S. Treasury bond yields. The central bank announced that it will increase its purchases of agency mortgage-backed securities by $750 million to $1.25 trillion this year, and purchase up to $300 billion of Treasury securities over the next six months. The 10-year Treasury bond yield dropped 47 basis points on the news to 2.53 percent, the biggest daily decline since October 1987. By the opening of trading on March 31, the yield had recovered to 2.74 percent in part due to a very poor 5-year Treasury auction last week. Part of the reason for the immediate plunge in yields after the Treasury’s announcement was that it was a surprise; there was little indication that the Fed was ready to make such a drastic move, although it makes sense in the context of trying to keep mortgage rates down.
PPIP (sounds like…)
The Treasury’s dramatic announcement was followed a few days later by Treasury Secretary Geithner’s unveiling of the Public-Private Investment Program (PPIP), the Obama Administration’s plan to finance a public-private partnership to purchase toxic assets from banks. Like many unveilings, this one left many of the explicit details in the shadows and full denuding is still several weeks away. HCM views this plan with deep reservations. On the surface, the new administration appears to be pulling out all the stops to address the worst economic crisis in nearly a century. But a careful examination of the plan causes us to suspect that it is another example of a plan devised by the government in cahoots with elite financial interests that favors a small group of insiders at the expense of the American taxpayers. Furthermore, we view the plan’s prospects of actually succeeding in purging bank balance sheets of toxic assets and then leading banks to begin lending again to be extremely dubious.
The Nobel Prize-winning economist Paul Krugman has opposed this plan based in part on the argument that it offers a one-sided subsidy to a select group of institutional investors. In a recent column (“America the Tarnished,” The New York Times, March 30, 2009), Professor Krugman referenced a recent article in The Atlantic by economist Simon Johnson which states the case quite compellingly. Mr. Johnson is a former chief economist of the International Monetary Fund and is now a professor at M.I.T. (it isn’t Brown, but we won’t hold that against him). He characterizes America’s current crisis as one of crony capitalism, writing that “elite business interests – financiers in the case of the U.S. – played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.”
HCM has deep reservations about a plan developed by lifetime regulators and academics – however well-intentioned and intelligent they may be - consulting with self-interested private sector actors who would be the primary participants to profit from the plan. The government isn’t even being particularly subtle in trying to disguise this. In order to qualify to purchase these assets, a firm must have over $10 billion in assets under management, which disqualifies all but a very few firms from participation. Moreover, the government is limiting the number of firms that can participate initially in one part of the program, the Legacy Securities Investments Funds, to only five. Some will argue that as a matter of convenience the line of participation had to be drawn at a relatively high level, but this will be the first time when large size or wealth has been a positive qualification in the Obama Administration’s policy calculus.
1 Charlie English, The Snow Tourist: A Search for the World’s Purest, Deepest Snowfall (Portobello Books: London, 2008).
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