Yesterday was a day of political kabuki in the US Senate as Sec. Paulson and Chairman Ben were
raked over the coals, tripped, stripped and drug back over 'em again and again and again. It was truly a massive display of unusual bi-partisan unity by every Senator of both parties with nary a display of understanding, sympathy or constructive suggestions. As political theater it was entertaining to the extent that you admire the works of the Marquis de Sade. Whether it will turn out to be unavoidable and useful are really the questions. Put another way given how angry, ill-informed and torch-waving the electorate is was this 1/3 posturing and 2/3 preparation or 1/3 posturing, 5/6 dead serious and 1/6 who knows ? On the answers to that question hinges the fate of the economy, literally.
Market as Proxy
During the bulk of the day I had the chance to listen to the live testimonay and questions on-line while tracking the markets performance and it was amazing. After a very bad Monday Tue. started out flattish and then started falling apart as the level of objections became clear. Then when it looked as if some rationality was setting in and folks had calmed down the markets picked up considerably, much to the relief of the traders who'd bet on a relief rally following Mon's debacle. Alas it was not to be because around 3pm the the stories started to hit and the realities of the kabuki reached a wider audience....call it the kabuki kaboom. By close of business we were down 4+% in the worst 2-day drop in years. So far today things have been oscillating wildly as the Buffet Goldman put faded instantly to be replaced by apprehensive waiting for today's play.
Clearing the Air
Let's try and clear the air a little bit despite the fact that everything you're hearing, reading and people are talking about is largely distorted, serves an agenda that's not necessarily helpful or is just plain wrong. Sadly, for myself in particular, some of the financial journalists and bloggers for whom my respect has been the utmost are among those getting it wrong, being non-contributory or just terminally - implications intended - ideological. You should know who you are and it's rather sad that you don't. Let me give you two acid test questions for all of those "pontificating poobahs of pessimism": 1) if you don't like the proposal what's wrong with it and how would you fix it ? 2) in the timeframe we have before the markets crash and take the economy with it ? 3) if you don't like the plan at all what's your alternative proposal - let it all fail so the devil can sort out the hindmost ? Fortunately there are a few folks who are acting sensibly with names like Gross, Buffett, et.al. And our friends at BNN come thru again with a fair, balanced and reasonable interview.
First off it's not either a bailout or $700B. In fact none of the so-called bailouts are even that from Bear-Sterns to AIG to this "re-capitalization" plan. Nor are the Wall St. fatcats getting rich off of it. In fact many of them are getting wiped out, not to mention the ordinary folks being put on the street. There's a lot more secretaries than poobahs at Lehman or any of these firms. Dick Fuld sold his stock for something like $600K when last year it was worth about $170M. In the AIG case the $85B "bailout" is a loan, the Fed gets 90% of the stock, the CEO was fired and the stockholders were wiped out. And the Fed's getting paid 11% on the money - try and find that sort of return anywhere. When you take each one of these apart the details vary but they are variations on the same theme.
Take the giant bailout for example. The idea is to buy up the bad investments on the banks books because if they sold them at "fire-sale prices" the result would be many would be out of business and credit in the US economy would vanish. I'm not sure how to to make clear what that means - most companies in the US borrow money every day or every week to fund receivables, smooth out payables, finance payrolls while waiting to get paid and all that's just the normal course of business. Most people have car loans, many have mortgages, credit cards and so forth. THAT ALL GOES AWAY. The economy slows down and then stops completely...pretty soon no more car loans...no more auto manufacturing...no more auto jobs....well maybe that's a bad example but you get the idea. We're not talking about rescuing the fat cats we're talking about Joe Boilermaker's job, paycheck, healthcare, and everything else under the sun.
Objections and Consequences 
The major trotted out objections seem to be four: an equity stake, more oversight, help with foreclosure prevention and no golden executive comp. First off this was a proposal on three pages originally put together at Congress's request for them to turn into legislation, which they did, rather quickly and well. With the exception of the adders. Second off some speed was and is of the essence. As Sen. Dodd put it perfectly during his closing comments yesterday, "our legislative process doesn't lend itself to responding to crisis like this". They want weeks and months to carefully craft a package. I'd ask what's wrong with pushing something thru now to keep the markets from imploding while crafting a more meticulous package over the next 2-3 months. By the way for all those asking for fundamental strategic reform of financial regulation Sec. Paulson put forward a comprehensive proposal in March which the Congress has chosen not to act on. Be that as it may as a proposal it was supposed to be emended. As the Sec. testified he's not asking for no oversight and welcomes it. As for controlling executive compensation well enough, bargain that thru. An equity stake - that'd have to be thought thru but the precedents are already in place. Foreclosure prevention - that's populist pork-barrel-rolling at it's worst. First, until housing prices come down to reasonable levels this whole thing will keep breaking out. Second, everybody needs a haircut. And third that's a separate, major issue where the clock isn't ticking away in seconds.
As a final point consider this - even if we lost every dime of the $700B plus all the prior investments but managed to get economic growth to stay higher than it would be we make money. Put another way we don't end up with 10-12% unemployment and an economy growing at 1% for ten years. Consider the last graphic which shows actual GDP vs Potentil - the gap between them is lost output. To make those differences bigger we also graphed (on the right-hand scale) the YoY growth rates. Now we have an $11T economy. Supposed we get a decline for the next two years of -3%/year (possible but optimistic in a credit collapse), so we have a minimal deadweight loss of -$333B x 2 = -$666B (accidental but meaningful numerology). And suppose we slowly recover for ten years at 1% instead of growing at potential. Let's close with a little worked out table:

At the end of ten years the difference between a mild downturn followed by a return over several years to potential growth and a slightly more severe downturn followed by a Japalaise decade is $2.6T in the last year alone. The total difference over all ten years is -$14T while the net present value is -$9.4T ! In either case that's a lot of lost jobs, people dying in emergency rooms, unbuilt houses and un-educated kids. And that's comparing a good case to a bad one...not the terrible one we're at risk of. Seems to me $700B is a pretty good investment for that kind of return.
Continue reading "Political Kabuki: It's NOT a Bailout, It's Your Life !" »