Wednesday, January 28, 2009

"Bad Bank" good for stocks

Stocks were strong from the outset today, led financial stocks, as the proposal of a "bad bank" looked like a tangible action to relieve credit market constraints. Finally there is a proposal to actually do something, said the market. After giving consumers money in the hopes that they would spend in the spring and summer and giving banks money in the hopes that they would lend in the fall and winter, this is an effort to take charge of the situation. I see the fingerprints of Larry Summers all over this, but who knows.

There was one prior effort to take an action that wasn't passive. That was the original TARP proposal to rapidly buy up to $700 billion of illiquid securities at market prices, create liquidity, and then recoup the government's expense and maybe more as markets improved. Remember the three page proposal. From this perspective that was on purpose. It was. Paulson was thinking like an investment banker that knows how capital markets work. The idea was to go into the market in a powerful way and have an impact. In the capital markets traders are proprietary to the extreme about their positions and their plans. So was Paulson. Three things went wrong and it was not approved as hoped. First, as a friend reminded me last week, we had a president with no credibility and who gave the appearance of having no understanding of the issue; second, there was a faux populist revolt against "bailing out the banks" when this might have effectively bailed out the economy; and third, in a democracy it was a stretch to think that one person could get as much power as Paulson was asking for on such short notice, even if he was right.

So the result was that weeks later, Paulson received approval for half of the amount requested and was handed a 400 page playbook for all the world to see. Forget behaving like a capital markets force that could turn things around. The original plan, a great idea possibly, was out of the question. Then the money went into myriad company supporting investments, mainly investments in bank preferred stock, which I do not understand. That's essentially a subordinated loan with really high interest. Why not just make straight equity investments if there is any confidence at all and "risk" getting the potential substantial benefit of capital appreciation rather than weigh down the firms to be helped with a corner boy vig.

That's the past. The market welcomes another substantive plan, and the sooner the better.


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