Let's not rush to blow $700 billion
A Wall Street 'rescue' must be done right, and hastily committing our money -- and our children's money -- is wrong, wrong, wrong. Congress needs to pin down the details first.
By Jim Jubak
Stop the $700 billion stampede. Despite the table pounding by Treasury Secretary Henry Paulson and President Bush, the world, even Wall Street's world, won't come to an end if Congress doesn't pass a plan next weekend to bail out the nation's financial system.
Even as news reports circulate that a deal is close, there's no good reason for Congress to pass this "rescue" plan without nailing down more of the details. And I can think of three good reasons that our representatives should take big, calming breaths before committing $700 billion of our money.
If we don't nail down these details, we risk: (1) creating this mess all over again; (2) giving Wall Street executives a free pass on any criminal acts they may have or might commit; and (3) putting the same Wall Street companies that got us into this mess in charge of the cleanup.
Let's take these one at a time.
No. 1: Don't solve a problem with a problem
Paulson says the crisis is so pressing that we need to rescue Wall Street immediately -- and then later develop new regulations to prevent this problem from ever occurring again.
Absolutely, 100% WRONG. Once Wall Street has got its hands on taxpayer money and is starting to breathe easily again, the federal government will have lost all of its leverage to force meaningful change on the financial system.
Remember that business as usual in Washington means powerful industry lobbyists writing the laws that govern their industry that are then introduced by senators and representatives in return for the money that Wall Street gave to their campaigns.
How else do you think we got laws that exempted derivatives from regulation? Unless "We the People" exact our pound of regulatory flesh now, while we hold the power of the purse, nothing, or as close to nothing as possible, will get fixed.
That's especially true because the required fix isn't a question of a few tweaks here and there. Meaningful reform will require an overhaul of the regulatory agencies in Washington that failed us so thoroughly in this crisis. It will require new regulations to govern the derivatives markets. It will require new rules governing how much and what kind of capital a financial institution requires.
And just in case you're so cynical that you think none of that can happen, just look at what has happened in New York state in the past few days. On Sept. 22, Gov. David Paterson and state Insurance Superintendent Eric Dinallo announced new regulations that will govern the kind of derivatives -- credit default swaps -- that led to the downfall of insurer American International Group (AIG, news, msgs) .
Starting Jan. 1, the state will begin to regulate credit default swaps as insurance products in cases where the buyer of a swap also owns the underlying bond that the swap is meant to insure. In these cases, the new rules will increase the minimum capital and reserves that a financial company must have and limit the number of swaps that a financial company can use to insure a single bond issuer.
The state has authority over only about 20% of the credit-default-swap market, but if a state government can move this fast on basic reform, there's no reason Washington can't.
What Paterson and Dinallo grasped was the need to strike while Wall Street is panicked and disorganized. In Washington, it's now or never.
No. 2: Catch the Crooks
Paulson has demanded that Congress and the courts waive all authority to review the decisions of the Treasury in running this bailout. Congress shouldn't buy this grab for legal immunity. It's absolutely, 100% WRONG.Here's what the wonderful folks at the Treasury and the Federal Reserve proposed: "Decisions by the Secretary pursuant to the authority of this ACT are non-reviewable and committed to the agency discretion, and may not be reviewed by any court of law or any administrative agency."
You've got to be kidding! Wall Street CEOs could lie to the Treasury, inflate the prices of their securities, fraudulently misrepresent what they were selling to taxpayers, and, if the Treasury decided to look the other way in order to get the markets back on their feet again, no one could take anybody to court, recover any damages or even hold a meaningful congressional hearing on the issue.
Take just one example: the creation of false prices. A financial company that is required to mark the prices of the securities in its portfolio to the levels paid during real trades can create artificial prices if it colludes with traders to buy those securities at an inflated price. All it takes is one trade, especially in a thinly traded security, to create a price far above the real price.
This practice is what landed former Enron CEO Jeffrey Skilling in prison. And there's no doubt that in the run-up to this crisis some financial companies used questionable prices to inflate the value of their portfolios so they could borrow more money to buy more securities and derivatives.
With the Treasury looking to buy damaged securities and derivatives that aren't trading at all right now, the temptation to create a false price would be greater than some financial companies could resist. Especially if they knew they wouldn't be prosecuted unless Treasury officials focused on getting the market working were willing to bring a case and rock the boat. Investors or taxpayers who were cheated in this process would have no legal recourse.
No. 3: Don't let the drunks drive again
Managing a $700 billion portfolio of damaged securities and derivatives is way beyond the capability of the Treasury. The plan now is to farm out that work to, you guessed it, the Wall Street experts who helped create this crisis. That's absolutely, 100% WRONG.
At the moment there are no credible standards to prevent conflicts of interest. Would an expert manager be tempted to inflate the prices of the damaged paper held or issued by the expert's company? Of course. What would keep these managers honest? The oversight that the Treasury proposal makes impossible? How about fees? These experts wouldn't do their work for free. Who would decide what constituted a reasonable fee for these services? Treasury again. Without any oversight.
Congress could take a shot at fixing these problems and others -- this is by no means an exhaustive list -- even though most members of Congress don't know a derivative from a doughnut. The major financial committees have staffs that, given a reasonable amount of time, could come up with regulations that improved the workings of the financial markets and take temptation to manipulate prices and fees out of the reach of Wall Street.
But the chairman of the Federal Reserve and the secretary of the Treasury say Congress doesn't have the time to waste on such superficialities. If Congress doesn't act this weekend, they say, the consequences are too dire to imagine. By and large, the financial pundits have echoed this view.
To which I say: That's absolutely, 100% WRONG.
Did haste equal $85 billion waste?
The lesson of the crisis solutions from the Treasury and the Fed so far say haste is exactly what we don't need. For example, because the Treasury didn't nail down the details of the AIG rescue, the company last week was able to send two letters to the Securities and Exchange Commission that took contradictory positions on whether taxpayers would get equity in the company and whether the $85 billion loan required approval from company shareholders. If that's the level of detail that escapes the Treasury and the Fed when they're doing one $85 billion deal in haste, I don't see any reason to rush to give them access to $700 billion.
A few financial experts have even suggested that the decision by the Treasury and the Fed to force Lehman Bros. (LEHMQ, news, msgs) into bankruptcy created the collapse of AIG. They argue that the failure of Lehman critically undermined confidence in the derivatives market and led to a massive margin call on the insurance giant.
I don't know whether those critics are correct, but it does raise the best argument against the haste that Paulson and Fed Chairman Ben Bernanke advocate. These markets are incredibly complex, and the dangers of doing something that doesn't work or that has an effect opposite from the one intended are very real.
The Treasury and the Fed have proposed using $700 billion of taxpayer money to buy damaged securities and derivatives. They believe this will help end the crisis in the financial markets by putting prices on currently unpriced paper so that everyone will know what these securities and derivatives are worth. That's a good thing, Paulson and Bernanke say.
But is it? Their assumption is, at the very least, open to question. The only thing keeping some financial companies from having to raise massive amounts of new capital is the unavailability of prices on big hunks of their portfolios. If they had to mark what they hold to market, they'd suddenly be in danger of falling below minimum capital requirements. The solution to that, of course, is to raise more capital in the financial markets. But it's exactly that new capital that isn't available in the markets right now. Ask Lehman and AIG.
You can look at the Treasury plan and legitimately say, "Hey, this is only part of a solution, and in the short run it could well make things worse." The right thing to do then is to sit down and work out a comprehensive solution. But it's exactly the time that might be required to work out a comprehensive solution that Paulson and Bernanke seem determined not to give Congress.
In their argument for hurry, the Federal Reserve and the Treasury have focused almost exclusively on Wall Street. And, indeed, a delay now would probably knock financial stocks and the market as a whole for a loop.
But the damage to the stock market shouldn't be the sole focus. The economy moves a lot more slowly. Passing a plan now won't produce a stronger economy next week, and delaying a plan for a month or six won't take the economy into a tailspin, especially if Congress passed a modest second stimulus package of $50 billion or so.
That would buy some time to make sure that bailing out Wall Street doesn't do permanent damage -- in the form of higher interest rates and slower growth -- to the economy. Last time I looked, $50 billion was considerably less than $700 billion.
Last line of defense
I worry that Congress won't have the backbone to stand up to the Treasury and the Fed, but a few members are saying the right things. The Democrats, by and large, remain unfortunately focused on adding a homeowner mortgage bailout to the package rather than stopping the stampede to quick action dead in its tracks, but Sen. Richard Shelby of Alabama, the top Republican on the Senate Finance Committee, sounds just cranky enough to maybe stop the stampede.
Congress, Shelby said, probably can't "solve this crisis by spending a massive amount of money on bad securities." He has called for "a comprehensive and workable plan for resolving this crisis before we waste $700 billion of taxpayer money."
If you want to weigh in on the plan and how your money would be spent, contact your senators here and House representative here. The key players for this in Congress are Shelby; Sen. Christopher Dodd, D-Conn., the head of the Senate Banking Committee; Sen. Charles Schumer, D-N.Y.; and Rep. Barney Frank, D-Mass., who heads the House Financial Services Committee. Frank has published a draft of his proposal for solving the crisis, and Dodd has put out a summary of the changes he would make to the Treasury plan.
BA- Jim Jubak, as usual, nails it.