Wednesday, September 24, 2008
Congress wrangles over how best to avoid financial Armageddon
IF ONLY, America’s financial authorities must feel, they could gag congressmen as easily as they have muzzled short-sellers. Financial markets around the world were choppy this week as Republicans and Democrats wrangled over the $700 billion rescue plan for Wall Street proposed last week by Hank Paulson, America's treasury secretary. One fear is that Mr Paulson’s troubled asset relief programme (TARP) will be blocked on Capitol Hill. That is possibly overdone: the risk of being blamed for plunging the world’s greatest economy into financial ruin is a good incentive for all sides to reach a compromise. Of more concern is that the plan, if it were approved, would neither shore up the financial system nor save the American economy. On that point there is room for argument, and hence for more uncertainty in the markets. Mr Paulson’s plan is to use public money to buy assets from banks whose value has slumped with every lurch downwards in America’s housing market and which have been shunned by the private sector. With a floor put under the value of those instruments it should be easier for banks to raise capital. Without capital, and amid relentless write-downs on those toxic assets, banks would have to curtail lending, causing a massive credit drought in America. That would not only further batter the housing market. It might also push companies into bankruptcy, too, causing mayhem in the $62 trillion market for credit derivatives. “Despite the efforts of the Federal Reserve, the Treasury and other agencies, global financial markets remain under extraordinary stress,” Ben Bernanke, chairman of the Federal Reserve, said in prepared remarks for a hearing of the Senate Banking Committee on Tuesday September 23rd. “Action by Congress is urgently required to stabilise the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy.” Few dispute the potential threat; the demise of a 75-year-old investment-banking model on Wall Street in just a few days shows the financial system to be vulnerable. But there is plenty for everyone to dislike about aspects of Mr Paulson’s plan. It could safeguard irresponsible bankers’ jobs, while doing little to stop troubled mortgage debtors from being thrown out of their homes. It seeks to invest massive power in a treasury secretary with a lifelong loyalty to Wall Street. The banks with the worst assets (ie, those which have made the worst decisions) could receive the most help. Most disturbing, the taxpayer will be funding an enormous, ill-defined programme, without any stipulation as yet that the banks who orchestrated the mess will pay a penalty. All those points have been raised in Congress by legislators who are understandably fearful of the political consequences of bailing out Wall Street. But there is a legitimate riposte. The more restrictions they put on the bail-out, the more likely it will emerge as a messy fudge, lacking the wallop necessary to put the banks on a more stable footing. Financiers have different concerns. If the TARP seeks to buy assets too cheaply, banks will not take part. If prices are too high, the taxpayer may lose out. Even if the purchase of toxic assets goes ahead, might banks remain undercapitalised? Some have proposed a parallel scheme in which the government would take shares (or warrants) in troubled banks, if necessary, to build up their capital. This might be unnecessary. The TARP could be extended to allow the purchase of bank shares if necessary, or even of mortgages, which might allay some of the fears of homeowners. With enough force, it could prevent financial Armageddon. But it may also prolong the period necessary for asset prices to reach their natural floor, dragging out the crisis. With such high stakes involved, it is no wonder that markets are on their toes. Bank shares led a slump in European and Asian stock markets on Tuesday, though the Dow Jones Industrial Average opened slightly higher after an oil rally on Monday petered out. Three-month interbank spreads in London loosened from the extraordinarily tight levels of last week, but were still “at highly stressed levels,” according to Morgan Stanley. The dollar, meanwhile, was slightly stronger against the euro after four days of decline. How long it can remain as firm as it is, with the Treasury pumping money into all manner of financial assets with possible inflationary consequences, is one question the markets are not keen to address.