The past few weeks have yielded some very strange behaviors, some of which reflect a lack of understanding of what needs to be accomplished while others display the sheer fear and panic felt by many in the financial markets. This will make for good entertainment at some point in the future, though right now there is nothing funny about the recent turn of events. Here are just a few items that raised eyebrows, though why they happened is perfectly understandable in light of the current financial crisis.
- Treasury Secretary Paulson argues for the need to pay above-market prices for illiquid assets
- The SEC proposes relaxing FAS 157 (mark-to-market accounting rules)
- The SEC's selective ban on short selling
- GE sells $3 billion in 10% preferred stock plus warrants to Berkshire Hathaway
- 2-year swap spreads exceed 160 bps
Paulson and mark-to-market: I understand the arguments for why Secretary Paulson, and many others in Congress, think the only way to save the banks is to buy their illiquid inventories and carrying value: there is no true "market" for their asset portfolios; dramatic write-downs arising from sales at "market" relative to carrying value would render them insolvent; it gives the U.S. Government the ability to pay arbitrary prices for the illiquid assets as they are the only game in town, etc. I understand the arguments: I just find them specious. As I've stated previously, it has to be a two-part plan. Step 1: buy busted asset portfolios at market. The U.S. Government is only one bidder. If they come up with prices that are too low, private equity firms, distressed hedge funds with long lock-ups and sovereign wealth funds will come in and bid. There is over a trillion dollars of liquidity on the sidelines, easy, plenty to create a rich market in illiquid assets with intrinsic value if they can be held for an extended period. The U.S. Government is only one potential bidder; the others keep them honest and create a true market. Step 2: determine what the seller's capital gap is after the asset sale. Here the U.S. Government will buy either debt + warrants or a variant that provides the regulatory capital necessary to bring the bank into compliance, and provides the U.S. taxpayer with a senior claim and equity upside when the market stabilizes. I really don't get why Paulson and his buddies are at odds with me on this. I think what I am proposing is pretty straight-forward and fair. Then again, this is why the issue made my top 5 list of eyebrow-raisers.
SEC and FAS 157: This is related to the points above.
