A dodgy deal is getting closer
The US Congress appeared on the verge of a deal on the Paulson plan, securing some token concessions on oversights and the compensation of bank executives, but it looks this morning that the Paulson plan remains largely intact. Legislation could be passed within the next few days. Reuters has the story that the Democrats in the House and the Senate have reached agreement of what should be in the bill, and what should not. It will be less than $700bn initially, the story makes no mention of an equity component, as demanded by virtually every economist on earth, so the main focus of these package will consist of buying up dodgy securities at above market prices, which is about the most intransparent ways to recapitalise a banking. There is still some debate about a plan for “Main Street”, such as helping families with payment arrears to avoid bankruptcy. And John McCain is interrupting his campaign to deal personally with the situation. Tragedy is turning into farce.
Meanwhile, the global financial crisis seemed to be getting a lot worse yesterday. In the US, the TED spread – the difference between 3-month interest rates on treasury bills and 3-month Libor – widen again to over 3%, close to its crisis peak. The TED spread is a favourite metric of distress in the money market because it is almost a pure measure of default risk. A 3% TED spread tells us that the inter-banking money market is effectively dead. All liquidity comes from central banks.
Il Sole 24 ore reports that the IMF has increased its estimate of the total costs of the subprime crisis from $1 trillion to $1.3 trillion. There were also signs of the crisis spreading to Asia. In Hong-Kong, the Bank of East Asia yesterday suffered a classic bank run, with people queuing up outside the branch offices to withdraw their money. The bank was able to fulfil the claims, as customers were worried about the impact on the credit crisis on Asian financial institutions. The New York Times has the story (aka Calculated Risk) – and a picture of people queuing in front of the bank - though we are left wondering why this particular bank.
The debate about equity capital
At the heart of the debate about the Paulson plan is the absence of any equity injection. The US government is supposed to pay money, but gets nothing in return. Ben Bernanke said that the bailout plan is recapitalisation because the Treasury would be buying at above market value. There have been some reports that Hank Paulson admitted as much in a conference call over the weekend. The problem is, of course, that this is subsidised recapitalisation, something for nothing, as the taxpayer has all the risk, and the banks’ shareholders have all the gains. Calculated Risk has the story, quoting one analyst as saying that handing out equity to the state would make it more difficult for banks to raise funds in the private sector afterwards.
Writing in Martin Wolf’s Economics Forum, Simon Johnson and James Kwak argue that it is best to separate asset purchases from capital injection, as this is more transparent. They also have an interesting discussion on various alternative valuations at which the government could purchase MBS. There are five prices one could chose. 1. The par value (meaningless). 2 The current book value (too high). 3. Current market value (possibly, but not necessarily, too low. 4. Market value after government intervention. 5. Mathematical model value.
Writing in the Financial Times, George Soros lists a number of conditions that need to be attached to this bill for it work. Apart from the equity component, which is a no-brainer, he also advocates supply-side reform in the housing market, changes in bankruptcy law to reduce the number of foreclosures. He said it was right for the government to recapitalise the banking system, but not every bank deserves to be saved, and it is the job of the authorities to make the right judgements.
Our favourite comment this morning is from Naked Capitalism. We agree with this fully, and, unusually for us, we reprint the comment.
“As we said when the idea of this bill was first mooted, bye bye US AAA rating, bye bye dollar. Not overnight, but the die is cast. We have also said that the eagerness to pass this measure is based on the faulty premise that this package will actually do something to solve the problem. It won't.
“Trying to prop up assets at above market levels is destined to fail, and worse, only digs us deeper in the debt hole in the process, making the ultimate resolution of our economic mess even more costly and painful. We are not alone in this view. Virtually no economist is in favor of the program (save Alan Blinder). University of Chicago even published an open letter with a long list of signatories against it. And commentary on econoblogs has been as close to unanimity as one sees in these parts against it.
“All it will do is provide a short-lived burst of confidence, then as market participants think through its operation and ramifications, the anxiety and stressed conditions will return. How long will the false euphoria last? Two weeks to six weeks, I'd hazard. And worse, the existence of this program will block any other course of action being taken. It is so large and resource-intensive an approach that it precludes other remedies.”
Even more evidence of a slowdown
Business confidence in Germany, France and Italy fell sharply further yesterday, as the euro area is now increasingly likely to have entered a recession. Among those is the German Ifo index, which fell from 94.8 to 92.9 in September. French business confidence is down to the lowest level since 2003, and pressure is now growing on the ECB to cut interest rates. The FT quotes an analyst saying that the hawks are running out of argument, but that the ECB would move only very slowly.
Political repercussions
Francoise Fressoz in Le Monde says that the economic slowdown has not hurt Sarkozy’s popularity yet but will eventually as the French economy worsens. Unemployment is on a rise, the public deficit resists all consolidation efforts and the trade deficit is ballooning. Sarkozy’s recent political activism on the international scene and in Europe seems to have compensated for an incipient disillusionment about Sarkozy’s economic campaign promises. Fressoz warns that the time for public scrutiny is yet to come amid rising unemployment and a rising discomfort in his own party.
Who are the short sellers?
El Pais has an interesting story about the short sellers of Spanish banking stocks after the decision by the Spanish stock market regulator earlier this week to force transparency on all transaction above 0.25% of the share capital. Most of the investments came from hedge funds. The Banco Popular is the most popular prey of those hedge funds, with almost 4% of its share capital held in short positions. Two hedge funds with particular activity in Spain are Harbinger Capital Partners, of the US, and Goldman Sachs’ Amber Master Fund.
No credit crunch in the euro area
Greek’s new central bank governor Giorgos Provopoulos said in Athens that credit conditions in the euro area are not nearly as bad as they are in the US, according to Kathimerini. while Greece in particular is not affected at all by the crisis, as local banks had virtually no exposure to US subprime debt.
The mother of all conspiracy theories
For some light – it probably is not more – look at FT Deutschland and other European newspapers reports that the US military funded the Irish No campaign. Of course, no one has any proves. There is a lot of innuendo, and plausibilities. The story reads like a good old-fashioned European conspiracy theory, the CIA trying to sabotage European integration. Too good to be tru
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