Friday, April 10, 2009

Double Helix Thinking

Each day I become more incredulous regarding the solutions being presented by the administration and begin increasingly convinced that the issue is being approached backwards. The issue and problem is not simply to stumble upon the solution. Rather, it is to discover the problem. Thus far the approach seems to be to address a seemingly intractable problem with an equally complex and convoluted solution. The solutions thus far are to scatter the dragons teeth while hoping they do not grow into new monsters. I think they are failing thus far.

The large and insolvent banks are being allowed to remain a drag on the economy, and an impediment to market price discovery for bad assets. In the process the rot is spreading. The recently announced Private Public Investment Program creates a convoluted solution that obscures both problem and solution with complexity. Why the FDIC, an program specifically created to protect small depositors of member banks has now been pressed into service to provide multimillion dollar investment firms with guarantees of more than one trillion dollars is a solution by recreating the problem of massively integrated financial firms.

The FDIC will guarantee 85% of the debt so that a select group of private investment firms can acquire the toxic assets. It is questionable that by compressing the market to find the correct prices for these assets the process will be efficient.

Through an act of accounting legerdemain in order to circumvent congressional approval the FDIC will by far exceed its own charter limits which limit obligations to $30 Billion. So just how does one turn $30 Billion into over $1 Trillion you may ask. The obligation will be calculated not as a monetary obligation, but rather as a contingent liability which FDIC head Sheila Bair (a very competent and forthright manager I thought)now estimates as zero. From the Trillions of dollars of deeply impaired loans which they will guarantee the FDIC estimates losses in the future to be zip, nada, nothing, not one thin dime. That is how one keeps under the $30 Billion cap.

This Washington-Wall Street corridor sleight of hand keeps the bond holders
intact while transferring the risk straight to the taxpayer. How it is the taxpayer's obligation to underwrite the risks taken by poorly managed investment firms eludes me. Why taxpayer funds were transferred to Goldman Sachs to pay AIG's credit default swap obligation baffles me.

There are legal systems that have worked for many years for failed business entities. First there is an attempt to reorganize under the chapter 11 bankruptcy code. Failing that, chapter 7 liquidation would sell the profitable or recoverable segments of the business to others. The FDIC was created precisely to deal with insolvent banks. To suggest that the complexities of breaking up these failed banks exceeds those of trying to act as if humpty dumpty can be put together again is misguided.

It was moral hazard that got us into this mess, it sure isn't going to get us out.

John Barnyak