What I Don’t Know Can Hurt You
Wow, what a week. Not that markets ended up moving much, mind: as others have noticed, everything in the US closed pretty much where it opened the previous week (see Barry Ritholtz’s post on the subject). But even if those indicators indicate that nothing has changed, it is pretty clear that everything has changed. And I’m more focused now on what I don’t know, rather than what I know.
So what don’t I know? Let’s start with the vaunted US$700bn Paulson Plan to purchase distressed assets from the financial sector.
Why US$700bn? It seems like one of those numbers that sounds impressive and well-thought out, but is really just plucked out of a hat. Like that scene in The Manchurian Candidate when the Joseph McCarthy-like Senator has to decide over his meal how many members of the State Department he should accuse of being communists, and after looking at a Heinz ketchup bottle, his wife decides that 57 sounds about right. I’d say that US$700bn figure is just a place-holder, as befitting a balance sheet item. By my reading, the Treasury can theoretically buy US$700bn in bad debt, sell it all off (at a loss, most likely), and then buy another US$700bn. This is tantamount to a blank cheque. That is unlikely to be good for the taxpayer.
What price to place on distressed assets? Here are the choices, as I see them. Buy bad assets from banks at an obviously inflated price, guaranteeing taxpayer losses. Buy bad assets from banks at an estimated price based on the Treasury’s own evaluations, which probably also guarantees taxpayer losses, as recovery rates on the most toxic securities are likely to be dire. Or as a third option, allow an open auction to determine prices, which would make it more likely that the US Treasury pays a fair price, but would almost certainly force banks to mark the value of toxic securities down to market, further exacerbating the downward liquidation spiral.
Who’s watching? Apparently nobody: the Treasury has called for complete autonomy over its debt-purchasing operations, with no Congressional or legal oversight. I suppose if you really trusted Hank Paulson to get everything right the first time, this is not so appalling an option. But this monolithic toxic debt beast is likely to live on for years. There’s a presidential election in six weeks, and the winner gets to pick Paulson’s successor. It seems to me that both Obama and McCain would be happy to have Paulson back. But what if they don’t? And if they do, what if he doesn’t accept? This seems to be a massive source of uncertainty for the plan’s outlook, because if it comes down to having one person at the helm steering the ship, taxpayers and foreign central banks buying US Treasury bonds are going to want to make darn sure it’s the right captain.
How bad is this for the dollar? The big risk to the dollar, in my view, is not a slow unwind, but rather an all-out collapse. The FX markets are certainly reacting negatively to this renewed US government profligacy, but the jury seems to be out pending confirmation of the debt programme’s details. The fate of the dollar is perhaps a rhetorical question: how can the destruction of the US’s number one export (debt), an economic slowdown, and unheard of fiscal profligacy, be good news for the currency?
How much Diet Coke was downed last week at the US Treasury? This may be the easiest question of all. The answer: lots. Hank Paulson is a notorious (Diet) Coke fiend, requiring a ‘steady infusion’ of the beverage at the best of times. If he really only did have four hours of sleep last week, we’d put the cost of Diet Coke to the taxpayer at at least $50 (assuming seven a day at 70 cents a can, which may be on the low side, on both quantity consumed and price. Hey, inflation). So maybe that’s your dollar hedge: buy Coca-Cola stock. Unless, of course, you think that the Federal Reserve is going to have the worst of it now, as it tries to manage a behemoth insurance firm while considering whether to lower interest rates. In that case, Ben Bernanke’s drink of choice is Diet Dr. Pepper. (Dr. Pepper Snapple Group Inc. is your choice there.)
September 22nd, 2008 at 2:36 pm
On this post a congressional staffer says he sat in a call with Hank and congressional leaders. He says that, behind closed doors, Hank says he’s going to buy assets at above market prices. So maybe it will be taxpayer losses.