Financial crisis: Bail out in haste, repent at leisure

[avaistheone1]

This may seem heresy amid impending global crisis, but it is hard to know what should make us more scared: financial nuclear winter or botched rescues put together too quickly by governments.

By Adrian Michaels

In Britain, another bank is being nationalised, while in the US the outlines of an extraordinary $700 billion bail-out package have been agreed by Congress and the White House. As exhausted as lawmakers already look, they and their advisers have barely started on the implementation of their plans.

Never mind the cash, a massive infusion of badly directed regulation now and economies will be stifled for decades. So far, the signs are not good that politicians know what they are doing.
At least Washington's Troubled Assets Relief Program to help struggling banks and save us all from ruin has been blessed with the perfect acronym; as TARP, it does indeed resemble an enormous canvas sheet thrown over a whole load of problems which we'll weigh down with tyres and leave to fester at the bottom of the yard.

But if it does not work, there isn't another $700 billion to follow. At stake is the creditworthiness of the US government – a government that in about three months will have a different president, possibly a very different Congress and probably a new treasury secretary.
That ought to make lawmakers think through the consequences of their haste. The excuse of leaving for home to start campaigning for the November elections is lame. Another reason for speed is the temporary absence of key legislators after the start of the Jewish New Year on Monday.

But only the self-fulfilling prophecy that disaster starts tomorrow without a stunningly large bail-out gives a proper explanation for why something so complicated is being rammed through so fast.
No matter, the bail-out is agreed, and it is universally accepted that something, anything, is needed to help to restore functioning markets and stave off global disaster. If we are lucky the headlines will talk about the huge amounts made available to market participants while the details stay sketchy. At the least, legislators should offer a great deal less than $700 billion and then wait for a new White House and Congress to reassess.

There are few grounds for optimism this will happen. An old saw in Washington is that Congress only ever does two things well: the first is nothing and the second is overreacting.

In 2002, in the wake of horrendous fraud at Enron, WorldCom and other companies, Congress and the White House passed into law the Sarbanes-Oxley Act after what now seems a luxurious one month of deliberation. It was the most sweeping piece of financial legislation for 70 years and US business and markets have been paying for its unintended consequences ever since.
The rationale was that something, anything, was needed to restore investor confidence in companies and markets. Most of the act has worked well: boards of directors are taking their jobs more seriously; auditors are examining books more carefully; no doubt some wrongdoing has been deterred by extraordinary sentences for fraud.

But auditors and consultants were able to substantially increase their fees to do more checking inside corporations, crippling small company finances; companies fled from listing their shares in the US, handing public relations victories to stock markets in London and elsewhere; and, crucially, competent executives complained that they were so busy on compliance and regulation that they had no time to manage.

The new plan to let banks sell unwanted mortgage-related assets to the government looks like it will have been put together in about two weeks. There has been market failure, for sure: struggling financial services groups have demonstrated that they can't find buyers at the right price to offload enough of this garbage from their books. Sovereign wealth funds and private equity groups, on the other hand, had confidence in their ability to price deals and bought numerous stakes in failing banks. They are looking pretty stupid now.

What is the chance then that sensible pricing mechanisms will have been worked out by clueless politicians in the middle of an election campaign? What faith should we have that houses will be saved, economies will stir and the sun will shine?

Banks helped by the bail-out, it is hoped, will be able to resume lending to each other, so ungluing the credit markets and helping companies and individuals obtain finance. Yet banks will lend to each other only once they are paid enough to do so; since their business models are being rewritten extensively, inter-bank lending will remain hesitant.

Regulators and politicians – including those aspiring for Congress and the White House – will have to be consistent.

The US bail-out's existence is in part an unintended consequence of inconsistent decision-making: the government allowing Lehman Brothers to go down. For the first time in a generation, a large investment bank failed and its bondholders will lose much of what they assumed were safe investments. It is no wonder people are reluctant to lend to other banks. And few in Washington have asked for better mechanisms to force banks dumping assets on the government to make mortgages available in comparable amounts. It is trusting to the hope that a top-down approach will see a resumption of lending to consumers.

It is easy to see how the measures could make matters worse. When the government buys a bank's toxic assets, it will place a "market" value on them. That could affect even banks that want to stay out of the whole affair, as accounting rules force them to re-price similar assets on their books. Their ability to offer mortgages could be diminished still further.

These are difficult areas of regulation, of accountancy standards, of derivative mathematics, of market behaviour. US legislation in 1933 formally separated commercial banks from investment banks. The idea was to keep those groups engaged in the riskiest financial activities away from ordinary customers and homeowners. No more. Goldman Sachs and Morgan Stanley, the two US investment banks left standing, have been allowed to become more like ordinary banks again. They will be "bank holding companies", regulated by the Federal Reserve. They need access to protection and funding because of their previous risk-taking.

Such tremendous changes in policy have been made with little time for consultation with the experts. So what should we make of the debate on this side of the Atlantic? What debate?

At least there is a public airing of issues in the US. In Britain, the decision to nationalise Bradford & Bingley, the latest failed bank, seems to have been made in about two days while the Prime Minister was trying to insert himself into the diaries of important people in America.
Parts of B&B will probably be subsumed into the already-nationalised Northern Rock as the UK organises its own stuffing of toxic waste under the tarpaulin. We must surely be close to having a grand plan inflicted upon us here, too.

At the heart of the Enron scandal was the energy company's use of "special purpose vehicles" – accounting tricks that allowed assets to be hidden from the balance sheet and so mislead investors as to group's wellbeing. The US government is on the verge of creating the mother of all special purpose vehicles, while Britain is creating one of its own without showing any signs of knowing how to run it. In the process, the whole structure of awards and penalties in the capitalist system is being changed. We would surely be better served by greater deliberation about the consequences.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3098241/Financial-crisis-Bail-out-in-haste-repent-at-leisure.html