For a day, it seemed that interventions were over. The U.S. Treasury had allowed Lehman Brothers to file for Chapter 11 bankruptcy protection. The Federal Reserve tried to cajole the financial sector to extend a multibillion-dollar bridge loan to AIG, but no one wanted to – or could – step up. By midweek, as the world markets seemed on the verge of meltdown, U.S. taxpayers became owners of up to 79.9 percent of the giant insurance company, in exchange for a loan from the Fed that could reach $85 billion. Not enough, Treasury Secretary Henry M. Paulson and Fed chairman Ben Bernanke told Congressional leaders in a secret session. Treasury must now buy all of those nonperforming exotic securities gumming up U.S. financial institutions. And over the weekend he sent to Congress what could be described as a Mad-Lib, I’ll fill in the blanks proposal: No specifics, no detailed plan of execution, no limits on the secretary’s authority, and a carte blanche legal immunity. Give him $700 billion and Treasury will do the rest.
Paulson and President George W. Bush demanded that Congress act without delay and without altering the amorphous plan, or face responsibility for bringing down the global financial system. However, the world markets gyrated because Paulson’s proposal lacked specifics. Senate Democrats came up with their own version, adorned with CEO salary caps, regulatory imperatives, and oversight, along with aid to the foreclosed. Lurking in the hallways are all sorts of folks holding bad bets that they earnestly believe taxpayers should cover.
There is some merit to the vagueness in Paulson’s effort to remove the toxic securities from the financial market, since their valuation is so notional. Still, oversight would be appropriate, especially since this is taxpayer money he’s talking about. More discussion about structure and process would be welcome, too.
Will it work? “The proclivity of Paulson, Bernanke, the FDIC, and the Comptroller of the Currency to intervene is exactly what you want to see,” according to David Levy, chairman of the Jerome Levy Forecasting Center. “Maybe we’ll need a bank holiday – we had one after 9/11. People greatly underestimate the government’s ability to take on more debt. Not that fiscal responsibility is a bad thing, of course it’s good. But right now whatever you have to spend is absolutely worth it,” Levy believes.
Financial Insights senior analyst Sean O’Dowd gives credit to Paulson for “wading into a situation they have no benchmarks to go by. While there may be criticism, and there certainly are taxpayer and deficit issues, it’s better to be looking into the abyss rather than from the abyss.”
Levy calls the economy a “long train rounding a bend. The locomotive has made the turn – home prices and the mortgage market peaked in the second half of 2005, but because of structured finance other cars continued to lurch ahead and things didn’t seem so bad in certain sectors. Now we have a saw-tooth erosion, with more and more pullbacks. Consumers have hit a wall, and we have begun what we like to call around here the mother of all retrenchments.”
After losing and then almost regaining around 800 points last week, the Dow Jones Industrial Average closed down 372.75 points to 11015.69 on September 22. Oil surged a record $25 on an intra-day basis, and settled at $120.92 a barrel. Gold jumped above $900, and the U.S. dollar and treasuries pulled back sharply. Keep those seatbelts buckled.