The $700bn bail-out is already hurting your wallet
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David Stevenson Sep 25, 2008
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Henry Paulson: already costing us money
If US Treasury Secretary Henry 'Hank' Paulson thought his $700bn plan to bail out markets would boost investor confidence, he must be feeling sorely disappointed – they're more scared than ever. And if his plan goes through, things could get even worse.
Paulson's proposed Troubled Asset Relief Programme (TARP) would be the biggest-ever 'bad bank' bailout, buying up to $700bn of dodgy debt – mostly mortgage related – from the banks.
But far from welcoming it as the solution to the crisis we've all been waiting for, the money markets have gone haywire - interest rates around the world are soaring as banks become even more fearful of letting cash out of their vaults.
The one-month London Interbank Offered rate - LIBOR, at which banks supposedly lend to each other - yesterday jumped over 0.25% to 3.47% for US dollars, the highest since January. Today, "brokers expect 3.64%", says the FT. That compares with the 'official' Federal Reserve funds rate of just 2%.
Meanwhile, sterling LIBOR has reached 5.99%, the most in 2008, while the one-month Euribor rate today hit 4.98%, the highest level since December 2000. Hong Kong and Singapore three-month rates also rose overnight. And the difference between three-month dollar LIBOR and the overnight indexed swap rate – another key money market indicator – has widened to the most on record.
This is all bad news. These rates are basically the rates that your mortgage and your personal loans are priced off, not to mention the cost of debt for small businesses. Mr Paulson's plan is supposed to be making banks more confident of lending to one another, not drive them into a mad panic.
Some are arguing that rates are rising because of the fear that the plan won't succeed. But maybe – just maybe - it's because investors are thinking: "If that's the best you can come up with, we really are doomed."
You can see why. For a start, the CVs of the guys behind this plan don't inspire a lot of confidence. Hank Paulson might be trying to sell the plan past US Congress by complaining about the "irresponsible, terrible and inexcusable" things done by the finance industry in recent years, but where was he working before he took on his current role?
That's right, he was the boss of Goldman Sachs, arguably the boom's most iconic investment bank. Surely he must have worked out where his salary and bonuses were coming from?
Then there's Fed chairman Ben Bernanke, who assured us that subprime would be contained, and said as recently as last July that total write-offs were likely to be less than $100bn. They're already $500bn and counting.
And there's a good argument to be made – and one we've made many times before – that much of the blame for the current situation can be laid at the feet of Bernanke's predecessor, Alan Greenspan.
So there's no reason to have much confidence in the ability of the authorities to steer us out of this mess.
But on top of this, the Tarp is just a bad idea, plain and simple. As the FT's Martin Wolf puts it, "the Paulson scheme is neither necessary, because the Federal Reserve can manage illiquidity through its lender-of-last resort operations, nor efficient, because it can only deal with insolvency by buying bad assets at far above their true value, guaranteeing big losses for taxpayers and providing an open-ended bail-out to the most irresponsible investors".
And as Robert Cyran on Breakingviews adds, if this bail-out is simply about driving the price of troubled assets higher, there's an easy solution – just scrap mark-to-market accounting, and allow banks to price assets on "a held-to-maturity basis", which would reduce their write-downs (and perhaps even lead to write-ups in some cases.
And if it's about actively recapitalising banks, then the government would "get a lot more bang for the taxpayer buck by just investing directly in them, preferably at onerous terms for the institutions involved."
It might be a "disappointingly non-market solution", but it "would be the lesser of two evils." As it stands, "taxpayers will take a shellacking", particularly as the $700bn "probably isn't enough to fully clean up the mess."
Maybe Paulson realises this. There's a clause in the act that states that "decisions made by the secretary… may not be reviewed by any court of law or any administrative agency." It's a nice backside-covering clause for Hank, but giving one man dictatorship-style powers over America's finances is hardly the way to restore confidence.
And markets clearly agree. Not only are short-term interest rates rising as banks hoard cash, but long-term borrowing costs are also rising (the yield on US 10-year Treasury bonds has climbed to 3.8% from 3.24% just over a week ago) as investors realise that this could destroy the value of the dollar.
So the Tarp is already hitting investors in the wallet – and it hasn't even been enacted yet. Nice work, guys.
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