As several have commented on the posting below, there is now more detail on the bailout package details.
I’m not sure how much value there is in analyzing all these moves and wrinkles, in part because I think the whole situation is just too complicated to predict, and partly because I doubt we are being entrusted with the whole truth.
Still, there’s some interesting stuff here.
Joint Statement by Treasury, Federal Reserve and FDIC
Today we are taking decisive actions to protect the U.S. economy, to strengthen public confidence in our financial institutions, and to foster the robust functioning of our credit markets. These steps will ensure that the U.S. financial system performs its vital role of providing credit to households and businesses and protecting savings and investments in a manner that promotes strong economic growth in the U.S. and around the world. The overwhelming majority of banks in the United States are strong and well-capitalized. These actions will bolster public confidence in our system to restore and stabilize liquidity necessary to support economic growth
Translation: Boilerplate all the way. Nothing interesting here, except that it reveals a bias that economic growth will return once "liquidity is stabilized." I hold a different view. I happen to think that we were living on borrowed money and borrowed time. I do not believe that we can return to "the way it was" by simply restoring liquidity.
Last week, the President’s Working Group on Financial Markets announced that the U.S. government would deploy all of our tools in a strategic and collaborative manner to address the current instability in our financial markets and mitigate the risks that instability poses for broader economic growth. This past weekend, we and our G7 colleagues committed to a comprehensive global strategy to provide liquidity to markets, to strengthen financial institutions, to prevent failures that pose systemic risk, to protect savers, and to enforce investor protections.
Translation: Okay, this is positively Orwellian in some places. I would dare say that "protecting savers" would include not forcing them to bailout rich Wall Street banks with direct subsidies and future inflation. Further, savers would certainly enjoy some free market interest rates (lots higher than the Fed’s fictitious rates) that are higher than inflation. Allowing savers a positive return would be the best way to "protect savers," while negative rates would reward banks and speculators. Virtually everything done by the Fed and the Treasury to date has been at the pronounced deficit of savers.
And the part about "enforcing investor protections" is thoroughly duplicitous, given the recent mid-flight rule changes that the SEC has dropped on the market lately (e.g. shorting rules). And I won’t even mention the options backdating scandal and other well-documented abuses that were never investigated or concluded.
(more)
First, Treasury is announcing a voluntary capital purchase program. A broad array of financial institutions is eligible to participate in this program by selling preferred shares to the U.S. government on attractive terms that protect the taxpayer. Second, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Paulson signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily guarantee the senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts. Regulators will implement an enhanced supervisory framework to assure appropriate use of this new guarantee.
Translation: Whoa! Hold on there! This is an enormous rule change, enforced with little discussion and even less reporting. I am quite surprised to have had to dig this information up off of a relatively obscure portion of the Treasury website. Okay, maybe not that surprised.
What does it mean that the FDIC is now guaranteeing "the senior debt of all FDIC-insured institutions"?
We can be certain that this is a fairly large expansion of the FDIC program, but I do not yet know how large the potential exposure might be. We might guess that this new authority was granted to stem the flow of debt financing away from troubled institutions. Now that the government is guaranteeing the senior debt of all FDIC-insured institutions, it means that holding that debt is as "safe as treasuries," only with better yields.
This is another gross marketplace distortion of the highest order. It means that sharp investors will now scramble for the highest-yielding junk debt of the most troubled institutions, so as to grab all that extra free yield. Suffice it to say that moral hazard has just been kicked up a notch. Instead of poorly performing banks being shunned, as they should be, they are now advanced to the front of the pack by virtue of offering a higher "risk free" yield than their more cautious competitors.
But the real kicker was that tag line, "and their holding companies." *Gulp* Unless there are some hidden details saying otherwise, this means that the senior debt of any holding company of an insured bank is now covered by the FDIC. Look for crappy banks to suddenly become highly desirable acquisition targets of non-related companies seeking a government subsidy for their own senior debt offerings.
Again, I have no way of knowing by how much, but this was an absolutely massive increase in the potential liability coverage for the FDIC.
It’s going to take a while to figure out all of the ramifications of all of these unprecedented rule changes, but I am quite confident that the law of unintended consequences is crouching on taut haunches in the tall grass somewhere nearby.
by rlee