Wednesday, October 1, 2008

Why the Treasury and the Fed's previous actions failed

As Hank Paulson seeks to resubmit his action plan to save the US financial system, Euromoney considers whether he was ever the right man for the job, asks the questions that he desperately needs to answer, and analyses the mistakes he has made which mean, whether his bill is eventually passed or not, he has failed as Treasury secretary.

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Q: Every time you’ve spent money, you’ve said it would solve the problem. What’s different this time?
Fannie Mae and Freddie Mac were off-balance-sheet conduits for the federal government designed to disguise the extent of the public debt taken on to sustain the housing market boom. They ought to have been consolidated on the nation’s balance sheet years ago.

Yet when they were finally nationalized, no immediate risk to their capital positions and access to funding was apparent. Why did Paulson feel he had to spend money to do this now – was he held hostage by the threat of a Treasury and GSE bond buyers’ strike of investors from California to Beijing?

Maybe he had no choice. But estimates of the cost to the public purse of nationalizing Fannie Mae and Freddie Mac range from $200 billion to $300 billion. Doing so was meant to stabilize financial markets. They continued to deteriorate.

On September 17, the Treasury announced a supplementary finance programme to support the Federal Reserve’s balance sheet depleted by weeks and months of liquidity provision to the markets. No number has been put on this: private sector estimates suggest $100 billion and this was before the extension of swap authorization limits with foreign central banks to $620 billion from $290 billion to ease dollar liquidity, and the increases in term auction facilities secured against a wide variety of collateral to ease the system through the year-end.

Another $85 billion was lent to AIG and $50 billion spent on insuring money market funds, and the Treasury has spent at least $10 billion buying agency MBS.

A lot of money has been spent and the markets are still not working. So although it is understandable that Paulson and Bernanke should ask for a far bigger sum – $1 trillion was probably politically unacceptable but $700 billion sounded like an impressive enough amount to get the job done – to resolve all these problems with one knockout blow, it is also understandable that this would only be delivered with many strings attached and questions asked. That meant playing a political game. Paulson couldn’t manage it.

Why Hank Paulson has failed as Treasury secretary

Q: If you know so much, why didn’t you see the crisis coming?

Q: Every time you’ve spent money, you’ve said it would solve the problem. What’s different this time?

Q: If you’re going to cook up a plan, why not make sure it isn’t half-baked?

Q: Surely as a former investment banker, let alone Treasury secretary, you could have told SEC chairman Cox how ridiculous his short-selling restrictions were?

Q: Why was the bail out plan as originally presented so desperately short on detail?

Q: Did you forget that the negotiations were about politics as much as they were about saving the banking system?

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Why the Treasury and the Fed's previous actions failed

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