Congress does a bale-out deal, but will it work? Kohler

The deadline for getting a Congressional deal done on the TARP (troubled asset relief program) was always said to be “before the markets opened Monday”, preferably the Asian markets, including Australia’s.

The deadline for getting a Congressional deal done on the TARP (troubled asset relief program) was always said to be “before the markets opened Monday”, preferably the Asian markets, including Australia’s.

But in fact the more important deadline is tomorrow – the end of the quarter.

If bank accountants and auditors have to use market values for mortgage securities when they rule off the books tomorrow, a number of banks will be broke by the end of the week. Markets would collapse next Monday instead of today.

The stated aim of Henry Paulson’s TARP is to apply “hold-to-maturity” pricing to mortgages in default rather than “fire sale” prices.

Exactly how that will relieve the accounting situation for affected banks for tomorrow’s end of quarter valuations is unclear, but presumably if Congress has passed a law that puts $US700 billion of public money behind hold-to-maturity valuations, the auditors will be satisfied till next quarter. Phew.

Speaker of the House Nancy Pelosi and Treasury Secretary Paulson went to bed about 1am on Saturday night having reached a verbal deal and sent drafting staff off to an all-night and all-day session to finalise the wording.

As they worked yesterday, Republicans in the House of Representatives came out with a string of one-minute tirades against the plan, but it seems unlikely that the outspoken opposition from both sides of politics will pull the TARP before it is passed today.

Will it work?

Well, while the banks and their accountants definitely support the TARP because it will keep them alive until the weekend, there is a lot of opposition from economists.

Here’s one. Nobel prize-winning Joseph Stiglitz who told the Washington Post: “There is a kind of suggestion in the Paulson proposal that if we only provide enough money to financial markets, this problem will disappear. But that does nothing to address the fundamental problem of bleeding foreclosures and the holes in the balance sheets of banks.”

One clue to its efficacy lies in the number – $US700 billion. One Treasury staffer was quoted as saying: “We just wanted to pick a really big number.” But there does seem to be more science to it than that.

The total number of mortgages in the United States is about $US12 trillion. Half of those are backed by Fannie Mae and Freddie Mac, which are now in “conservatorship”, so that half of the market has been stabilised by Government support.

The other half is to be dealt with by the TARP. The amount being requested by Paulson – $US700 billion – is about 12% of the total of $US6 trillion. Delinquencies are running at about 6%, so the TARP should cover half the defaults and leave a buffer for further deterioration in the market. That’s the theory anyway.

The deal between Paulson and Pelosi provides for a first instalment of $US250 billion followed by further tranches of $US100 billion as required.

The $US350 billion that Pelosi wants to keep it to would just cover the 6% of delinquencies, with no buffer; under Pelosi’s scheme Paulson would have to come back to Congress for the buffer, or if delinquencies rose further.

Next question is whether the US Government can afford it, or whether it will be paid for by money printing and inflation.

The president of the Federal Reserve Bank of Dallas, Richard Fisher, raised this in a talk to a group of New York University students on Thursday: “We need to bear in mind that the TARP places one more straw on the back of the frightfully encumbered camel that is the Federal Government ledger.

“Foremost among the existing liabilities are some $13 trillion in unfunded Social Security benefits and Medicare obligations already promised to the people but as yet unfunded, an obligation that the Dallas Fed staff estimates at a present value of over $80 trillion.

“The former comptroller general of the United States, David Walker, estimates the Medicare deficit to be less, only $34 trillion, so let’s work with his less-excitable numbers. With everything including Social Security and Medicare properly accounted for, Mr Walker estimates that ‘as of September 30, 2007, the Federal Government was in a $53 trillion fiscal hole, equal to $455,000 per household and $175,000 per person’.”

Fisher concludes: “We are deeply submerged in a fiscal chasm.”

By the way, he has been voting against rate cuts because, he says, credit markets have contracted an STD – securitisation transmitted disease – for which lowering the fed funds rate to negative real levels will not only prove ineffective, but would only encouraged “further mischief”.

Meanwhile Bloomberg is carrying a story this morning putting the new fiscal burden into context. It starts off: “Wall Street’s five biggest firms paid more than $3 billion in the last five years to their top executives, while they presided over the packaging and sale of loans that helped bring down the investment-banking system.”

We haven’t heard the end of that.

This article first appeared on Business Spectator

 

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