Tuesday, October 14, 2008

Hank Listens Up

Treasury Said to Invest $250 Billion in U.S. Banks
By Robert Schmidt and Peter Cook

Oct. 14 (Bloomberg) -- The U.S. will invest about $125 billion in nine of the nation's biggest financial institutions, including Citigroup Inc. and Goldman Sachs Group Inc., as part of a $250 billion effort to shore up the banking system.

It seems like only a few weeks ago we here at NotMakingThisUp urged Hank Paulson—who at the time was pushing Congress for nearly a trillion dollars to buy bad assets from regretful bankers—to adopt, instead, the Warren Buffett plan of taking preferred equity stakes instead.

Hey, it was just a few weeks ago.

September 24, in fact.

In “The ‘Oracle’ Speaks: Listen Up, Hank,” we asked: “How is it that Warren Buffett can cut a better deal with the best-run financial company in America [Goldman Sachs] than the U.S. Treasury can ask from the worst-run financial companies in America?”

It looks like somebody else has been asking the same question, for in the Bloomberg story, we read the following:

The proposed cash injections in exchange for preferred shares are part of a $700 billion rescue approved by Congress and follow similar moves by European leaders to unfreeze credit markets by helping beleaguered banks….

The purchases represent a new approach for Treasury Secretary Henry Paulson, who first promoted a bailout targeted at illiquid mortgage-related assets.

Now, we claim no special smarts in having suggested Hank Paulson follow Warren Buffett’s example, as he is now doing.

John Paulson, the genius who made billions shorting the very bonds the Treasury was planning to buy, came out for much the same plan in a Wall Street Journal op-ed piece not long after.

And it seemed fairly obvious to us that a dollar spent buying bank equity would be worth seven or more dollars spent buying bank debt, given the leverage banks employ in the normal course of business.

Furthermore, if you were asked to bail out your errant neighbor who had misspent his fortune building a McMansion and now couldn’t pay his mortgage, would you really want to take over your errant neighbor’s mortgage, and become his creditor?

Of course not.

You’d rather get ownership in the house, not only to make sure the guy keeps up the place, but to get the upside when he finally sells it.

Like that errant neighbor, Wall Street did, after all, screw it up, only on a super-spectacular scale beyond all imagination.

And Wall Street did so after decades of lobbying government to deregulate the very industry Wall Street subsequently destroyed.

So now that all those Wall Street hotshots are running to the government as the buyer of last resort, it seems only fair that those hotshots give up the most valuable piece of the capital structure: ownership.

Is it any wonder that Hank Paulson—the former head of Goldman Sachs, and one of the hottest of those hotshots—didn’t want to do that in the first place?

Jeff Matthews
I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.


GS751 said...

am I going to far speculating that Warren and Henry had a heart to heart. There was an article in the WSJ somewhere that Warren was "the coach"

Anonymous said...

I think McCain is listening up also. Just read McCain's speech today about "re-regluating" the financial industry after the mess they've created. You'd think after reading his speech, McCain was a Democrat! Here's the link to the speech which I'm referring. Classic flip-flop...

Michael_Corleone said...

So according to various news reports, Paulson summoned 9 bank CEOs to Washington, put a piece of paper ( a ONE PAGE document) in front of them giving the Treasury a preferred equity stake in each company... and then informed them that no one was leaving until everyone signed.

The CEO of Wells Fargo (at minimum) objected that his company did not need or want the Treasury's money. He was told to sign anyway.

After three and a half hours, everyone capitulated.

If we take one of these news stories and substitute "Corleone" instead of "Paulson"-- it sounds like a scene from The Godfather.

The Treasury Secretary basically committed kidnap and extortion to "heal" the financial system?

Michael_Corleone said...

Hank Paulson summoned 9 bank CEOs to Washington, sat them in a room, placed a piece of paper in front of them and said no one was leaving until everyone signed.

The ONE PAGE document gave the Treasury a preferred equity interest in each bank.

The CEO of Wells Fargo said his bank did not need or want the investment, but he was told to sign anyway.

The CEOs were in the room for three and a half hours -- whatever you might think of CEO intelligence, it doesnt take 3.5 hours to read one page. And at least one CEO is known to have voiced objection -- but was told to sign anyway.

Imagine this same story, but substitute "Don Corleone" everywhere you see "Secretary Paulson"...

To summarize: in the name of "healing the financial system", the United States Secretary of the Treasury committed kidnap and extortion.

Lyon Jewett said...

Paulson just said on Kudlow that the meeting went wonderfully.

I don't believe him.

Hayseed said...

how about instead, letting the bad banks fail and the good banks survive??? novel idea huh? oh i know, we need this injection and that infusion and this preferred position... this central planning grab to me is the most distasteful occurrence in the history of capital markets. just because we dont have the stomach to ride out what we perceive as a downturn, then we turn to the printing press to rescue bad management.

here is the reason we must let the markets work: it is precisely during these times, where firms or people or theories or constructs are challenged, when out of the ashes much like the phoenix, that new paradigms are created, new ideas are liberated. think of edison and the light bulb... think of the mcilhenny family whose sugar cane crops were burned during the civil war, and the only thing that could grow were those pesky tabasco peppers... think of the japanese who had nothing after ww2, and became the top car manufacturer in the world in 30 yrs, and without domestic steel... think of, well, the great depression, where investment banks were liberated to offer the world the greatest source of constant capital in the history of the world. NOW, we have change, and change is always good.

LET THE MARKETS WORK!!! the weak die, the strong and well-managed survive and thrive, and an entirely new investment intermediary will likely emerge, something that we havent thought of before now. not letting the markets work will have consequences that we cannot imagine, and will be long-lasting and probably detrimental. besides, if in fact the market is a discounting mechanism, which of course it is, then what does it say about $1 trillion spent by your governemnt so far on the problem???