MonkeyBusinessBlog

Hank Paulson Clearly Has Lost His Mind.

From Bloomberg News;

Former Treasury Secretary Henry Paulson said letting Bank of America Corp. scuttle its takeover of Merrill Lynch & Co. last year was “unthinkable,” and his remarks about ousting management were “appropriate.”

Paulson “intended to deliver a strong message” to Chief Executive Officer Kenneth Lewis in December “that it would be unthinkable for Bank of America to take this destructive action for which there was no reasonable legal basis and which would show a lack of judgment,” the former official said in remarks prepared for a congressional hearing tomorrow. The text was obtained today by Bloomberg News.

Lawmakers on the House Committee on Oversight and Government Reform are trying to determine whether regulators overstepped their authority by pressuring Bank of America to complete the purchase of Merrill. The panel has already heard from Lewis, who declined to characterize the pressure as a threat, and from Federal Reserve Chairman Ben S. Bernanke, who testified that Lewis had the final say on the Merrill takeover.

Paulson told Lewis on Dec. 21 that backing out of the deal “would show a colossal lack of judgment and would jeopardize Bank of America, Merrill Lynch, and the financial system,” according to the testimony. Paulson confirmed he had told Lewis the Fed might remove management and the board of the Charlotte, North Carolina-based bank if they failed to complete the takeover of New York-based Merrill Lynch.

Lewis told Congress last month the bank had considered abandoning the transaction in mid-December as losses at Merrill spiraled toward more than $15 billion. Bank of America completed the acquisition of New York-based Merrill Lynch in January without telling investors about the losses. The lender is the biggest in the U.S. by assets and deposits.

There it is folks.  The Secretary of The United States Treasury threatened the CEO of a public company with dismissal if he backed out of a deal that clearly had turned against him.  More importantly, Ken Lewis and BofA would have certainly had a case for breaking the deal under a material adverse condition clause after Merrill turned up another $15 billion in losses for Q4 2008.  If you want to get really diabolical (and why the hell not) we can surmise that by sticking BofA with Merrill, Hank Paulson essentially got rid of two Goldman rivals as opposed to just one!  Maybe that's too much. Perhaps most importantly however, I get to re post an imaginary conversation I wish took place between Ken Lewis and Hank Paulson back in December 2008!  

Ken: "Hank, I tried to do you boys a favor in September when the world was about to end by taking Merrill off your hands.  Turns out this guy Thain is not only full of poop but he and his little buddies are trying to eat the entire place out from the inside.  I'm breaking the transaction."

Hank: "You can't do that Ken.  You try it and I'll toss you and your boys out."

Ken:  "Oh yeah, you and what legal army chrome-dome?  You're a lame duck with an approval rating of minus ten!  These boys misrepresented themselves at that emergency sale back in September AND this $80 million head trader Montag is losing new money faster than a jack-rabbit humps.  You ever see a jack rabbit.....

Hank: "Listen here Ken, when I was at Goldman we used to...

Ken: "First of all you ain't at Goldman anymore.  Secondly, don't interrupt me again.  Now Hank, I am the CEO of perhaps the most important bank in this country.  I can invoke all sorts of market condition clauses that get me out of that Merrill trade.  I know it and you might know it if you weren't so damn stupid.  So we can play nice and you use that great big Goldman Sachs brain of yours and figure out a way to make these $15 billion of losses end up in that Omnibus Bill those boys in Washington pass every year.  $15 billy clubs is a rounding error for those boys.  OR I'll see your behind in court as the whole damn system goes down in flames.  You choose Hank.

That's what I would have said if I were Kenny!

When is Enough.....Enough?

There's a great scene from the TV show M*A*S*H* (I feel I have to say it was a TV show for our younger readers) where Hawkeye and Trapper John are getting chewed out by Colonel Blake for some stunt they pulled.  Here's the dialog from memory;

Colonel Blake:  "Ok, this does it!  This time you've gone too far!  What were you thinking??"

Hawkeye :  "I don't know, we were too busy going too far!"

This is how I feel about this article from Bloomberg News Wall Street Begins Campaign to Thwart 'Populist Overreaction'

Wall Street’s largest trade group has started a campaign to counter the “populist” backlash against bankers, enlisting two former aides to Treasury Secretary Henry Paulson to spearhead the effort.

In memos of confidential meetings with top financial executives, the Securities Industry and Financial Markets Association said it began this month the “execution phase” of the operation, which pledges to “embrace change” and accountability. The plan targets policy makers and the media in New York, London, Washington and Brussels and calls for a “city-by-city, grass roots” approach.

Have a read.  SIFMA is doing some sneaky stuff like using smaller regional dealers to grease Congress since these smaller dealers are under the radar, but that isn't what really bothers me (maybe I should be really bothered that that doesn't really bother me).  What should be poking all of us in the eye is two of Hank Paulson's deputies are getting a $70,000 monthly retainer to "craft the message".  Jim Wilkinson was Hapless Hank's Chief of Staff and Michele Davis was his spokesperson. 

As soon as the jig was up in January, these two signed on with The Brunswick Group.  You think it's just random that the Street decided to start a Congressional petting session and they just happened to find these two working at The Brunswick Group?  No?  Neither do I.  Ms. Davis knows exactly how to "get the message across" and Wilkinson knows who to "get it across to."  This was probably in the works when they were both sitting at Treasury.

This sh*t just has to stop....now!  You want to work for the government and then go and work in the industry you were either regulating or doing business with, fine....unless it has to do with using your Rolodex of Congressional and government contacts to peddle influence.  If that's the case then NO YOU CAN'T!  When is enough enough?

Hank Paulson National Hero?

The Wall Street Journal Blog "Mean Street" was out with this yesterday It's Time To Enshrine Hank Paulson as National Hero . Hmmm. Have a read.  The actual piece isn't nearly as dramatic as the title, except at the end where Mr. Newmark says, "If something works, it works. Just give credit where it’s due. And that would be with Hank Paulson, national hero."  Personally, I think that had Paulson truly understood the magnitude of what was happening during the latter half of 2007 and throughout 2008, the complete collapse that Paulson and Bernanke averted in October 2008, may not have gone down the way it did. 

Let me be clear on one big point.  The credit disaster that started in residential mortgages and the chain reaction that took down (or is in the process of taking down) commercial mortgages, corporate loans and emerging market debt, was fully baked in the cake by the end of 2006.  Probably sooner.  The bonds were bad and the financial system and investors were very highly levered.  The sucker was going to blow when in late 2006 subprime loans started going delinquent and then defaulting about 3 months from origination!  The Street tried to put the loans back to the titans of subprime finance like Ameriquest and New Century and those institutions showed what they were.....machines cranking out horrible loans to feed the Street's securitization factory, with little to no capital.  Boom!  All the dominoes started to fall.  Liquidity and risk license were violently pulled across all structured credit product and you know the rest of the story.  Paulson got to Treasury in mid-2006. I think you have to be fair to him that by the time he figured out where the men's room was at Treasury, there wasn't much to do to stop the explosion.

However,  I think it's pretty apparent that Paulson underestimated what was going on throughout 2007 and was pretty oblivious to the catastrophe that was on its way for 2008.  It would have helped if others in positions of power, like Tim Geithner and Ben Bernanke, had recognized the problems that could have been at least partially mitigated.  However, they were no help either.  Nevertheless, Hank Paulson should have, based on the fact that he came from and ran a large investment bank, known the following;

1. Investment banks such as Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley had tremendous exposure to the above mentioned assets.
2. Any one of these practically unregulated institutions had the ability to take the whole system down if they failed.
3. All of these institutions were highly leveraged with mostly wholesale funding.  They did not have access to the Fed window and had a huge presence in the commercial paper markets, thus threatening the all important money markets.
4. AIG was a gigantic presence in all the structured credit markets.  You wanted a guarantee on just about ANYTHING, you knew you could go to AIG.  AIG was one of the great common denominators in this crisis.  If you ran Goldman Sachs you have to have known that AIG was a repository of risk and they weren't exactly charging an arm and a leg for it.  Anything happens to them (and lets not forget that everyone on the Street knew that AIG had been monkeying around with their capital and reserve levels as well as much of reinsurance industry for years.  There was a little trial going on sending the heads of Gen Re to jail for its dealings with AIG) and Houston we have a problem. 
5. Like AIG, the monolines like MBIA, Ambac, FGIC, etc...were in the same systemic risk bucket as AIG.
6. While we are on the subject of "guarantors of risk", Freddie and Fannie were on their way down the toilet too.  You just had to do the arithmetic on a $3.5 trillion guarantor book. One-percent loss = $35 billion.  Two-percent loss = $70 billion.....game over.
7. The all important commercial paper markets had nearly $1 trillion of assets backed by structured securities and many of the issuers were members of our banking system, running SIVs and asset-backed commercial paper conduits.  If the commercial paper investors didn't want to play anymore, somebody had to come up with nearly $1 trillion of balance sheet....fast.

Imagine if Paulson started taking action, behind the scenes as much as possible, to get the investment banks to raise more capital in early '07, improve their liquidity profiles and start slowly delevering.  What if he made it known to Freddie and Fannie to immediately cease and desist guaranteeing subprime and Alt-A crap?  What if he and Bernanke spotted the coming disaster in the CP markets and moved, again behind the scenes to get a facility in place to back stop the money market mutual fund market.  This way if one of the investment banks went down, they could flick a switch and the MMMF's like Reserve Fund wouldn't break the buck and cause a run on the bank (which is what happened in September after Lehman went down).  What if Hank paid Marty Sullivan at AIG a visit (along with the monolines) and told them their capital positions versus their risk were making him very uncomfortable.  What if Hank polled the investment banks on their exposure to AIG?

I can go on and on.  I can say, if you have read this blog for a while, we called a lot of this because we were in these markets and saw what was happening.  Therefore, this isn't all Monday morning quarterbacking.  If we knew, how come Hank didn't?  Sorry, but you can't call Hank Paulson a hero in my book.  There was plenty he could have done to lessen this crisis.  He didn't.

Perfect Stupidity Storm Forming Over Financial System Today!

What a day this is going to be!  We have;

1. Day two of the greatest "he said-he said" since Larry Birkhead and Howard K. Stern staged their epic battle for fatherhood of Anna Nicole Smith's baby daughter!  Our dear friend Rita Cosby chronicled this duel in her best selling book, "Blonde Ambition".  We may ask her to take on the epic Ken Lewis- Hank Paulson- Ben Bernanke saga next!  BofA CEO Kenny Lewis claimed to New York Attorney General Andrew Cuomo that Hank Paulson (then Secretary of the Treasury) threatened his job if he didn't take Merrill Lynch back in December 2008, after Lewis got a early Christmas present from "The John Thain Gang " in the form of a surprise $15 billion loss.  Lewis claims that it was Paulson who "encouraged" him not to disclose these losses to BofA shareholders until after the deal was done.  Meanwhile, Paulson at first told A.G. Cuomo, according to Cuomo, that HE was pressured to do this by Federal Reserve Chairman Ben Bernanke.  Ben Bernanke denied this and Hank immediately recanted.  Chairman Bernanke did not give deposition to the A.G. citing "bank examiner privilege"!  This is amazing.  Firstly, any process that makes Andrew Cuomo look like the "White Knight" is pretty damn heinous!  Secondly, as a perfect lead in to item number two, why would ANYONE trust ANYTHING the government tells us while watching this sh*tastrophe??
2. Today the government will get its first indication of who wants to play ball in Timmy's legacy asset flea market!  Check this out:  Investors are actually afraid to play ball with the government because, paranoid as it sounds, they are worried the government might change the rules on them midstream!  I can't imagine where they got that idea...do you?  Get this, after allowing our financial institutions to mark to model, many institutions may not participate in the cleansing.  Who knew?  Let a guy mark a bond worth 40-00 to 90-00 and then he won't sell it at 75-00?  Crazy.  Additionally, Citigroup says they won't participate, which considering the FDIC has already wrapped $300 billion of their garbage, makes sense.  They've already been cleansed and all it cost them was some preferred stock that they got to convert to common.  Meanwhile, Morgan Stanley says they WILL participate.  They want to buy stuff!  Awesome.  A company that was given a bank charter, had all their new debt guaranteed by the FDIC and got $10 billion in TARP capital wants to sell their assets at the governments pumped up price, THEN buy another bank's assets with the government's generous financing and put option on the asset!  I just wish Timmy would take one of us aside and say, "Look dude, I know it's nuts, I'm not stupid, just corrupt."  That would make me feel a little better.
3. The "Stress Tests" start getting released to the "Gang of 19" today!  This is easy for me because Mark Gilbert at Bloomberg wrote a great piece  Stress Test Scores 'C' If Name Ends in 'itigroup'  Very funny, check it out.
4. Finally there is this also from Bloomberg Bear Stearns, AIG Dumped $74 Billion in Subprime CDOs on Fed.  Ahh yes, Maiden Lane I II & III.  This is the financial markets equivalent to "Area 51" (where we keep all the UFOs and the identitity of the guys who bought the March 30-00 puts on Bear Stearns in March 2008 when the stock was trading at 70-00).  The Fed says they are only down $9.6 billion.  Hah!  Dream on.  The Fed said they are using mathematical models to value the assets.  The guys who don't want to participate in Timmy's plan should call the Fed's model for a better bid!  The article also points out that the Fed has lent about $2 trillion to banks, taking many of the financial creatures as collateral.  I'm sure they took the proper haircut.  Whatever the case, since the Fed isn't allowed to take a loss, we do.

Strap in and don't forget to put on your "I'm With Stupid" shirts on!  

He's Slowly Making His Way Back to Being "Hapless Hank"

Important Inter-Bank Lending Rate Goes in Wrong Direction. TED Spreads Too.

A bit of disconcerting data this morning; Three-Month Libor, the rate banks lend to each other on a unsecured basis, jumped nine basis points to 2.24%.  This is the second daily increase after a string of twenty-three consecutive days of decline.  Additionally "TED Spreads", the difference between three-month Libor and three-month Treasury bills increased six basis points, breaching 200 basis points (2%) for the first time this week.

There is a lot of nervousness in the money markets again over the health of key players and the perceived loss of focus from the TARP.  Talking with our friends on bank funding desks, fear is starting to return to an area that just about ten days ago seemed to be stabilizing itself.  Citigroup seems to be rudderless right now as they prepare for a onslaught of consumer credit defaults.  Goldman Sachs equity has taken a dreadful pounding the last two weeks, which is not comforting to the money markets.  After all, once you've been glorified as the bell-weather for greatness, showing the world that you can be just as dopey as everyone else isn't a confidence builder.  GE is also showing itself to be just another over-leveraged entity that can't delever quick enough and needs to be hooked up to the Federal Reserve life-support system.  Another myth dispelled by cold reality.

I also strongly believe that AIG's ability to completely jerk the Fed and Treasury around late last week did a lot to damage those institutions credibility.  The view from inside "The Monkey Cage" is that AIG has gained the upper hand in this relationship and is now embarrassing the Fed.  I believe that letting AIG live may actually turn into more of a systemic risk than if they died.  The Fed and Treasury, in my opinion, revived their credibility in October with the number of bold moves that stabilized the banking system.  AIG, with all their hubris and obnoxiousness is degrading that hard earned credibility.  The Fed loses it again and I have a hard time seeing them get it back.  I strongly believe that psychology is a VERY powerful factor in determining if and when we come out of this mess.  AIG is working against us.  It's time for them to go.

Another thing that is working against us is the media and congresses lack of understanding of what the TARP was supposed to be about.  And I will not give Treasury a pass here because they have done a horrible job at getting the right message out.  Secretary Paulson's appointment of Neel Kashkari, a thirty-five year old investment banker, to be the head of the TARP has been a disaster.  It's nothing against Mr. Kashkari, but this is not his game.  Anyway, last night I watched "The Jim Lehrer News Hour".  Mr. Lehrer had Mr. Paulson on and Lehrer just kept pounding away at Paulson,(paraphrasing)

Lehrer: "We gave you $700 billion to fix this mess, how come the economy is getting worse not better?"

Paulson: "The mission of the TARP was to stabilize the banking system.  The system had reached the tipping point and we kept it from failing.  That's what the TARP was and is for."

Lehrer: "Well, what is the difference between the economy and the banking system?  Aren't they the same?  Does the public know there's a difference?  Is there any difference?"

Paulson: "Oh, if the banking system failed they would know the difference."

Lehrer: "Ok, but how come things keep getting worse when we gave you all this money?"

And on and on it went.  Treasury has done a crappy job communicating the effect of what a collapse of the banking system would have on the American people, period.  Honestly, I KNOW I could have done a better job and I'm free if they want to give me a call!  Additionally, politicians don't seem to have done any homework over the last few weeks about the financial system and the economy and are fanning the flames of despair.  Yesterday, Senator Chris Dodd thundered that they gave the banks billions and they better start making loans.  Who should they lend to Senator?  Lets face it, good credits (commercial and consumer) are cutting back on their debt, not increasing it.  The only people who need credit right now are people (and companies like our friends in Detroit) that don't meet the underwriting standards the banks have just retrieved from the dumpster that they were thrown in sometime around 2003.  The capital was not injected to run around the country like a drunken sailor handing out money to anyone who asked.  The capital was injected to shore some banks up against oncoming losses, allow some banks to use capital to buy weak banks and write down the weak bank's bad assets, attract private capital to TARP participants, and allow the banking system to stabilize and begin to heal itself.  The public could have been enlightened (Congress is a lost cause!) to this many many times over in the last month.  Treasury and the Fed fell down on the job when it comes to this and now we are paying the price.

Well that's enough of that.  There's more about Treasury's change of focus with regard to the second half of TARP that has given the impression that Treasury is just flailing about.  Personally, I believe they are doing the right thing on that.  Here's a link to what we said about that yesterday TARP Changes Focus

Be lucky today.

Looks Like Paulson Might be Getting us a Good Deal

Remember in the Godfather II, when Michael Corleone confronts brother Fredo about his relationship with Hyman Roth and Johnny Ola and rival crime boss Don Barzini? And Fredo says, "They said there was something in it for MEEEEEE!" Then he goes on to talk about how he is smaht not dumb like people say. Well as a US taxpayer for awhile there it looked like we were getting a WORSE deal then Fredo in this mess! As in we were giving something up (money) and getting what could be nothing (or worse) in return.

Now Eric points out below that Paulson might be getting us a better deal a la Warren Buffett. We, as taxpayers, might get preferred shares in some of the banks we help. Seems like the Brits are going that way and Hammerin' Hank Paulson likes the idea. That makes me feel better and it should make you feel better too. To paraphrase Tom Hagen from the Godfather: Its now late 2008, nobody wants anymore bloodshed. Now back again by popular demand.

Still Kinda Quiet in DC

Sure the U.S. House of Representatives is off today for Rosh Hashanah and the stock market seems to have come back somewhat. There's a little lull in the action. That won't be for long as the Congress will need to readress this issue quickly.

It got me to thinking back oh so long ago like 2 weeks........Cant you see Hank Paulson sitting there saying "yeah Mr. President, I'll just tell Congress to give me the $700bn of the taxpayers money with this 2 page release form. I'm the Treasury Secretary for chrissakes. I'm a big important guy."

So in keeping with our cultural references one of the most well known actors of the 20th century passed away this week. Now in this clip lets have Paulson be "Fast Eddie" of course played by the now deceased Paul Newman. We'll have Bernanke be the guy in the hat. Then lets make the gent who is going to introduce him to the guy who can give him a big can of whupass be Barney Frank. Minnesota Fats (who was played so well by Jackie Gleason) would be the U.S. House of Representatives but that's for another clip. Ladies and gentleman one of the classic movies of all time......"The Hustler". 

Maybe Yelling Fire at The Fatman's Convention Wasn't The Way to Go

I am sure that Hank Paulson is a smart guy.  I pray that he is a smart guy.  However, you have to admit, he couldn't sell a drowning man a life boat!  First we had the whole GSE fiasco.  Hank asked for and got the authority to take out Freddie and Fannie.  His big selling point to Congress was, "Give me a big old bazooka gun in the form of a couple hundred billion dollars.  As long as the world knows I got that big old gun in my pocket, they will have faith and not make me pull it out!"  Unfortunately, Hank didn't realize that a lot of street smart people were going to buy up agency debt at fat spreads, and then tell him (force him) to use the bazooka so they could watch those spreads snap in and make millions.  It didn't help that he didn't realize that Freddie and Fannie were carrying between $60 to $70 billion of fantasy capital.  That and a late but full appreciation of how far down the credit curve the two Fredos went and how bad the housing situation really was, forced Hank to take out the bazooka.  The congressmen, especially the congressmen from his administration's party felt like they got hoodwinked.

Now we come to the final mother of all crises, the situation we are in now.  Paulson and Bernanke see the true horror that is coming in residential mortgages, commercial mortgages, corporate and consumer debt and we have to get to high ground pretty damn soon.  Then on Wednesday and Thursday of last week, the crisis in the money market mutual fund sector brought all of us right to the edge of the abyss.  Paulson and Bernanke save the day with a quick backstop to insure money market mutual fund investments.  However, they know that things are deteriorating at an accelerating pace.  They have to go back to Congress, the same guys who Hank just pissed off two weeks ago, with the GSE bailout (not to mention the little AIG conservatorship) and ask for at least $700 billion.  How does Paulson go about doing it;

"Oh my God, FIRE.....this things gonna blow.....TOMORROW!!!  Quick, here's a three page document giving me martial law over EVERYTHING FINANCIAL!  I need it NOW!  Don't worry how we're gonna do it, Bernanke's got a PHd, he'll come up with a methodology to price two hundred and twelve types of structured mortgage product over the weekend.  W, get your head out of the baseball game and warn the Country of its impending doom!  Congress, just sign the damn thing!!"   

Unfortunately, two things happened. 

1. The congressmen who feel liked they've jerked around the last month or two are pissed.  A lot of the congressmen don't believe in spending all this taxpayer money and they certainly don't like having to work on something as boring as finance when there's fund raising and boondoggling to do.  Additionally, Hank and Ben showed up at the hearings Monday without doing their homework on how to actually use the $700 billion. 
2. You have now scared the country and the market out of its wits, which in turn makes the Congress and The White House feel like they have to pass the quickest bit of legislation they can, even if it is far from the best.  This is the biggest piece of financial legislation in history and it's almost like debate has been outlawed.

Paulson and Bernanke convinced a good part of the country that Armageddon is coming Monday if a piece of legislation isn't passed and now we have the buzzards swirling around Wachovia, and getting a nice whiff of Morgan Stanley.  The public unfortunately, was not aware of what a slow moving trainwreck Wamu was (it could have failed anytime between last month and now) and they will associate "No-Bailout Bill" with "Largest Bank Failure in History"  That's not good.

We had a small luxury of time to try to get this right.  However, the hysterical way this plan was pitched has robbed us of that time.

Hank & Ben Say "We Need it TODAY!" Congress Pushes Back..At 6pm Goldman Sachs Gets $5 Billion From Buffett! Now I'm Really Scared!!

It takes a lot to shock me these days.  Yesterday I watched Hank Paulson and Ben Bernanke come up to Capital Hill armed with a two to three page proposal to spend $700 billion on the "Troubled Asset Relief Act".  They told Congress that they planned on paying something that Bernanke called, "Held to Maturity Value", and I started getting real nervous.  Senators pushed back on Hank and Ben and maybe for the first time since I was eight, I was on the side of the Senators!  Chairman Bernanke and Secretary Paulson see the tidal wave coming.  It is a tidal wave that some of us have seen for some time now.  I think that in the first week of September, Paulson and Bernanke finally saw what we saw.  The defaults and losses in residential mortgages were just in first-gear.  A whole bunch of subprime, Atl-A, and Alt-A Option ARMS are going to reset over the next twelve months and hundreds of billions of mortgages are going to default at a time when Loan to Value ratios where soaring to 120-130%.  Here is something we wrote back on September 7, 2008.  It was titled "Freddie & Fannie Bailout: Why Now and Why You Should Be Scared"

Today, the Government of the United States took over Fannie Mae and Freddie Mac.  It was a move that Treasury Secretary Henry Paulson and The White House desperately did NOT want to make on their watch.  Hence, all the talk about bazookas in pockets.  As most have predicted, Treasury now will begin a series of preferred stock purchase agreements, adding capital to Freddie and Fannie as needed.  Each time Treasury buys in, existing common and preferred share holders get pushed further and further down the capital structure until the losses Freddie and Fannie will take consume them.  It sounds right out of an "Animal Planet" documentary.  Dick Syron and Dan Mudd can now leave to "pursue other interests" or "spend more time with family."

What you might be asking is, "Why now?"  After all, Paulson has been talking right up until the middle of last week that he's confident he won't have to use his Treasury preferred purchase powers (the bazooka).  What changed his mind so suddenly?  Paulson is claiming that based on discussions with his advisors at Morgan Stanley (I still laugh every time I think about Paulson bringing them in as "advisors") he now sees that both Freddie and Fannie are essentially insolvent.  I'm not sure why he needed Morgan Stanley to tell him that.  After all, It's not rocket science or fifty little line-items that may or may not add up to insolvency.  It's the "Tax Deferred Asset" and the "Temporary Loss on Securities" entries. The Tax Deferred Asset alone is $35 billion for the combined entities!  The Temporary-Loss item is at least $20 billion.  I'm assuming Paulson took a couple of accounting courses when he attended The Harvard Business School.  He really didn't need an advisor to tell him these guys were cooked. 

Here's what scares the crap out of me;

1. The Mortgage Bankers of America put out their monthly delinquency and foreclosure data on Friday.  Serious delinquencies (90 days or greater) and foreclosures on BOTH PRIME AND SUBPRIME continue to increase unabated.  With the rise in unemployment, continued deterioration of real estate prices, and the specter of billions of negatively amortizing option ARMs hitting their principal caps, (thus driving more mortgagees into default), the housing situation is getting worse at an increasing rate.
2. Former Federal Reserve Chairman Paul Volcker said on Friday, "This bright new system, this practice  in the United States, this practice in the United Kingdom and elsewhere has broken down.  Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.  It is the most complicated financial crisis I have ever experienced and I have experienced a few."
3. Finally, Secretary Paulson, a man who seems to increase the frequency of his "all is well" speeches right when we are on the brink of something really bad, said in his statement today, "Nothing about our actions today in any way reflects a changed view of the housing correction or the strength of other U.S. financial institutions."

I don't know about you, but if numbers one and two didn't get you, number three has to clinch it!  Stock up on the bottled water, canned foods and ammo because things are about to get a whole lot worse.

Bernanke and Paulson have got religion now and they are trying to say it in any way possible without having to just come out and say it.  They need that $700 billion to get the assets that are going to take catastrophic hits off the bank books and on to our "non-public" books.  We know this because if Paulson and Bernanke truly believed that market prices are purely based on fear and illiquidity and that many of these assets are going to return their original cost (some combination of principal and interest), they would just wave the mark to market accounting on these assets and let institutions hold them at cost.  In some cases, this would allow for write-ups.  You might be saying, "Eric, that's stupid.  Do you know how difficult and damaging it would be to get everyone on board with that type of accounting methodology change?"  My answer would be, "Is it harder than raising $700 billion to buy these assets at cost from the banks and convince tax-payers that it has to be done?"  The government knows that if it just lets banks carry these assets at cost, the defaults and losses coming will force them to take huge writedowns as the assets become impaired.  If they are on "OUR" books, who is going to notice?

Finally, after Congress pushed back hard yesterday and most probably today, Goldman Sachs raises $5 billion of perpetual preferred from Warren Buffett, with a 10% coupon, and gives him $5 billion of five-year warrants to buy more Goldman shares at $115 (GS closed at $125 yesterday) at 6PM!  Goldman also plans to raise $2.5 billion of common stock.  Morgan Stanley and even Goldman Sachs found themselves staring into the abyss last Thursday as a run on money market mutual funds intensified.  Hence, the bank charters and the capital raises.  Do you think Goldman makes a sweet, sweet deal with Buffett yesterday if Congress just rolled over and gave Hank and Ben their $700 billion?  I don't think so.  The Buffett deal was,  in my opinion, Plan B.

Hang on to your hats.

**AND JUST NOW Goldman has doubled the $2.5 billion of Common Stock they were raising to $5 billion!

While Hank Paulson Plays a Horrific Game of Poker, Fannie & Freddie Uncertainty Causes Real Damage

A long time ago I had always assumed that guys who rose to the top chair at big banks must be great poker players.  I just figured that fellows like these were good strategic thinkers with an eye toward detail and a keen knowledge of their opponents (both internal and external) strengths and weaknesses.  I imagined that one of their greatest strengths was the ability to bluff successfully.  I have been disabused of this notion over the last year and a half.  These guys, including Treasury Secretary Hank Paulson, are just horrible players. 

If we go back to March and April of 2007 and equate things to a poker game, we essentially had Stan O'Neal, Dick Fuld, John Mack, Chuck Prince, Angelo Mozilo, Jimmy Cayne and a host of others all take turns bluffing the hell out of a good majority of the investment community.  All these guys were showing cards that had them beat on the table.  However, because they so confidently bluffed us with claims that losses were insignificant and everything was hedged, investors said to themselves, "Well, he does have three clubs showing, he saw me and raised me double, he must have two clubs in his hand for a flush, I'm out."  However, after the third of fourth time of bluffing, investors called them and they folded.  It has become common knowledge now that when any of these guys (on your player roster now playing for O'Neal is John Thain, while playing for Chuck Prince is Vikram Pandit) says they have enough capital, or things are turning the corner, they are bluffing.  We therefore, call them and low and behold, they don't even have a low pair!

Lets turn to Hank Paulson, former chief of Goldman Sachs and now Treasury Secretary.  He has played a huge bluff with the Fannie Mae, Freddie Mac bailout.  Paulson made the dramatic move of asking for and receiving the authority to essentially nationalize Fannie and Freddie.  However, after receiving such authority he, along with other Treasury officials and The White House, have repeatedly stated that they have no intention of having to actually do the deed.  This move worked for a few weeks because frankly, there's just a lot of investors out there that either aren't doing their homework, or just don't get it.  Both Fannie Mae and Freddie Mac are, after you adjust for accounting shenanigans like unreserved tax deferred assets (not reserving against them AND for fair value purposes, actually marking the tax deferred assets UP) and their "temporary losses" in their securities portfolios, insolvent on a GAAP basis and a "Fair Value" basis.  That is a fact.  It is also a fact that both companies have just a sliver of capital against a $3.6 trillion mortgage insurance book that only needs to take about 1.5% actual losses (and they are coming) to wipe out Fannie and Freddie.  It's arithmetic.  You can't argue that 2+2= 5.

So now here we are, after Freddie and Fannie's disastrous second quarter earnings, with Hank Paulson at the table showing not even a pair or a decent flush or straight possibility and he's still trying to bluff us.  It's not working anymore.  In fact it is starting to have a very detrimental effect on housing finance.  Spreads on Fannie and Freddie mortgage backed securities are blowing out to record levels.  Because the secondary market yield for these securities determine the rates mortgage originators charge you on a mortgage loan, this is making the already horrific housing technicals worse.  These spreads are reflecting credit risk due to Paulson's bad bluff.  More importantly, these spreads are moving out because everyone that invests in Freddie and Fannie MBS needs to know what the plan is for this multi-$trillion market once Treasury steps in.  Questions like,

• Will they eventually stop making new Freddie and Fannie MBS (thats a good short term technical, but a real bad long term technical)? 
• If they do stop, what will replace them?  Will anything replace them? 

This very harmful uncertainty has come about because Treasury and Congress and The White House have spent precious time bluffing and praying.  We need a plan for the future of housing finance and a "Covered-Bond" photo-op with Paulson and a few bank chiefs doesn't cut it.  I proposed a solution on this blog "What to do with Fannie and Freddie".  Treasury's bluff has been called and its time for it to fold it's crappy hand and take charge.

Imagine Henry Paulson and John Paulson as Brothers.

I love working on the theme that Henry Paulson (Secretary of the Treasury) and John Paulson (hedge fund superstar) are secretly related.  Henry "plays dumb", cheer-leading the economy and working with the SEC to artificially take bank stocks up, which allows John to set his shorts at a higher price. In fact it reminds of the movie, "Dirty Rotten Scoundrels".  Remember that movie where Michael Caine and Steve Martin are con-men?  In one scene, Cain and Martin pretend to be brothers as they target some ultra-rich lady.  Michael Cain plays the smart brother and Steve Martin plays the severely mentally challenged Ruprecht.  Imagine Michael Cain as John Paulson and Steve Martin as Henry Paulson

Paulson vs Paulson?

               

Is anyone else troubled by the fact that two guys named Paulson have been taking market views diametricaly opposed to one another for over a year and one is making billions and the other his helping him make billions with his astounding ability to misread the market?  Lets think about it. 

John Paulson is a hedge fund manager that has made many $ billions betting against the U.S. housing market starting in 2006 .  John Paulson was in  the news yesterday issuing dire warnings that the capital destruction within the financial sector has really only just begun.  He believes that mortgage related losses for the financial sector (which I am assuming includes insurance companies like AIG and the GSEs, Freddie Mac and Fannie Mae) are going to total $1.3 Trillion.  We couldn't agree more with John Paulson, as unfortunate as that is.

Meanwhile, Henry Paulson, Secretary of the United States Treasury, has been going against the grain since he took his cabinet position.  Last spring he boldly pronounced that the "subprime" housing crisis was well contained and shouldn't spill over to the broader economy.  Hell, forget the economy, he basically said that the category of "subprime" was an isolated sector and wouldn't spill over into other categories of mortgages.  Also in 2007 he showed a surprising lack of knowledge for a former CEO of Goldman Sachs, with regards to banks horrific exposure to "off-balance sheet" structures like SIVs.  When he finally got around to SIVs he proposed "Super-SIV".  Super SIV would have been a multi-bank structure that would have essentially taken $ billions of missrated AAA CDOs and stuck them under the floor boards, exactly like Japan did in the 1990s.  Luckily the deal never got done.  Over the last 9 months, Henry Paulson has been cheerleading the economy and has been wrong almost everytime.

Ok, so what's my point?  The point is, John is obviously a bear, short selling financials, buying credit default swaps on housing related assets and making money all the merry-long way.  Few have helped him more along this path than Henry Paulson.  You see, when you are the former CEO of Goldman Sachs and the current Treasury Secretary, lots of people listen to you.  When he says things aren't so bad, or things are improving, investors act on those pronouncements and take the market up (or in the case of CDS, tighten spreads).  Henry Paulson has been doing that a little over a year now.  Everytime the market gets taken up, it just gives guys like John Paulson another entry point to set more shorts or buy CDS protection.  It's like they've been working hand in hand!

My opinion here is no one is that smart (John) and no one is that stupid (Henry)!  I don't know about you but I think it's time to take a deep dive into The Paulson Family tree!

                                                                                                                                                         

Being There with Hank the Gardener

Did anyone watch or read Henry Paulson’s speech today? Today, the Secretary of The Treasury unveiled a sort of blue print for the future regulatory framework for our country’s financial system. I wasn’t paying much attention because Paulson himself said that it would take years to hash out and implement and wouldn’t have a direct impact to what was currently happening in our world. So I got back to doing whatever it was that I was doing, hearing Paulson drone on behind me. Suddenly, I look at my little ETF portfolio of short financials and short real estate…and its getting pummeled. I let out an audible WTF??!! All the news over the weekend and that morning was bad, why the heck were the financials rallying?? I pull up Bloomberg Top Stories and number 1 is this:

"Paulson Backs Regulatory Overhaul, Broader Fed Role. March 31 (Bloomberg) -Treasury Secretary Henry Paulson proposed the broadest overhaul of U.S. financial regulation since the Great Depression, saying American capitalism needs to be better prepared for ``inevitable market disruptions."

Umm, okay maybe I missed something important because the financials are starting to run right up my tucas! So I read the next paragraph:

"Our current regulatory regime is almost solely focused above ground at the tree level,'' Paulson said in remarks at the Treasury in Washington. “The real threat to market stability is below ground, at the root level where the health of financial firms is intertwined.”

Holy cow…roots? Trees? Paulson is doing an impression of Peter Sellers famous character, Chance the Gardener from the great movie “Being There”!!! Paulson is talking in gardening metaphors and the market is so desperate for anything that looks like leadership that its rallying off this….fantastic!! Do you remember “Being There”? If not, here is the readers digest version. Peter Sellers is Chance the gardener. He lived his whole life being cared for and working for some wealthy woman in a Washington DC townhouse. He is slow witted, utterly simple and has never been outside the grounds of the townhouse…..ever! All he knows is the garden and television. One day the wealthy woman dies, the house is sold and middle aged Chance is cast out onto the streets of DC (It’s the late 1970’s) wearing a 1940’s style suit and his suitcase. He has no idea how to do anything! Long story short, he gets hit by a car. Not just any car, but Shirley Maclaine’s car! Shirley is the wife of an older Washington master power broker….the guy who picks and advises presidents.

He is taken to their vast estate and when asked his name he says, “Chance the Gardener”. This is mistaken for Chauncey Gardener. A series of events take place where everyone mistakes his simplicity and honesty for a Zen-like genius! He relates everything he says to gardening because that is all he knows. Anyway, one day the president himself comes calling on “Chauncey’s” new host…Benjamin Rand…the kingmaker. The economy is in crisis and the president must make a speech. Benjamin calls “Chauncey” in and this is what takes place:
President: Mr. Gardner, do you agree with Ben, or do you think that we can stimulate growth through temporary incentives?

[Long pause]

Chance the Gardener: As long as the roots are not severed, all is well. And all will be well in the garden.

President: In the garden?

Chance the Gardener: Yes. In the garden, growth has it seasons. First comes
spring and summer, but then we have fall and winter. And then we get spring and summer again.

President: Spring and summer?

Chance the Gardener: Yes.

President: Then fall and winter!

Chance the Gardener: Yes.

Benjamin Rand: I think what our insightful young friend is saying is that we
welcome the inevitable seasons of nature, but we're upset by the seasons of our economy.

Chance the Gardener: Yes! There will be growth in the spring!

Benjamin Rand: Hmm!

Chance the Gardener: Hmm!

President: Hmm. Well, Mr. Gardner, I must admit that is one of the most
refreshing and optimistic statements I've heard in a very, very long time.
[Benjamin Rand applauds]

President: I admire your good, solid sense. That's precisely what we lack on Capitol Hill!

With that, Chauncey becomes the hit of Washington! Of course I’m thinking, Jeez, did Hank Paulson pull “Being There” out from Netflix and try to pull a “Chance the Gardener”? I believe he did and for a few hours it worked! I of course used the opportunity to buy some more of those short financial ETFs a few points lower and wouldn’t you know it, Lehman came out with a 3bb equity raise at 4pm! Back to the garden Chauncey!!