Now that Hank Paulson is a lame duck, and we’ve seen the majority of his contributions as Treasury Secretary, we can begin to assess whether he has been handling the unfolding economic downturn effectively, or as some might suggest, made it worse. As is usually the case with economic policy, we can rarely determine with certainty what was a ‘correct move’ for several months if not years afterwards. My opinion is that Paulson has done an adequate job so far in terms of avoiding a deeper recession or depression, but has made some questionable moves and has been less than sensitive to the needs of Wall Street.
First things first: many would agree this recession was brought on by a housing bubble which has left millions of Americans in foreclosure who were either encouraged in some way to become a homeowner (when they weren’t quite ready) or straight up duped by a bank or other broker into taking on a confusing mortgage product which would presumably be beneficial in the long-run. So, it would seem to me that preventing future foreclosures would be an equally important priority, especially from a moral perspective, than protecting the banks which ultimately take on the mortgage losses.
Taking the ‘moral high rode’ hasn’t really happened, or at least hasn’t been pushed strongly enough. Some people in my office weren’t even aware of the ‘Hope Now Alliance’ which was established over a year ago by Bush, Paulson and their other advisors to help financially troubled homeowners avoid foreclosure. As far as I know, the quantity of foreclosures has increased dramatically in 2008, certainly outnumbering the people aided by this program. And when the details of the TARP (Troubled Asset Relief Fund) otherwise known as the ‘$700B Bailout’ were revealed, among the major criticisms was the focus on helping banks rather than troubled homeowners.
I also believe Paulson could have been a bit more sensitive to the precipitous drop in the markets, the worst of which we saw last week when all the major market indexes touched intraday levels not seen since the 90’s. Granted, it is not the Treasury Secretary’s job, nor is it the Fed’s job to intervene with the daily movement of the stock market. If they did, and it helped to push markets to unnaturally high levels, it would lead to more economic problems rather than the stated goals of moderating inflation and sustaining reasonable levels of economic growth. Even so, there is more Paulson could be doing to moderate these unprecedented levels of volatility. This recession is the worst we’ve seen since the Great Depression; many financial institutions have either collapsed, been diluted by the government, or sought an enormous influx of capital. Investors are scared about where and when the next shoe will fall. As the stock and bond markets deteriorate, the recession gets worse. As people’s homes and retirement accounts decline in value, they spend less as a cautionary measure, often exacerbating the existing problems and forcing the government into enormous spending patterns.
One opportunity Paulson had to moderate these declines was to suspend the mark-to-market accounting rules which have nearly crippled the balance sheets of financial firms along with the bond market over the past few months. Market-to-market accounting essentially forces companies to value the securities they hold (such as the mortgage-backed stuff) at their fair market value—essentially the current market price. Because much of the collateralized debt market has nearly disappeared, the market prices are often 50-80% lower than they were a year ago. Some organizations such as the The American Bankers Association have argued that mark to market accounting doesn’t work in extremely volatile and turbulent markets. It’s designed more for markets in which the securities have liquidity. And because of bank requirements regarding capital levels, write-downs due to mark-to-market accounting force banks to raise more money, raising eyebrows and snowballing the problem further. It should be noted that scaling back these accounting rules still remains on the table for the SEC, despite Paulson’s support against doing so.
Others would argue Paulson handled a certain investment bank failure very poorly. I can’t say the name of the bankrupt bank for compliance reasons but it should be fairly obvious considering it’s the only one Paulson let fall. The result of this failure was a crisis in the commercial paper and money markets. The ‘systemic risk’ of letting such a large and diverse global bank fail was sending shockwaves through every institution doing business with the bank. That is precisely what happened and the stock markets got much worse in September and throughout November. If Paulson is going to become the bailout guy, don’t discriminate—save each business which has a reasonable chance at surviving after this recession pans out.
Finally, and most recently, Paulson has been very ambiguous when it comes to details for spending the TARP funds. If you’re going to dump a mega-bailout on taxpayers, the least you can do is provide the same transparency for taxpayers which you’re promising investors. Paulson has bent the rules such that public and private institutions—basically anybody who can cough up a reason why their business failure may pose a systemic risk to functional markets, can ask for a piece of the pie. The updates on the program have been unclear and the distribution of funds has already been questionable.
I’ll give Hank Paulson one thing: John Snow and Paul O’Neill had it much easier than Paulson. Even Larry Summers, who was Treasury Secretary during the dot com bubble, had much less to deal with than a global financial meltdown. Paulson may have been dealt the worst cards in memory and the fact that we’re not in a deeper recession already is a credit to him.
As always, questions and comments are welcomed.
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.