How to Cover Wall Street

Bailouts work when one or two otherwise viable companies need temporary assistance either to survive a short-term cash shortage or to effect an orderly wind-down.  An example of a successful bailout occurred in 1998 when Wall Street and the Feds came together to prevent the immediate bankruptcy of Long Term Capital Management—in that case, Wall Street firms bore the brunt of the monetary pain.  LTCM’s bailout, although government initiated, also posed a low risk of moral hazard because the plan was an industry-funded solution and was manageable because it only involved one firm.

The government rescue of an entire industry felled by greed and poor leadership, however, becomes an expensive quagmire, which is what TARP is proving to be.

After LTCM’s rescue, the Cleveland Fed reviewed the Federal Reserve’s action.  The number one lesson learned:  Context matters.  Large losses at a financial firm do not by themselves create a need for Federal Reserve action; the losses must have a systemic component.

While one could argue that the failure of the big three would worsen the unemployment significantly and cause a spate of follow-on bankruptcies, the orderly unwinding of the auto manufacturers still does not pose the same kind of systemic risk that failure of the major U.S. commercial banks would have.

A bailout for the Big Three also would not force the kind of changes that domestic auto manufactures need but which a pre-packaged bankruptcy plan created outside a courtroom might.  More importantly, it would prevent the obvious scenario a few months from now when the auto industry comes back for an even bigger handout.

The financial services bailout is exhorbitant, messy and rife with moral hazard.   It was also necessary to avoid a meltdown of world financial markets.  Unpalatable as a bailout for financial services is for the country, replicating it for the automakers makes no sense.

The problem with Capitalism is that when it doesn’t work, everybody expects a quick fix.

My original thought in September was that the U.S. government should never bail out financial institutions, especially using taxpayer money.

But the Treasury can’t undo what’s been done, they can only consider what TARP is actually doing to relieve a one-year-old recession and a tumorous financial crisis.

If you ask me — and I’m sure if asked Adam Smith — Corporate America needs to lean from its mistakes and accept that a free-market economy has its pros and cons. The more we soften the collapse of embattled corporations, the less likely those business will ever make genuine changes in how they run their operations or how they cut corners to make a bigger profit.

And the more our government tries to clean up the mess, the more likely future generations of American consumers, businesses, banks and investors will make the same mistakes.

The intervention between JP Morgan and Bear Sterns was tolerable. It was less a bailout in my view than an aggressive push. But it also flipped open a Pandora’s Box.

TARP is becoming a well-recognized mistake and any similar initiatives given to the auto industry would show equally lame results. Yet the Big Three have their open palms out now.

Goldman is sinking. Citi is imploding. And U.S. taxpayers are out $700 billion. Why would Ford, GM and Chrysler prove any different?

Here’s a solution: Take all that bailout money, put it towards education and start teaching finance and economics to kids in elementary school. Make it part of the core curricculum in all public and private schools all the way up to high school.

Treasury Secretary, Henry Paulson, is trying to save the financial system. But the Treasury’s Troubled Asset Relief Program or TARP cannot fund all of the financial institutions that have applied for it.

Regulators for the Treasury have announced that the agency expects at least 1,800 publicly-held financial institutions to line up for their piece of the $700 billion bailout designed to rid banks of toxic assets.

Paulson moved quickly to shore up the financial services sector in the midst of a meltdown. And, to date, Treasury plans to divide $33 billion  among the nine largest US banks and 16 regional banks. But the Treasury Secretary may have opened up a Pandora’s box since, now, almost any financial institution can apply for a piece of the pie.

(more…)

Fed chair Ben Bernanke said Wednesday to expect economic activity to “fall short of potential for a time.”

A bit of an understatement on the day that the Dow dropped another 733 points, eh?

Peter Goodman at The Times noted Mr. Bernanke also made this curious observation at his Economic Club of NY appearance:

The real concern that we have is that we have got and developed, in this country, a very serious ‘too big to fail’ problem. And that problem, we’ve just recognized now in the current situation, how severe it is.

Just recognized? That’s right. I forgot the banks just kinda merged themselves.

Or has this all just been a red scare?

(more…)