Investment Management Blog - Montague Capital

Paulson has proved that he was right about one thing all along.  A failed deal is worse than no deal at all.  This was why the US authorities had refrained from interference until ten days ago.  Confidence would best be restored by leaving the market to sort its own problems out, with occasional official nudges such as Bear Stearns, Merrill Lynch, Fannie Mae, Freddie Mac,….. Well, obviously, not.  What Paulson has got horribly wrong is that the Goldman Sachs negotiation techniques, which earned him his estimated US$700m personal fortune, do not work when it comes to bullying politicians up for re-election.  “But this, or you’re dead meat” is likely to achieve precisely the opposite result.  And so, sadly, it has proved. Taking a leaf straight from Junior’s “Inturnashnul deeplomasi fer dummees” Paulson failed dismally to establish even a tentative consensus before the real horse trading got started.  And there was no Plan B for when Plan A crashed and burned.  As America isn’t Iraq (yet) he couldn’t then do what he wanted to all along anyway. But there’s delicious irony in the breakdown of yesterday’s vote in the House of Representatives.  60% of Democrats, possessed of sufficient intelligence to understand the economic consequences of failing to come up with some sort of deal, voted in favour.  60% of Republicans, far more concerned to protect the rights of the American way of doing business (and banks’ CEO megasalaries) voted against, one describing the deal bizarrely as “a cow patty topped with a marshmallow”.  (If the issues involved weren’t so serious, we should all be screaming with laughter at the fact that four of the nineteen Congressmen from Junior’s home state of Texas voted against!) Intuitively the voting split should have been the other way around.  With elections looming, the Republicans would have been better served by presenting a united front.  Even if they had somehow been responsible for the current mess, they had an answer of sorts and the will to carry it out.  Meanwhile the Democrats would have been doing what any decent UK Tory Opposition (sic) would do, picking holes in the plan but offering no better ideas of their own. In all the horror of Wall Street recording its biggest-ever one-day fall in absolute terms (7% is not the biggest one-day percentage fall by a long shot) we should remind ourselves that it is not all over yet.  The market is only back to where it was before The Plan was unveiled.  A few more banks have joined the list of “the disappeared”, Wachovia being gobbled up yesterday by Citigroup for example.  But we now have a much better idea of what will fly and what won’t. Republicans trying to pin the blame on a very punchy speech by the Democrat House Speaker Nancy Pelosi have instead done a brilliant job of highlighting this.  Voters are simply not going to hand US banks a blank cheque (for they definitely will come back for more) and leave them to get on with it unsupervised.  Voters are not going to pass up the opportunity to impose far tighter regulation on a greedy, self-serving and immoral industry which has brought them (but not the industry’s executives) to the brink of financial ruin.  Sooner or later a deal will get done.  But for each near-miss that is experienced in the process, the banks’ freedom of action for the future will become more constrained.  When a deal is struck the banks will have another Thursday September 18^th, after which they’re going to be out in the wilderness for a very long time. While politicians on Capitol Hill haggle over a solution for banks’ toxic “assets”, monetary authorities around the world continue to appear powerless to solve an equally pressing problem.  How to make banks lends to each other once more?  Because there’s precious little point tidying up one side of the balance sheet if the other then remains static.  Unfortunately, that is exactly what is happening at the moment.  Tens of billions of dollars daily are being injected by way of new liquidity, yet it all seems to soak away into the sands.  Figures from the Bank of England yesterday showed that only £143m of new mortgages were issued last month.  This was a 98% y/y fall.  Where is all the liquidity going?  And rates being paid by borrowers who can find a deal are still going up. Injecting liquidity eases the pressure on banks which have decided to rely too heavily on the frozen interbank market.  That is a good thing, because otherwise they would be going bust.  But it serves no positive purpose sitting there idle.  Nor is there any point (even if inflation rates permitted it – which they don’t) of cutting interest rates.  It is the unwillingness of banks to lend to each other that is pushing interbank rates up, not an “excessive” base rate.  The time has come to get tough on how the liquidity is then used. One draconian answer might go like this.  Banks can already apply for emergency funding by offering qualifying collateral (on ever looser standards) which incur a “haircut” so that a bit of pain focuses the mind better.  They then get more liquidity than current arrangements allow, but a chunk of this must be immediately recycled into new mortgages or corporate lending or the whole amount is withdrawn.  The banks get more than they say they really need and the poor punter finally sees something coming out of the other end of this chronically constipated beast.  Once normal operating conditions are restored, the facility is withdrawn.  Mind you, it might just be easier to nationalise this sorry mess altogether and have done.  Because, quite frankly, it just does not work.  What faith can any of us have in an industry which moans about its problems yet complains when it is asked to pay to insure its customers’ deposits?