Like you, I’m awestruck by the sudden implosion of our financial markets over the past weeks. The magnitude of the crisis before us is unprecedented but the storm clouds have been on the horizon for some time. Here’s an excerpt from an economic policy piece I authored last December:
Here’s what scares me about our economy……the collapse in the mortgage/ derivative securities market has begun rippling through the economy. Only $50 billion of the estimated $400 billion in losses sustained by investors in exotic mortgage/derivative securities have been accounted for. Our largest financial institutions have been weakened. Given the rapid decline in the value of the dollar during the Bush Administration’s unchecked stewardship of our economy, there is a very real concern that the Euro may displace the dollar as the gold standard held by investors and central banks worldwide. Should that happen, the dollar would weaken even further and, to put it simply, our economic strength would be undermined dramatically.
Nine months later only $500 million of the now $1.6 trillion of mortgage security-related losses have been accounted for, suggesting a further $1.1 trillion of further losses by Wall Street.
Observations about the crisis.
1. We're swimming in unchartered waters. Nobody on the Hill, in an Ivory Tower or on Wall Street has convincingly demonstrated the benefit to Americans for our bailing out financial institutions.
2. Arguments for immediate action resonate as fear-mongering by the very same people who have been reassuring the American public about the stability of our economy and our financial system up until weeks ago.
3. Americans of all political persuasions are outraged. Thirty-eight days before the election there is more finger pointing and political theatre in Washington than there is action. Resolving this crisis requires bipartisanship leadership colored by thoughtful, deliberative debate. Suggesting that this must happen over the span of one week is wreckless pandering. ?
• Congress and the Administration have but one remaining opportunity to architect a Rescue Plan that works. The consequences will affect all aspects of your future: economic growth, national security, global warming. We are quite literally at a historical crossroads.
4. The American public should absolutely not, as currently conceived, bailout shareholders of financial institutions. The Rescue Plan must assure that taxpayers receive a full return of their monies before shareholders receive a dime. The Treasury’s plan, even with modification for bipartisan oversight, caps on executive compensation and window-dressing to aid to homeowners, remains a shareholder bailout, the proverbial sow’s ear dressed up as a silk purse.
5. Panic-based warnings for immediate Government intervention argue that financial markets will implode and consumers will suffer lost jobs, savings and access to credit to support their businesses. This argument is strikingly analogous to those underpinning trickle-down economics. It’s premised on the assumption that a wealth transfer of taxpayer dollars to Wall Street will engender market liquidity thereby benefiting the public good; trickle-down economics is premised on the assumption that slashing tax revenues for corporations stimulates economic growth thereby benefiting public good.
I don't deny that this crisis requires extraordinary Government intervention. Alternative approaches to how the Government intervenes, who pays for the intervention and who oversees that intervention have been discussed. And there is a better mousetrap which can be enacted quickly, provide more protection to taxpayers and restore confidence in financial markets. Fundamentally, the debate needs to shift toward authorization of an investor of last resort as opposed to a buyer of last resort.
I was an investment banker on Wall Street and advised financial institutions, public and private. That doesn't mean that I'm a financial wizard-- but I have thought intelligently about this crisis. I've watch this drama unfold from the start. Were I (and many of my former colleagues with whom I've consulted) advising Washington in the same manner as I would a client seeking to invest in distressed institutions, I would turn to a tried-and-true investment model. Here's a snapshot of what I have advocated in letters, an Op-Ed piece and numerous diaries.
1. Establish an independent Government entity with its own budget and ability to hire and fire management. That’s akin to what public universities like UNC-CH do in forming quasi-independent investment firms like UNC Management Co. to oversee the university’s endowment.
2. Capitalize it with $X billion from the Treasury to make investments in financial institutions mired in the liquidity crisis.
3. Employ as its template investment instrument a convertible preferred stock paying a dividend and allowing for the conversion of the preferred stock into common stock. In that fashion, Americans will have priority over common shareholders in the event that these institutions fail while sharing in gains from a rise in their stock price—unlike the current bail-out proposal.
4. Invest in newly-issued convertible preferred stock of troubled financial institutions, providing them with badly-needing capital and leaving to them, not the Treasury Department, the job of disposing of toxic securities at a time and price they determine. Their financial condition would be no worse than had Treasury acquired those assets outright. Returns realized by the new Government entity from its preferred stock investment would be returned to the Treasury.
This mousetrap is Warren Buffet. It is the convention he has followed again and again over the past 30 years to invest in firms under duress including GEICO, The Washington Post Company, Coca-Cola and my former employer Salomon Brothers. He did so again on Tuesday through a $5 billion investment in newly-issued convertible preferred stock of Goldman Sachs (one-time employer of Secretary Paulson, ex-Clinton Secretary of Treasury Robert Rubin, White House Chief of Staff Joshua Bolton, New Jersey Governor Jon Corzine, former director of the National Security Council Stephen Friedman, newly-appointed Wachovia CEO Robert Steele and former Obama campaign advisor Jim Johnson.) I worked for Goldman as a 21 year-old junior analyst after college. These folks and Buffet are, collectively, extremely bright.
Though Buffet has endorsed the Treasury's bail out plan, pay attention to how he structured Berkshire Hathaway's investment in Goldman. He negotiated that investment with executives of what is the world’s most-admired investment firm. They reached out to Buffet because they feared that their firm would go down in the panic spreading across financial markets.
Buffet didn't buy any of Goldman's mortgage investments, he made an investment. By all accounts he got a good deal.
Warren Buffet puts the interest of his shareholders first. The Congress should do likewise by putting the interests of Americans first.
Comments or questions please post. I'll check in and answer to the best of my ability.
And-- it's nice to be back on BlueNC.