A “New” Bailout Plan? Hardly

I watched our President’s brief address on prime time this evening. His delivery was passionate. His message, strong and partisan. His intentions were clear. Rally support for his stimulus program. In the wake of a few really bad days of press, his honeymoon period clearly over, I thought he did a strong and ballsy thing. Problem is, the plans being bandied about concerning the financial sector are still off the mark. How is it, after the mistakes made by Paulson and the prior Administration that we are still unclear as to what the plan should be? As I’ve said before, I just don’t get it.

But now it’s even worse. It seems as if the discussion among those in power has gone back to what we had during Bush II, injecting capital into sick institutions, yet on “tougher” terms than we had previously. Simply doing more of something that was flawed from the beginning isn’t going to help solve the problem any better. Why the brainy President Obama or the equally brainy Larry Summers don’t seem to get this is beyond me. From tonight’s WSJ Online:

WASHINGTON — The Obama administration’s financial-rescue plan is shaping up to include capital injections with tougher terms than the first round and an expansion of an existing Federal Reserve lending facility that could potentially buy up toxic assets clogging the system, according to people familiar with the plans.

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Instead of buying preferred shares, as it did before, the government is discussing taking convertible preferred stakes that automatically convert into common shares in seven years. Such a move could help banks as they look for ways to bolster common equity. When a bank takes a loss, it has to subtract that amount from the value of its common equity. As losses mount, investors increasingly believe banks need to find ways to shore up this first line of defense on their balance sheets.

To get money, banks would likely have to pay a higher dividend to the government than the 5% rate the government charged in the first round of infusions and agree to a host of new restrictions, such as lending above a baseline level, reporting frequently on their use of the money and curbing executive salaries. While Treasury wouldn’t preclude healthy banks from participating, the stricter terms would likely attract primarily weaker banks in need of capital.

Does anyone else see how dumb this is? Let’s see:

1. The sickest banks with the lousiest managements get access to Government (read: taxpayer) capital.

2. The Government is looking to play accounting/ratings games by making the instruments convertible into common after seven years, by which time any self-respecting and solvent bank will have paid off the preferred well before its conversion date.

3. The curbs on salaries will likely cause many firms to reject Government capital even if they are very sick, preferring to hang onto their compensation “call option” and hope that things turn around in order that their firm avoids bankruptcy. By this time they will have scooped out far more compensation than what is permitted under the new Government guidelines.

And let’s not forget these not-so-trifling issues:

1. Banks with toxic asset-laden balance sheets will still be reluctant to lend, even with Government capital injections. And forcing them to lend will only put us right back in to the world of the GSEs (Fannie Mae, Freddie Mac), which may well cost taxpayers several trillion dollars.

2. Bad managements will still be running the show, even after losing billions or even tens of billions of dollars.

3. Common equity holders and debt holders are still being bailed out, perpetuating a moral hazard that should have ended months ago for many (Citi, BofA, etc.).

Have we learned nothing over the past six months? The ideas being proposed simply won’t work, and I don’t care which Harvard Ph.Ds are saying so. It is a matter of transparency. It is a matter of good governance. It is a matter of creating healthy institutions that are in a position to fund the renewal and growth of this country. Current plans do not contemplate any of these things. Why not? That is a mystery. President Obama has his chance to take a stand, the right stand, and I’m afraid his first big step forward will in fact be two steps backwards. And the country will suffer for it.

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About Roger Ehrenberg 94 Articles

Roger is an active early-stage investor, having seeded or invested in over 20 companies in asset management, financial technology and digital media since 2004. Prior to his venture days Roger spent 18 years on Wall Street in M&A, Derivatives and proprietary trading.

Throughout his career he has held numerous executive positions, including:

President and CEO of DB Advisors LLC, a wholly-owned subsidiary of Deutsche Bank AG. His 130-person team managed over $6 billion in capital through a twenty-strategy hedge fund platform with offices in New York, London and Hong Kong.

Managing Director and Co-head of Deutsche Bank’s Global Strategic Equity Transactions Group. In 2000, his team won Institutional Investor magazine’s “Derivatives Deal of the Year” award.

As an Investment Banker and Managing Director at Citibank, he held a variety of roles and responsibilities in the Global Derivatives, Capital Markets, Mergers & Acquisitions and Capital Structuring groups.

Roger sits on the Boards of BlogTalkRadio; Buddy Media; Clear Asset Management; Global Bay Mobile Technologies and Monitor110. He is currently Managing Partner of IA Capital Partners, LLC.

He holds an MBA in Finance, Accounting and Management from Columbia Business School and a BBA in Finance, Economics and Organizational Psychology from the University of Michigan.

Visit: Information Arbitrage

1 Comment on A “New” Bailout Plan? Hardly

  1. I agree. I don’t think the right actions are being taken. And I don’t think Bush’s admin. made the right actions either. Frankly I think that the action that should have been taken is that they should have let the companies fail that made bad decisions and not bail them out. Unless of course the government is covering themselves because they forced the banks to make loans they wouldn’t normally make or if they were in bed with them.

    I think we’re in for a world of hurt no matter what happens with the way the fed is printing and spending money they don’t have. All the FED is doing is increasing our debt in the idea that spending more will get us out of our debt problems. That’s insanity. The dollar is going to be toast. I’m looking at gold with the real time widget ExactPrice http://www.learcapital.com/exactprice and it’s trading at $913.70 and ounce. Silver is really taking off so I’m thinking a lot of other people are thinking that all the FED actions are going to be bad in the long run and are jumping onto these commodities as a safe haven bet.

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