The US Government: Over-Engineering for Under-Performance

Beginning with Bush and Paulson and continuing with Obama, Geithner and the newly-emboldened Ben Bernanke, the US Government has adopted the posture of over-engineering our emergence from the financial crisis, with an eye on stock market performance. Plans have been highly complex, rescues have been largely one-off and Congress has gotten into the business of executive compensation, company-specific tax policy and other minutia. The alternative: broad, sweeping, clearly communicated and transparent policies, those to which investors and taxpayers alike can rapidly assimilate and react. It is a matter of trust, and trust has been in short supply ever since the crisis hit. Unfortunately, the US Government’s involvement has done little to rebuild trust on Wall Street or on Main Street. The result of the Administration’s plans is depression followed by mania followed by depression, as incomplete or misleading information is slowly disseminated into investor consciousness while the equity markets see-saw depending upon which side of the wave we find ourselves. And recent bank earnings are only one shining example of why we are now locked into a painful, protracted process of false hope, failure and rebirth, when we could have chosen quick, deep pain, and transitioned to real hope and rebirth in a much shorter time-frame. But the US Government does not believe the US citizen can withstand such pain; they’d rather take the path of least resistance, delay the inevitable, buy time and pray that we – the collective “we” – get bailed out. Unfortunately life seldom works this way. If you’ve got it coming to you it generally comes: the only question is how quickly you can get it to go away.

When I hear friends both inside the major banks say “But we just reported earnings of $x billion and beat Street estimates; why is our stock getting hammered?” or “Our stock is trading at x% of book value when our earnings power is improving, why do investors continue to lack faith in our institution?,” it only highlights the disconnect between the Wall Street (and Administration) world(s) and the real world. Clearly few investors look at Citigroup (C) and Bank of America’s (BAC) headline earnings and think them to be of high quality: out-sized trading revenues, debt revaluation and one-time gains dominate the story. Customer revenues generally are poor. Credit charges are skyrocketing. Every kind of loan portfolio is under pressure. And with the mind-bending error of weakening the mark-to-market guidelines, transparency and financial statement clarity is worse than ever. The American Bankers Association and their lobbyists thought they were really smart; let’s press the Financial Accounting Standards Board (FASB) to weaken FAS 157 (mark-to-market guidelines) in order that our member firms can show better earnings and capital ratios. And they were successful. But surprise! Investors are not all as stupid as they sometimes appear. They looked right through the reclassifications and accounting changes and determined that earnings quality stunk. Hooray! Citi beat Street estimates. Yippee! Bank of America hit the cover off the ball. But not if what you are looking for are real earnings and true indications of sustainable revenues and financial health. Once again, we have taken a big step backward in the transparency and trust departments. These are areas where the Administration and Congress should be showing strong, decisive leadership. Sadly, they are not.

You now have CEOs of TARP recipients rattling their sabers saying that they want to return the funds, shortly after printing historic trading gains off the backs of US Government debt guarantees and TARP funds. This is clearly not the outcome the US Government had in mind: a direct transfer of value from the US taxpayer to common stockholders of TARP recipients. But if you develop a program as complicated as TARP which impacts multiple constituencies in vastly different ways, it is not surprising that chaos and adverse PR would result. And, suffice it to say, we are still mired in the toxic asset issue. As predicted, the PPIP is dead on arrival. With a weakened FAS 157, regardless of the demand fomented by enormous liquidity on the sidelines together with cheap Government-sponsored leverage, the supply side will simply not show up. Without a clear requirement to clean up their balance sheets, banks will simply milk the option delivered to them on a silver platter by the FASB. They will wait it out, not lend significant sums, engage in financial engineering to make their capital ratios look good, all with the tacit if not outright support of the US Government. This was not the way it was supposed to work. But if you take the path of least resistance, you generally deserve the least attractive results. Not surprisingly, this is where we’ve ended up.

The US Governments, past and present, had a clear idea of how they wanted the financial reconstruction to go: stabilize the largest, most troubled institutions; let one go to show that they are still free marketeers at heart; loosen accounting standards to make supporting the largest institutions less costly, at least in the short run; use moral suasion and cajoling to encourage supported firms to lend; and then let time work its magic by enabling broken portfolios to recover in value and for earnings to be rebuilt through “riding the yield curve” and lending with Government-subsidized borrowings. But all did not go according to plan. Policies became highly fragmented as each institition was treated as its own separate case, creating uncertainty in the markets and on Main Street. Public relations became a problem as bailed-out firms started paying bonuses, ostensibly with taxpayer dollars. Compensation caps were enacted. Tax policy was used to attack contractual bonus payments. The forest was long ago lost for the trees. The dream of engineering a soft landing is now long gone. The best that can be hoped for is getting through without a financial crisis of staggering proportions. And it didn’t need to be this way. Fewer, clearer, more aggressive policies with an emphasis of transparency and communication. Then let the markets do what they will do. Obama & Co. should really be called the Bloomberg Administration: because with such a focus on Wall Street and the stock market there must be a Bloomberg terminal on every desk. Our leaders need to switch them off – now. They do not hold the answer.

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