The US "Trickle Down" Bailout Will Not Work

The bailout of the banks is just that: a bailout of the banks, designed by bankers, for bankers. It will not help repair the economy. It will not inspire confidence. Most of the money will be lost to insider dealing and narrow-minded favoritism.

This is yet another Bush Administration classic.

Joseph Stiglitz voices the hope that we have been expressing since the beginning of this year:

"Hopefully, our democracies are strong enough to overcome the power of money and special interests, and we will prove able to build the new regulatory system that the world needs if we are to have a prosperous and stable global economy in the 21st century."

We can start by voting this November, by overcoming our fears and our confusion, and throwing every Republican and the Democratic leadership out of public office. The message has to be clear, loud and unequivocal.

The Guardian
Paulson tries again
Joseph Stiglitz
Thursday October 16 2008

Unlike the UK plan, the revamped American bail-out puts banks first and taxpayers second

Gordon Brown has won plaudits over recent days for inspiring the turnaround in Hank Paulson's thinking that saw him progress from his "cash for trash" plan - derided by almost every economist, and many respected financiers - to a capital injection approach. The international pressure brought to bear on America may indeed have contributed to Paulson's volte-face. But Paulson figured he could reshape the UK approach in a way that was even better for America's banks than his original cash strategy. The fact that US taxpayers might get trashed in the process is simply part of the collateral damage that has been a hallmark of the Bush administration.

Will this bail-out be enough? We don't know. The banks have engaged in such non-transparency that not even they really know the shape they are in. Every day there are more foreclosures - Paulson's plan did little about that. That means new holes in the balance sheets are being opened up as old holes get filled. There is a consensus that our economic downturn will get worse, much worse; and in every economic downturn, bankruptcies go up. So even if the banks had exercised prudent lending - and we know that many didn't - they would be faced with more losses.

Britain showed at least that it still believed in some sort of system of accountability: heads of banks resigned. Nothing like this in the US. Britain understood that it made no sense to pour money into banks and have them pour out money to shareholders. The US only restricted the banks from increasing their dividends. The Treasury has sought to create a picture for the public of toughness, yet behind the scenes it is busy reassuring the banks not to worry, that it's all part of a show to keep voters and Congress placated. What is clear is that we will not have voting shares. Wall Street will have our money, but we will not have a full say in what should be done with it. A glance at the banks' recent track record of managing risk gives taxpayers every reason to be concerned.

For all the show of toughness, the details suggest the US taxpayer got a raw deal.

There is no comparison with the terms that Warren Buffett secured when he provided capital to Goldman Sachs. Buffett got a warrant - the right to buy in the future at a price that was even below the depressed price at the time. Paulson got for the US a warrant to buy in the future - at whatever the prevailing price at the time. The whole point of the warrant is so we participate in some of the upside, as the economy recovers from the crisis, and as the financial system starts to work.

The Paulson plan responded to Congress's demand to have something like a warrant, but as a matter of form, not substance. Buffett got warrants equal to 100% of the value of what he put in. America's taxpayers got just 15%. Moreover, as George Soros has pointed out, in a few years time, when the economy is recovered, the banks shouldn't need to turn to the government for capital. The government should have issued convertible shares that gave the right to the government to automatically share in the gain in share price.

Whether we were cheated or not, the banks now have our money. The next Congress will have two major tasks ahead. The first is to make sure that if the taxpayer loses on the deal, financial markets pay. The second is designing new regulations and a new regulatory system. Many in Wall Street have said that this should be postponed to a later date. We have a leaky boat, some argue, we need to fix that first. True, but we also know that there are really problems in the steering mechanism (and the captains who steer it) - if we don't fix those, we will crash on some other rocks before getting into port. Why should anyone have confidence in a banking system which has failed so badly, when nothing is being done to affect incentives? Many of those who urge postponing dealing with the reform of regulations really hope that, once the crisis is passed, business will return to usual, and nothing will be done. That's what happened after the last global financial crisis.

There is a hope: the last financial crisis happened in distant regions of the world. Then it was the taxpayers in Thailand, Korea and Indonesia who had to pick up the tab for the financial markets' bad lending; this time it is taxpayers in the US and Europe. They are angry, and well they should be. Hopefully, our democracies are strong enough to overcome the power of money and special interests, and we will prove able to build the new regulatory system that the world needs if we are to have a prosperous and stable global economy in the 21st century.

Joseph E Stiglitz is university professor at Columbia University and recipient of the Nobel memorial prize in economic science in 2001. He was chief economist at the World Bank at the time of the last global financial crisis.

Redemptions and Losses Expected to Hammer US Hedge Funds

"The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses"

"The industry, which manages close to $2,000 bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year."

The Financial Times
US hedge fund withdrawals hit $43bn in September
By Deborah Brewster and Henny Sender in New York
October 16 2008 00:16

Investors pulled at least $43bn from US hedge funds in September as market turmoil led to unprecedented withdrawals, an analysis by a leading research house shows.

The data from TrimTabs Investment Research – which was to be sent to clients late on Wednesday – come as hedge funds are working to prevent far bigger redemptions by the end of the year, when many funds give investors a chance to take out money. (Calling all bagholders - Jesse)

Withdrawals can lead to a vicious circle in the markets, as funds sell holdings to return money to clients, depressing prices and prompting further redemptions.

To prevent such an outcome, some hedge funds had offered to suspend fees if investors kept their money in until March, said Marc Freed, of Lyster Watson, which invests in hedge funds on behalf of institutional and private clients. (Oh yeah that sounds great considering they are getting decimated by the worst bear market since the Great Depression - Jesse)

“Every investor fears other investors will pull their money and so they worry they will be at the back of the line if they don’t also pull,” Mr Freed said. (If you are going to panic, be sure to panic first. - Jesse)

“Nobody will invest in anything illiquid because they think they may not survive long enough to see them rise in value.”

A fundraiser for a major hedge fund said the period “between now and December 1 is a sort of death march” for the industry.

The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses.

Conrad Gunn, chief operating officer of TrimTabs, said the $43bn in September withdrawals would mark “the beginning of what we expect to be a series of outflows for the remainder of the year. We expect October outflows to be larger”.

Mr Gunn said the September outflows were based on an analysis of preliminary data and that the final tally would probably be higher because funds with heavy redemptions tended to report data later.

The industry, which manages close to $2,000bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year.

JPMorgan Chase has estimated that hedge fund outflows could total up to $150bn over the coming year. As investors take their money out of hedge funds, the funds have to sell assets.

But because they use so much borrowed money, the amount of potential asset sales is far larger. For example, JPMorgan expects that an outflow of $150bn will lead to sales of about $400bn.

(The JPM estimates seems a little light. 150 billion in total redemptions based on 43 billion in September alone, with October to be larger, and a 'death march' to year end? They seem to be assuming blue skies by Christmas. Hey, no fees if you hold on until the flesh falls from your bones. - Jesse)

UBS Über Alles

Lose so much in your own trading book that people become afraid and seek your advice for their private wealth management. Nice corporate strategy.

Hubris? Or would it be just a case of "prétention démesurée?"

UBS says crisis vindicates own bank model
Wed Oct 15, 2008 4:33pm EDT

GENEVA (Reuters) - Switzerland's UBS the world's largest wealth manager, said its advice-driven, global banking business model will be a winner as others failed or were rescued by governments during the global financial turmoil.

UBS was hit early on in the crisis and has announced more write-downs on toxic assets than any other European bank.

"It's never been more obvious to clients that they need advice. This is going to be the proof to our business model," Juergen Zeltner, who heads UBS' wealth management operations in North, Central and Eastern Europe, told the Reuters Wealth Management Summit.
UBS has not given up on investment banking despite huge losses on the business and instead has divided its operations into three separate divisions -- wealth management, investment banking and asset management -- to boost transparency.

Banks which heavily relied on investment banking revenues, such as Lehman Brothers, have either gone bust or needed rescues via forced mergers or government aid.

"I strongly feel that the transparency that we put in place was well appreciated," Zeltner said.

Still, Zeltner said the damage to UBS' reputation from the huge losses in its investment banking division was obvious and had resulted in client outflows. The bank will report third quarter results on November 4.

"We lost trust. We do know that there was substantial damage and that will take years to rebuild," he said.

UBS recapitalized itself earlier than any other bank, before the deepening of the crisis in September, and is now in a position to exploit opportunities in markets where other players have failed, such as the United States, he said. (You'll have to compete with our 'national champions' who are getting their subordinated distress funding from the US Treasury - Jesse)
"The crisis gives us unique opportunities in the United States," Zeltner said.

"We want to grow and build market share."

The Practical Risk in the Fed and Treasury's 'Trickle Down" Approach

The 'trickle down' approach being taken by the Fed is in danger of not only failing to sustain the economy, but may precipitate a significant political crisis.

The current plan is to flood a few relatively large banks with public liquidity, without substantially changing their management, their charters, and their regulatory constraints.

What if these banks defer on lending to others as their primary objective, preferring instead to buy up valuable and productive non-financial assets on the cheap for their own speculative purposes? Or to provide the liquidity for their associated off-balance-sheet corporations to do the same, rather than funding organic growth?

Why would the banks limit themselves to commercial banking when they can still act like hedge funds buying assets and investing for their own tradebook and investment portfolios?

The short answer is that they always and everywhere have acted with their own interests first and foremost.

The obvious firms to watch are Goldman Sachs and Morgan Stanley. Why the Fed does not see this obvious moral hazard is astonishing. What is even more astonishing is that no one is calling out Paulson on this, who has a yawning conflict of interest with Goldman Sachs.

The inherent weakness in a centrally planned economy is that it invariably leads in distortion, corruption, and advantageous manipulation by insiders. To expect anything else is to ignore human nature and history.

The banks, our 'national champions,' must be constrained again as they were in the 1930's after their reckless speculation and credit expansion had financially decimated the nation's economy and the great majority of the public.