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Devastation or armageddon?

Created:
1 October 2008
Updated:
2 October 2008
Written by:
Alistair Blair

When I first heard - in a brief snatch of radio on the way home one night last week - of US Treasury Secretary Hank Paulson's rescue plan, it sounded bold, audacious and, alas, unlikely. Unlikely, because I could not conceive that the US government could afford to buy all that toxic debt. Like George Bush (I suspect), I have no idea how many brazillions of dollars of toxic debt are lurking around the global financial system, but I'd bet invading Iraq was cheap in comparison.

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I understand there are $500bn of "seriously delinquent" residential mortgages in the US, but no one knows how the slicing and dicing, and dollops of added leverage - which transformed them on to Collateralised Mortgage Obligations - has multiplied that base figure, which, in any case, will rise. Furthermore, the banks have lent to and invested capital in many other kinds of property and this exposure is less easily measured than plain vanilla residential mortgages.

The next morning the plan had some flesh on it and a figure attached: $700 billion. Not even one brazillion! Surely, it's more than that! The rescues of AIG and Bear Stearns having required the best part of $120bn, it didn't seem to me that $700bn was going to go very far. It took me a few days to grasp what was going on, which was this: "Buying the toxic debt" does not mean "Buying all the toxic debt". Paulson's "Troubled Assets Recovery Plan" or TARP, was just a roll of sticking plaster. It might be better than the single plasters so far applied one by one to all the big failures except Lehman, but it is by no means an all-encompassing solution.

Nevertheless, in the view of 228 Congressmen up for re-election next month - and their constituents - it looked far too opulent and one-sided. More concessions got it through the Senate, and the House will shortly be asked to think again. Still, even as the opposition within the House of Representatives was emerging, Citigroup elected to take on $43bn of known toxic assets by buying its domestic rival, Wachovia, and JP Morgan Chase had similarly taken on Washington Mutual. As in "Crisis? - What crisis?"

Will they change their minds?

If TARP is to lift off, 12 Congressmen need to change their minds, in a far more public and pressured situation than that already prevailing in the floodlit cockpit in which they made their minds up when first asked. It's not as if they have nothing to lose. They have got their elections to lose. To them, this will seem a worse prospect than the unfathomable and long-term consequences of some more banks going bust.

And stock markets refuse to crumble. Although the Dow Jones Industrial Average was down 7 per cent on Monday, it was up 5 per cent on Tuesday. But neither of these figures is as remarkable as the fact that, 15 months after current events were dubbed the credit crunch and the global financial system became imperilled, the Dow is still above 10,000, and the FTSE 100 is close to 5,000. They are both within 30 per cent of their recent all-time highs. There is a false logic here: supposedly buoyed by expectations that TARP will, in the end, be done, stock markets are refusing to send Congress the message that it HAS to be done. "30 per cent off" is not out of the ordinary. I'd guess that Congressmen need to see a further 50 per cent fall, taking the Dow to where it stood in the mid-1990s, before they felt that Mr Market was endorsing the message from Mr Bernanke and Mr Paulson.

Perspective

The Wall Street Crash was a 50 per cent fall in the Dow in the space of eight weeks (followed by a further 40 per cent fall over the next three years, taking the Dow from a high of 542 to a low of 58). As an alarm bell, 2008's 30 per cent retreat over 12 months just does not cut it.

Something along the lines of TARP will, in the end, be done, and it will be done in a shorter timescale than the corresponding action following the Wall Street Crash. But my feeling is that it cannot be concluded until the US presidential and other elections are out of the way. In any case, the credit crunch cannot be fixed in a week by a TARP.

Uncertainty, disillusion and distrust are so rampant that a measure of cleansing way beyond TARP is required.

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Read more of Alistair's columns at his IC home page.

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Alistair Blair is a past winner of the Business Writer of the Year Award, and has worked in investment banking and fund management.

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