The evolving story of the TARP bill’s difficult journey through WashingtonDC—set against a backdrop of poor economic releases and icy credit markets—drove the ups and downs throughout the week of September 22. Most importantly, political struggles between those who wanted to provide the support and those who didn’t drove the markets Monday through Wednesday. As Bernanke and Paulson urged immediate action in testimony before Congress on Tuesday, President Bush addressed the nation in support of TARP on Wednesday. Yet little apparent progress came out of Congress. Legislative momentum was interrupted by debates over the need for a more comprehensive bill with more significant aid for homeowners and better-defined limits on the authority of the Treasury. Compensation for executives at banks became a hot-button issue. Many other issues that had some politicians anti- and others pro- led to lots of arguing and little progress.
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Q2 hedge fund letters, conference, scoops etc
As is classic in deleveraging scenarios, this political debate took on populist overtones. Though congressional leaders mostly supported the bill, rank-and file members argued that it would be like a handout to the banks that caused so much trouble in the first place. Arguing over who ought to bear the costs is typical during deleveragings and highly counterproductive; it can be like doctors in the emergency ward arguing over who will pay the bill. All attention needs to be directed to saving the patient—how the costs should be handled can be decided later.
Even proposing the TARP bill was risky. If it didn’t pass, there was likely to be an extremely negative market reaction. And they needed it passed in very difficult circumstances: as soon as possible, weeks before a presidential election and amid a populist uproar from both the left and the right over its unprecedented size and scope. Given the vote counts in Congress, the bill would need to pass on a bipartisan basis, which by this point was extremely rare on any new important law (and has become even rarer since). If either of the presidential candidates opposed the bill, it would have been nearly impossible to get passed—McCain and Palin initially taking an anti-bailout position put the bill at risk, though they eventually supported it. (Paulson was on the phone almost daily with both presidential candidates.) The only factor working in the bill’s favor was that it usually takes a crisis to get Congress to act, and the financial crisis was in its most acute stage. The difficulties in getting TARP passed are a good illustration of why regulators need broad emergency authorities versus needing to rely on Congress to act.
Financial markets pulsated in response to each undulation between “they will” and “they won’t” do what was necessary in time. Credit spreads on CDS for Goldman Sachs and Morgan Stanley, which had narrowed following their transformations into bank holding companies over the weekend, widened through the week, and huge outflows from prime money-market funds and into government funds continued to put pressure on commercial paper. On Thursday night, the FDIC seized control of Washington Mutual, marking the largest bank failure in American history, before shifting its assets to JPMorgan in a $1.9 billion deal (they would seize Wachovia a few days later). As we wrote on Friday, September 26, “There is so much jam packed into each day that it is hard to pick what to comment on. The big picture through which we see all the daily news is that we are in the avalanche phase of the deleveraging.”
The political stalemate in Congress seemed to break early Sunday morning, as Secretary Paulson, flanked by House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, announced that an agreement had been reached on a $700 billion bailout bill.
But when the bill came up for a vote on Monday afternoon, it failed. Stocks fell 8.8 percent in the largest single-day drop since 1987. Around the world, reverberations sent markets spiraling downward; oil prices fell by $10 because in a depression the demand for it would be much less. Central banks, meanwhile, scrambled to offer emergency loans to shell-shocked institutions. Interbank lending markets froze, while rates on short-term treasuries fell to just above zero.
Again, among the most important aspects of successfully managing a crisis is having wise and knowledgeable decision-makers who have the authority to do whatever it takes. The Congressional vote was a sign that the Treasury would have to struggle to get the authority it needed. At the time, we wrote:
(BDO) September 29: A Credibility Test
The financing of US consumption and the global financial system operates on faith. Recent developments have obviously strained the faith in the financial system. Today’s failure in the House of the bill, whose passage was assured by those supposedly in control, has shined the global spotlight on US decision makers. The question of whether the US can do what needs to get done has been further complicated. In the end, the world’s financiers (China, OPEC) will decide whether US policy makers have passed the test.
Even had the bailout passed, maintaining the necessary global faith in the system would have been difficult. Today the degree of difficulty has risen and the risk of a loss of faith has increased given the chaotic process and lack of leadership illustrated in Washington. There is still a lot to lose.
Officials at the Treasury and Congressional leaders were working around the clock to get the bailout bill passed. The process was painful: Convincing Republicans and Democrats to work together is hard enough during a normal year, but TARP was being considered only a month before a hotly contested presidential election. Republicans hated to look as though they were abandoning their free-market principles and their commitment to fiscal responsibility just to support a bank bailout. Democrats worried about giving a major legislative win to an outgoing Republican administration just before an election. And both Obama and McCain worried that the other would try to bolster his populist credentials by taking a stand against a so-called “Wall Street bailout.” If that happened, Paulson worried, the bill would have little chance of passing.
But politics wasn’t the only headache associated with TARP. While the Treasury had been working with Congress to get TARP passed, two of the biggest bank failures in US history occurred (WaMu and Wachovia), and several European countries had to step up and bail out their own banks. Treasury officials could see that $700 billion in purchases of toxic assets wouldn’t be enough to rescue markets. But if the money was put directly into the banks as capital, they could buy many times the $700 billion because they could lever up.
Even though they said they weren’t going to put capital in the banks through TARP, they pushed to get authority to do it if necessary. The question would be how to do it fast and well. Rather than try to distinguish between healthy and unhealthy banks, an analytical nightmare, which would have prompted a lot of arguing and would have taken more time than they had while stigmatizing the banks they supported (which could have worsened the runs), the Treasury instead offered to buy preferred stocks on very attractive terms. This allowed it to put capital into 700 banks very quickly.
What Paulson did was enormously unpopular because, understandably, the public wanted to punish the banks. In my opinion, the move was necessary and appropriate. It also worked out very well for the taxpayer, because the money that went into TARP’s capital programs prevented a catastrophic collapse, which would have been as bad or worse than the Great Depression—not to mention that it all came back plus an almost $50 billion profit for the taxpayers. This willingness to do the unpopular but right things to benefit people is both heroic and underappreciated. Too many people who have never actually been on the field throw beer cans from the stands. This can lead to disastrous results, unless the players are smart enough and courageous enough to do what is right despite the unpopularity of doing it.
With a lot of negotiating, TARP eventually got through, which was an extraordinary accomplishment because it was a very rare, consequential bipartisan action from Congress. As you can imagine, everyone was on pins and needles because of the enormity of the uncertainties. As with most such cases, it took being at the edge of the precipice to bring about the coordinated action to do the right thing. While it would be great if policy makers could take the right steps early on to prevent such crises, that’s unfortunately not consistent with how political systems work. From having been through a bunch of these sorts of dramas in many countries over many years, I can attest that political systems typically make the right decisions only after heated fighting and literally just hours before disaster is about to strike.
But by the time the bill passed on October 3, there was broad agreement among investors that the bill wouldn’t be enough. Stocks sold off 1.4 percent.
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Article by Ray Dalio, LinkedIn
