by Robert Lenzner
“Very aggressive policy.”
Over dinner on Tuesday night, that’s what New York University economics professor Nouriel Roubini told me was required for a “U” shaped economic recovery “rather than a Japanese-like ‘L’ into oblivion. He puts the odds of a “U” at two-thirds and an “L” at only one-third, if these further policy actions take place. Such a voluble bear coming down in favor of a “U” should be welcome news to the crushed investment community.
Federal Reserve Chairman Ben Bernanke must have been eavesdropping on our conversation. The very next day, Bernanke did promulgate some “very aggressive action” indeed–another trillion dollars or so to be poured into the mortgage-backed and Treasury securities in a bold attempt to free the credit markets. Wall Street loved Bernanke’s move, extending the stock market gains here and abroad and driving interest rates on Treasury securities and mortgage-backed bonds lower. Hope alights again for housing as mortgage interest rates have been driven down to 4.79%, which should help to thin the gargantuan inventory of unsold homes.
Now it is time for Aggressive Action II from Treasury Secretary Timothy Geithner. It must be a decisive and clear creation of a “good bank/bad bank” arrangement to get rid of the albatross around the necks of Citigroup, Wells Fargo, JPMorgan Chase and Bank of America, for starters.
Roubini believes it is crucial to break up the big banks into three or four parts each, so that they can be better managed. “If you’re too big to fail,” he says, “then you’re too big, period.” If Geithner comes through with a clear, aggressive, bold and easy-to-understand program for the banks, his star will rise, and so will the bank share-led rally in this bear market. All eyes are on Uncle Sam.
There is a wonderful precedent of how a “good bank/bad bank” solution can rebuild debilitated capital structures in financial institutions. In 1988, John Vogelstein, a brilliant partner at E.M. Warburg Pincus & Co., together with Wachtell Lipton law partner Martin Lipton, was able to restore stability to Mellon Bank and make a profit of $1 billion by separating the terrible assets from the promising ones. It was the first non-assisted recapitalization of a major commercial bank, and out of it grew one of the nation’s top 25 bank holding companies. Mellon’s bad assets were put into a bad bank at a discount of 25% to 30%, and over an extended period of time, the stream of income net of interest from these assets brought exactly the value that Vogelstein had predicted. Warburg Pincus made $1 billion on its 20% interest from a bank that was losing $300 million on a balance sheet of only $750 million.
Mr. Geithner, please note that Mr. Vogelstein is still affiliated with Warburg Pincus and can be reached at (212) 878-0601.
If Geithner is smart, he will ask Vogelstein to come down to Washington and provide advice on this much greater, systemic situation that ultimately determines whether investors can expect the economy to stabilize anytime soon. For that matter, there’s a bunch of public-spirited investment bankers with no conflicts of interest over TARP who would be glad to help out. Another name that comes to mind is Christopher Lawrence of New York’s Rothschild Bank.
To work our way out of the current morass, it will be necessary to relax the mark-to-market rules for banks on valuing the assets that need to be taken off of their balance sheets. Congress is threatening to pass a bill creating a new Federal Accounting Oversight Board if FASB does not provide a change in fair value application by early April. It would help if the banks can price assets that are generating income at their holding values, which is a lot higher than the price buyers in the open market would currently be willing to pay. In this way, the write-downs would not be so severe.
Bold and aggressive action is required on home mortgages, as well. One proposal Croesus heard was to give home buyers a $20,000 tax credit and to guarantee a substantially reduced interest rate on the mortgage. Also, if the house has a mortgage on it, the buyer should be able to assume the mortgage at the sharply reduced interest rate. The ability to assume mortgages at a much lower rate of interest could get the 1.5 million foreclosed homes off banks’ balance sheets and make room again for productive lending.
To put the record straight, Croesus has learned that former Treasury Secretary Henry Paulson tried to bring about bold aggressive and action that would have saved the markets from the meltdown of the summer and fall of 2008. I’m told by an impeccable source who was there that Paulson wanted to bail out Lehman Brothers, but he was vociferously opposed by harsh congressional powers: Sen. Charles Schumer, D-N.Y., Sen. Christopher Dodd, D-Conn., House Speaker Nancy Pelosi and Rep. Barney Frank, D-Mass. Their mantra: “No more bailouts.”
For those who need a refresher course, after Lehman went down, the commercial paper market froze and General Electric could not refinance its short-term debt. General Electric Chairman & CEO Jeffrey R. Immelt was “going bananas,” Croesus has been told. On Sept. 18, three days after Lehman’s demise and overwhelmed by panicky calls from Immelt, Paulson relented and had the entire commercial paper market guaranteed by the U.S. government. This is one large part of the $9 trillion in loans, investments and guarantees handed out by the Federal Reserve, the Treasury and the FDIC since the crisis began. Paulson also hectored then Securities and Exchange Commission Chairman Christopher Cox and FASB about changing the mark-to-market rule and got absolutely nowhere.
Official Washington, in the form of the Fed, the SEC and Congress, was tarred and feathered this week in an Oxford-style debate sponsored by insurance executive Robert Rosenkranz’s Intelligence Squared. Sixty percent of the crowd, many with Wall Street connections, voted overwhelmingly that the cause of the meltdown was the government’s laissez-faire approach to regulation and the supply of easy money. Niall Ferguson, Harvard economist and author of the bestselling Ascent of Money, quipped most effectively that the fault wasn’t in Citigroup chairman Charles Prince’s desire to keep dancing while the music was playing, but “who was playing the music: the Fed, the SEC and Congress.”