Recapitalize & Steepen; Markets Paralyzed

Posted by urbandigs

Thu Sep 25th, 2008 06:32 AM

A: Alright, so I've read all the articles, read all the bloggers, and its clear there are very strong views on the flaws of this recapitalization plan that easily could exceed some $700,000,000,000. I'm more interested now on what the general theme is here. In my humble opinion, the goal is to recapitalize and strengthen the banks, period! Yea, Im sure there will be clauses inserted in the plan to help foreclosures, and work with struggled homeowners who might fall into foreclosure, but the main goal of this plan is to get the balance sheets fixed, the revenue generator for banks back running again, so that the lending can resume. Period. To do this, it seems first you recapitalize, then steepen the yield curve.

I'm so upset about all this bullshit you have no idea. I just know that the marks the future committee will be granting these toxic assets will be WAY HIGHER than true market value at the current time. But this IS the plan and those who mentioned write-ups will probably get them.

We are beyond what he said / she said at this point. We are beyond whether or not Paulson / Bernanke PUBLICLY acknowledged the health of our banking system at this point (behind closed doors, well then, that's a different story). We are beyond who dunnitt, at this point. I'm not saying I like it, I'm not saying it's right, I'm saying we are in dangerous territory, and Bernanke and Paulson know it. Their hand is revealed. The end game is either AWFUL or it's A BIT LESS THAN AWFUL w/ BAD SIDE EFFECTS. We will likely see the latter.

As Yves over at NakedCapitalism.com argues a recent NY Times article about the plan's intentions:

Vikas Bajaj of NY Times states: A big challenge for Treasury officials will be deciding whether to buy the troubled investments near the values at which the banks hold them on their books. That would help minimize losses for financial institutions.

Yves Counters: Huh? How can Bajaj not understand what this program is about? First, it is going to pay above, in fact considerably above, current market prices for the illiquid (frankly, often dud) assets. There is no point to this exercise otherwise. The banks are free to sell now at market price, but they aren't willing to. Hence the government is stepping in, paying over the mark.
Yves is spot on. The entire point to this plan, as I read it before revisions are made public, is to buy distressed assets at prices SIGNIFICANTLY ABOVE current marks that the free market today is willing to pay! By paying a great price for these junk assets, the banks:

a) get the toxic off their balance sheet AND
b) recapitalize

What you need to know is this, the markets are 'paralyzed' right now, as confirmed to me by an asset manager and a CDS (Credit Default Swap) trader. steep-yield-curve-fed.jpgAll eyes and trigger fingers are on what is to come. And as the waiting goes on, credit market indicators out there that we all use to check in on the fear level, or risk aversion, are going nutz. Something is going down, that is for sure! Oh, and by the way, you know we will eventually get economic data reflecting the past few troubled months here, so get ready for that too!

My bet is that a mega-revised plan packed with little add-ons to quell the public outrage will go through, banks will be recapitalized because they have to and our gov't will likely not stand idle, and you will see a steeper yield curve (above right is current US treasury yield curve); which is what they want to happen because it gives banks more chances for profits. The steeper yield curve this time around doesn't paint the rosy high growth / inflation from growth picture that it normally does. This time, we have significant negative macro forces at play that will likely result in higher longer term yields, at the same time our fed continues to battle a serious near term slowdown; hence the steepness.

Massive treasury issuance to fund all these programs/bailouts could eventually lead to longer term hyper-inflationary concerns, all dollar negative. For now, its about stopping a deflationary spiral. I guess I can imagine a world where this recapitalization plan fixes everything, and global investor confidence is fully restored, and no more failures occur, and the global economies don't slow down anymore, and the dollar ignores the national debt and account deficits (recall the Debt to GDP / Peak Credit discussion)....yea, I guess I can imagine that kind of world. But imagination usually doesn't translate into reality.

I expect the long end of the curve to see higher yields, and the short end to stay low as the fed will likely ease in response to a major event or very bad macro economic data. John Jansen over at Across The Curve, a great bond site, reflects in his post "Blank Check" and I agree:
Peter Orszag is head of the Congressional Budget Office and he testified before the House Budget Committee on Wednesday. He also testified that he expects the $700 billion authority, assuming it passes. to be fully utilized during fiscal 2009. I believe that the 2009 fiscal year will begin on October 1.

That is an enormous amount of borrowing by the Treasury and does not count funding of FNMA and Freddie Mac or purchases of MBS by the Treasury. Unless the economy heads into a serious contraction, very serious, current yields on 10 year notes and 30 year bonds will increase. We will be drowning in a sea of Treasury spittle.
Exactly. Only thinking out loud folks, this site is simply an open journal for me and others to blab on. Let's see how this Sunday evening looks in what is now a regular pre-global markets opening ceremony of rescues! It's a sad time for America.


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