Word on the street today is that the Obama administration's proposed budget includes a $250 "placeholder" for support of the financial system. (ht Economics of Contempt, Calculated Risk) President Obama made an admirable commitment "to restoring a sense of honesty and accountability to our budget". However, his administration has failed to live up to that commitment with respect to financial system support. Unusually for government expenditures, the budgeted $250 billion dollars represents an estimated "net cost". It presumes recovery of a substantial fraction of funds "invested" and actually enables cash payments that might amount to $750B. (See EoC, Marc Ambinder.). In plain English, buried in a $3.55 trillion dollar budget as a $250 billion dollar placeholder is a plan to more than double the controversial and unpopular TARP program, whose original enactment nearly tore the political system apart.
We do have a bit more transparency this time about how the "Capital Assistance Program" will be managed. Taxpayers will purchase securities at prices which, as Michael Shedlock points out, appear to have been back-dated in order to give taxpayers a raw deal. In an astonishing abuse of the customary language of finance, the "convertible preferred" shares the government intends to purchase, in addition to mandatory conversion after seven years, are convertible to common stock at the option of the the banks, rather than at the option of the taxpayers holding the securities. James Kwak unearthed this bit of chicanery in the must read piece of the day. In addition, existing bank shareholders would be protected upon any conversion by "customary anti-dilution adjustments". God forbid that shareholders in bankrupt institutions who would otherwise be wiped out entirely get diluted. The poor dears. (To be fair, it is inaccurate to characterize all institutions that will receive "capital assistance" as bankrupt. The new Treasury Secretary will almost certainly continue the old Treasury Secretary's strategy of "encouraging" healthy institutions to take government money, so that angry taxpayers cannot use acceptance of funds as evidence that a bank is in trouble. Under the new program, any publicly listed US bank can apply for a capital infusion of up to 2% of risk-weighted assets as a matter of course.)
President Obama's obvious intellect, idealism, and diplomacy are a breath of fresh air for a nation whose economic and political institutions have suffered a near catastrophic collapse. But the President cannot put his imprimatur on continued financial obscurantism and expect to retain a reputation for honesty and transparent government. It is wonderful that the President intends to come clean and account for the wars in Iraq and Afghanistan on-budget. But Mr. President, past and proposed expenditures to support the financial system dwarf the total financial costs of both those wars combined. This is not a small thing. You can't hide the terms of these transfers in fine-print befitting a credit-card agreement and expect to retain your reputation with the American people for forthrightness.
Here is my advice to the U.S. Congress: Put $750B in the budget, right up front, for financial system stabilization. But don't contribute another dime to Secretary Geithner and Neal Kashkari's little slush fund. Allocate funds to the sole use of the FDIC, for resolution of troubled banks as foreseen by Congress under the FDICIA (text). See this excellent piece by former bank regulator William Black. The government has been flouting the terms of a binding legal regime designed precisely to resolve insolvent and near insolvent banks transparently, at least cost to the taxpayer, in a manner that minimizes both moral hazard and systemic risk. Former Secretary Paulson's ad hoc let's-pretend approach has been tried, and has failed. Why not try following our own laws?
We have a new administration in Washington that claims to be committed to the rule of law and good governance. Congress should help the President achieve these goals by funding an accountable FDIC rather than by putting more discretionary funds into the hands of a compromised Treasury secretary.
Update: The always excellent Nemo also noticed the odd reverse-optionality of CAP "convertible preferreds". He finds the coincidence of widely publicized insider purchases during CAP's price-determining 20-day window to be intriguing as well. Purchasing shares with the intention of increasing their effective price to taxpayers under a foreseen government relief program would certainly constitute a crime. What did Ken Lewis know, and when did he know it?
(It's worth mentioning that the allegation of backdating and that of insider price manipulation are mutually inconsistent — if insiders knew that the window would be 20 days preceding Feb 9 in late January, that implies the price-determining date was appropriately set in the future. You can either suggest that the date was chosen retrospectively, or that it was chosen in advance and shares were bought and talked up, but you've got to pick one conspiracy and stick with it. I guess if you're really cynical, you might suggest that Feb 9 was tentatively chosen in advance, but only finalized when it was clear in retrospect that prices were advantageous, relatively speaking...)
- 26-Feb-2009, 5:15 p.m. EST: Added update re Nemo's posts.
- 26-Feb-2009, 5:25 p.m. EST: Added bit about inconsistency between back-dating and price-manipulation stories, and hedged the main text a bit, saying that the window appears to have been backdated rather than stating that as though it were fact.
- 26-Feb-2009, 6:05 p.m. EST: Removed an "as the" to split an overlong compound sentence about Geithner countinuing to encourage healthy institutions to accept money so the zombies blend in.