Tuesday, September 30, 2008

What Went Wrong With the Bailout

First of all, let me say that I have the utmost respect for Hank Paulson.  When I worked at Walgreens, Hank was the Goldman Sachs partner in charge of Chicago and I had the pleasure of dealing with him on a number of transactions.  He has a terrific knowledge of the financial markets and knows how to get things done on Wall Street.  However, that doesn’t necessarily mean that he knows how to get things done in Washington.  Herewith are a few modest suggestions that could have helped get the legislation through the halls of Congress, based on my years of dealing with communications issues, investors, and corporate management.


The people at Treasury never should have let this proposal see the light of day if it was going to be called a bailout.  They should have labeled their efforts the “Financial Securities Reform Act or, better yet, something that made a snappy acronym that highlighted the fact that they were going to take charge of the markets and wrestle down to earth all of these mortgage backed securities and collateralized debt obligations.  The agenda should have been reform, not bailout.

Offer Terms

Treasury treated Congress as if it were corporate management of a bank that was about to be seized by federal regulators.  The original proposal for legislation contained provisions that simply were not politically palatable to Congress – giving huge new powers to Treasury that were not reviewable by Congress or the Federal Courts and putting no limits on corporate compensation of executives of firms that benefited from the legislation.  Yet these were the same people who would have to vote on approving the funds, and are facing re-election in a month.  Then the people at Treasury proceeded to argue about it when Congress tried to make changes.  If the people at Treasury really wanted to get things done quickly, a more middle-of-the-road proposal that recognized some of the political realities would have worked much better.

Educating the Public

Your average American (and Congressman) does not understand the workings of the credit markets and how it affects them personally.  The perception of the legislation was that the U.S. taxpayer was going to buy all of these distressed securities from the big, bad banks leaving the banks free and clear and the taxpayer with the bill.  The reality is far more complex.  Banks are required to mark their securities to market. When fear grabs the credit markets and securities can’t trade, marking to market results in a cascade of lowering valuations that feeds on itself and erodes banks’ capital position.  With eroding capital, banks can’t lend and the economy grinds to a halt, and everybody from Wall Street to Main Street suffers. Treasury should have made it clear that their role was similar to that of a specialist or market maker.  They were going to step in, provide a market for the securities, initially as a buyer, but eventually as a seller as well. Banks, in selling to Treasury are going to take a loss, albeit not as big of a loss as if there were no buyer.  The point that needed to be made to the public was that banks were going to suffer here, not get off Scott free, and the ultimate beneficiaries are all people that borrow from banks, which is pretty much everyone in the U.S.

Treasury is not subject to mark to market accounting rules and can wait until the markets return to a semblance of order before selling.  In all probability, Treasury will probably make money on these trades as they can afford to wait the market out.  We may not know exactly what these mortgage backed securities are worth, but they clearly are not worthless and probably worth more than panicky sellers will unload them for.  One of the axioms of Wall Street is that you can make a lot of money if you can afford to be patient during a crisis.  So the second big educational point that needed to be made was that the intervention into the markets by Treasury would eventually be to the benefit of the U. S. taxpayer.

You can argue that the folks at Treasury and the Federal Reserve were in crisis mode and not thinking about communications issues, but if you want to get things done in Washington, communicating the story in the right way is half the battle.

1 comment:

Robert Boyd said...

I agree with your analysis and am still a bit dumbfounded that such a terrible package was presented to Congress by the Treasury in the first place. It was so bad--equally so to the left and right--that Congress was put on the defensive. It's not surprising in the end that they rejected the bill, even after it had been softened considerably.

Not calling it a "bailout," however, was out of the Treasury's hands. The term was already out there. But I agree that they should have come up with some other, more palatable name, but doubt they could have stopped most people from calling it a "bailout."

The last point about educating the public is key. I remember hearing a recording of FDR explaining how banks made money and why they needed to be temporarily closed to stop the bank run. The clarity of his speech was amazing. Here was a man who was clearly an "elite" speaking in language that ordinary Americans could understand.

I'm not sure if anyone in the administration has that ability, and even if there was a "great communicator" in the administration, its credibility is so low that many, if not most, listeners would simply view anything its spokesmen say as dubious or cynical.

This is a burden the administration has to live with. So if they hope to salvage the bailout, they should try to find some spokesman who is 1) percieved as independent and as a good-faith actor, and who 2) has the ability to explain what is at stake in relatively simple, straightforward "fireside chat" language. That's a tall order.