If I lose money in the markets, can I count on U.S. Treasury Secretary, Hank Paulson, to bail me out?
Investors have grown accustomed to similar government bail-outs, most recently the “Greenspan put” whereby the Federal Reserve would step in and alleviate market stress by cutting interest rates to address market crises and systemic threats to the financial system. The “Bernanke put” has effectively started following the Fed’s most recent cut in interest rates last month designed to assuage fears of a broader economic slump caused by the ongoing sub-prime mortgage crisis.
Is Paulson creating his own version of the Greenspan and Bernanke put?
That’s the message the former head of Goldman Sachs conveyed to investors and especially, speculators following the announcement of a “Super fund” to help alleviate credit stress on global markets caused by reckless mortgage-backed securities and their innovators on Monday. Although Paulson is not officially engineering a Treasury-led bail-out of housing-related securities, he is the architect of a new plan to consolidate the piles of illiquid mortgage paper that continue to clog short-term funding.
The freeze still suffocating the commercial-backed paper market is a global event, largely in North America and Europe, and mostly tied to housing. The biggest offender remains Citigroup (NYSE-C), responsible for about 75% of the problem. Citigroup holds approximately $80 billion dollars’ worth of securities tied to sub-prime commercial paper.
The Treasury, Citigroup, Bank of America and JP Morgan have come together to construct a “Super fund,” or a bail-out fund designed to lump all troubled mortgage-backed securities into one vehicle similar to what the Fed helped create in 1990-91 – the Resolution Trust Corporation or RTC. The RTC held assets of defaulted mortgages tied to the Savings & Loans crisis and effectively helped to bundle troubled loans, subsequently auctioning foreclosed assets at distressed prices.
Citigroup continues to hold over $75 billion dollars of mortgage-backed securities in off-balance sheet vehicles called conduits. Many banks harbor conduits to fund and hold commercial paper; as the sector grew illiquid and eventually froze this past summer, many banks revealed they could not trade these opaque securities amid a lending crunch. Banks in Canada, the United States and Germany have been hit hard by the crisis.
The question is therefore should Citigroup bite the sub-prime commercial paper bullet and mark the roughly $75-$80 billion in illiquid paper as a loss?
The Federal Reserve, the Treasury and every other government institution has no right to bail-out investors. Despite the market-based risks, which are systemic, the Treasury is setting another bad precedent by engineering this bail-out. Citigroup had amassed five years of massive retained earnings in the billions and should be responsible for its own neglect and stupidity. The bank should come clean with its mistakes, fire its CEO and absorb the cost of its financial blunders. The morale hazard has been set as future crises will look to government as the lender of last resort. The Paulson put is now underway.
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