Wednesday, June 10, 2009

Don't underestimate President Obama

President Bush and Treasury Secretary Paulson took a lesson out of Alan Greenspan's book "The Age of Turbulence" when they set up the bailouts of AIG and the banking system. In his book the Ex-Federal Reserve Chairman explains how bailouts like this were done several times in the past. The first time the Fed was happy just to get close to breaking even but, after that, the Fed actually started to make a profit from such bailouts.

In 2008's original plan, the government would buy troubled assets in the banks, bundle them and then sell them in auction, similar to how the government bailed out Mexico's loans back in the early 1990s. The original TARP program did not include the government holding stock or having any control over the banks. However, October 14, 2008, Secretary Paulson and President Bush revised the program to use the TARP money to buy non-voting Tier 1 preferred stock and warrants in the banks. They also put restrictions on how the banks could do business and on senior executive compensation.

Many economists argued that this plan would be ineffective in inducing banks to lend money, since it appeared that the bank would be paying more interest on the government loans than what they could charge customers. Here again, this was exactly what Alan Greenspan had done to Mexico and why Mexico ended up paying these loans back early.

Earlier this year some banks wanted to pay back the TARP money, to get the government restrictions removed from their companies. President Obama put this off by requiring bank stress tests.

Ten of these banks bought back $68 billion of these shares yesterday. That has given the government a 5% profit on that part of the transaction in a very short period of time. Now these banks may still have to buy back warrants worth approximately $5 billion more to completely free themselves from government restrictions.

President Obama and his team, being the shrewd politicians that they are, put the banks off long enough to insure that the banks were strong enough to survive and to make sure that the government came out of the process with a handsome profit. In doing so, they also gave notice that they are going to be a force to be reckoned with now and in the future.

So why did the banks want to pay this money back so very much? First, the executives did not like the government telling them how much and how they could get paid. Second, if someone gave you $100 at 7% interest and told you to loan it out at 3% or 5%, what would you do?

Now some people will say that the government has no place making a profit from something like this. I think they are damn lucky to still be in business.

I think Nassim Nicholas Taleb,author of the Black Swan, put it best. I will paraphrase what he said: The U.S. economy is broken, but not beyond repair. It does not necessarily need more regulation, but more intelligent regulation. Plus, we should let companies like Citibank and General Motors fail once they become too big and cumbersome and act irresponsibly. Nothing should be allowed to get too big to fail. What is fragile should break early while it is still small. People who drove a school bus blindfolded and crashed it should never be given a new bus.

To read more of what Taleb said go to