http://www.hussmanfunds.com/wmc/wmc080929.htm...
The only way that buying the questionable assets will increase capital on the liability side of the balance sheet is if the Treasury overpays for them.
A better approach would be for the government to provide capital directly, in the form of a “super-bond,” in an amount no greater than the debt to bondholders. The “super-bond” would be subordinate to customer liabilities, so it could be counted as capital for the purpose of capital requirements, and would be seen by customers as a legitimate cushion of protection. However, in the event of bankruptcy, it would have a senior claim in front of both stockholders and even senior bondholders. Do that, and you've actually got a mechanism to protect the financial system while at the same time protecting customers and taxpayers. Ideally, the super-bond accrues a relatively high rate of interest so that financials have an incentive to shift to private financing as soon as possible, but you would also defer the interest until the bank meets a minimal level of profitability to make sure that the financing doesn't strain the institution's liquidity.
But then, Congress didn't do this because nobody thinks in terms of balance sheets. So after a nice pop to maybe 1300 or even 1400 on the S&P 500, we can expect all hell to break loose again.As a side note, a lot has been made of Warren Buffett's investment in the senior preferred stock of Goldman Sachs. But it's notable that Buffett invested in Goldman only upon the conversion of Goldman to a bank holding company, which puts it under a different regulatory structure that gives it access to the Fed window. Goldman's balance sheet has $40 billion of shareholder equity that would have to be drilled through before getting at the preferred. Evidently, Buffett believes that Goldman's asset mix is diversified enough, and light enough in mortgage assets, that Goldman won't take a major haircut on its entire (largely hedged) portfolio of assets. Buffett's investment may reflect confidence in Goldman, particularly with a government backstop on whatever questionable assets it does own, but if anything,
it suggests that the government should have gone the same route – namely, provide capital in return for a financially viable security that is senior to common shareholder equity, have it accrue a relatively high rate of interest, and allow it to be repaid early (Buffett's preferred is callable by Goldman) as soon as the financial institution can secure cheaper financing.Instead, the government is taking on financially non-viable securities and warrants on common equity, while failing to improve the capital position of these financial companies at all (unless it overpays). Taxpayers will
not make money here. As Congressman Scott Garrett noted to taxpayers on Sunday, "This morning we should be very much alarmed. Obviously, Washington is not listening to your wishes. Those who used to work for Goldman Sachs will support this deal. Those who have blocked reform in the past will support this deal. I will not support this deal." I couldn't agree more. This is not a good deal, because it will waste taxpayer money without addressing the fundamental solvency problems.
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