The Tinker Bell Treasurer!

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I believe in Fairies

Tinker Bell started life as a character in J.M. Barrie's play first performed in London in 1904. She co-starred in the subsequent novel “Peter and Wendy”, and has since appeared in numerous adaptations including the widely known animated Disney film Peter Pan. In the original book and play, Tinker Bell is Tinkerbelldescribed as a common fairy who mends pots and kettles, i.e. a tinker, and is often referred to simply as "Tink". Though sometimes ill-behaved and vindictive, at other times she is helpful and kind to Peter (for whom she apparently has romantic feelings). The extremes in her personality are explained by the fact that a fairy's size prevents her from holding more than one feeling at a time. A bit like Wall Street. Tinker Bell, like other fairies in Barrie's works, can make it possible for others to fly, by sprinkling them with fairy dust.

Barrie's fairies can’t live unless others believe in them and their magic powers, much like the belief that Wall Street managed to engender that somebody there actually knew what they were doing with mortgage backed securities. In one famous scene in the play, Tinker Bell is dying, but she will survive if enough people believe in fairies. At the old theatre, the characters in the show make a plea to the children watching to sustain her by shouting out "I believe in fairies," and clapping. I still remember seeing this show in London as a 5 year old. I believed fervently in fairies and urgently joined in the childish screams: “I believe; I believe”.

I still believe in fairies. In fact I have two fairy dells in my garden, but even an old man as gullible as me finds it hard to swallow the latest fairy tale that Paulson will bail out the banks for the benefit of the nation. That’s a whopper that even Tinker Bell would shy from!

US Treasurer Hank Paulson and Fed Governor Ben Bernanke want you to cry “I believe in fairies”. History will remember them as men called by fate to undertake a momentous event. Nothing short of the resurrection of Wall Street.

Like Tinker Bell, Paulson believes that if he sprinkles enough fairy dust (taxpayers’ money) on the lame and the halt of Wall Street, they too can fly again. Bernanke has been reduced to irrelevance as the Fed has shot its ammo and he now wanders around looking like Hank’s lap dog. Just like the dying fairies, the Wall Street icons can only survive if the people believe. Aping the children at the famous play, the cast of Wall Street is now shouting “I believe in fairies” but the unanswered question as the sleight of hand continues virtually unquestioned in main street media and on Capitol Hill today is “Believe in what”?

Let me say that I am not opposed to the bailout. If US taxpayers are prepared to trust this administration with a trillion or more on the basis of a 3 page memo, and following a list of other “trust me” scenarios, that I guess is peculiarly a matter for them. US government debt on IMF measures is 48% of GDP compared with 57% for Germany, 94% for Japan and 108% for Italy, so even after the housing bill, the Fannie and Freddie bailout and other recent fiscal adventures, the US has ample scope to handle this new idea.  But if you are going to try to save the fairies you need to know exactly what you are being asked to believe in; and its not what you think.

The insolvency of major parts of the financial community is a truly dreadful indictment of the banking and shadow banking community and in particular its regulators whose ultimate chiefs (if push comes to shove) are, and have been Paulson and Bernanke. Having presided over at least the near end game and with both Paulson and Bernanke complicit in actively encouraging 60 other central banks and thousands of major institutions and funds to buy the endless supply of toxic paper spewed out largely by Wall Street, the head poachers or at the least their cheerleaders now ask you to accept them as the gatekeepers. A more improbable scenario is hard to imagine.

As the party heads to Capitol hill today with the administration parroting Chicken Little’s cry “The sky is falling”, it has more than a whiff of panic to accompany it. The urgency I suspect is tied to the notion that Hank can stampede Congress into giving him the unlimited powers he seeks so that he can “work it out” as he goes. The “work it out” part relates to Bernanke and Paulson’s assertion that a failure to rapidly approve their $700 billion plan to remove “illiquid” assets from the banking system will imperil the global financial system and harm ordinary Americans.

That is pure spin. Paulson and Bernanke wouldn’t know an ordinary American if they fell over one. Neither have lifted a finger to help beleaguered citizens stuffed into predatory mortgages. Their concern is only the restoration of order in the US banking system and that means capital.

The problem

You see, these “illiquid” assets are not illiquid at all. They, like all impaired assets are sellable at a price, but the asset holders, mainly the shadow banking community of banks, investment banks, hedge funds, monoline insurers, structured investment vehicles (SIVs), conduits, money market funds and thrift institutions won’t take what the market is prepared to pay for these assets. Indeed based on NAB’s total write off of its US mortgage backed CDOs and Merrill’s write down of its mortgage paper we have a fair idea that the broad brush value of the lower tranches of these horrors is between 25% of face value and zero.

And that is only the first part of the problem. The second is that in the push to gear up the profits flowing from these mortgage backed securities, banks and others added leverage to make the model work at the required rates of return. That leverage is generally about 10 times for regulated banks, thirty times for investment banks and more for others. So, if they take a 10% hit on the face value of the security and they have, let’s say 12 times leverage (modest by today’s standards) they effectively take a 120% write down on the value of that asset. Do the sums at a 50%-75% write down and you can see why these guys are staring into the abyss.

In short, if the wider banking system is forced to hold these assets because they can’t accept the market price for them, and if they are finally forced to value them at true market value (and one suspects even the clueless auditors have an inkling by now of what their clients are facing), they will effectively be insolvent or so capital impaired that they will not be able to undertake their proper functions. Indeed many are insolvent now, but nobody is prepared to shout the obvious, that the Emperor has no clothes. With insolvency comes dangerous secrets. UK regulators are just discovering that Lehman’s UK pension fund is light about $200 million. Many major US pension funds were also light on the necessary. And as most like to stuff the pension funds with their own shares, the problem of failing companies and lower stock prices compounds the staff and punters’ risks dramatically.

Paulson’s real job is to restore Capital

2Thus Paulson’s brief in making these institutions whole is not just to relieve them of the impaired assets as his public statements assert, but to do so in a manner that leaves the holders’ capital and balance sheets intact, and here is the great lie.

My father once told me in simpler days before CDO squared and other fiscal junk that there were only two ways to make a quid (dollar). Either you bought oranges for less than they were worth and sold them for what they were truly worth or you bought oranges for what they were worth and sold them for more than they were worth.

Paulson has found a third way. He is going to buy this toxic paper for many times what it is worth and sell it to the taxpayer for even more!

Unless he pays the banks somewhere near face value, less a haircut for these securities, the plan is useless. The real plan is to restore capital.  And that is precisely what he and Bernanke are plotting. Talk of illiquid assets is just the smokescreen.

In the process he is asking for immunity from judicial review, a very good idea as otherwise he can plan on spending the rest of his natural days in various courtrooms explaining the unexplainable. To add to this witches brew he is offering to extend the same largess to foreign banks and institutions. Why, you ask, should US Treasury be bailing out German, French and other banks? It’s the same story as Freddie and Fannie. Foreign banks bought this paper on the specific or implied assurance from Treasury and the Fed that the paper was good. In many instances the banks and their central banks acted at the specific request of Treasury to assist in the earlier efforts to forestall the inevitable, so now, naturally, they expect US Treasury to make their losses whole. Bet the punters aren’t told that!

Many spout the hope that Treasury and nominally the taxpayer will eventually make a profit out of this mess. They may but it’s a very long shot. Remember that even Paulson concedes the root of the problem is falling house prices and that can’t get back to previous bubble values at which these securities were written until income equal 3.3 times the capital sum. Absent a 50% increase in US wages in the foreseeable future this trillion dollar adventure will become just another black hole.

By all means join in the screaming. I believe in fairies. I believe. Better still believe that the spin as the masters pretend to buy the bonds at “market” or “auction” price in the interests of taxpayers will be as pervasive as the spin that US citizens will ultimately benefit.

The boys are bailing out Wall Street and you are paying the bill for all those multi million dollar bonuses. You are also paying for the negligence or incompetence (it must be one or the other) of all those regulators who knew what was happening but acquiesced to keep the game going. When asked if he thought that executives of companies taking the handout should have some restrictions on their salaries and bonuses, Paulson replied that such action would be punitive. Clearly that is not on his agenda. No accountability and now no consequences.

So the game is to pass the parcel to an entity that can disguise the losses for many years and whose balance sheet is not really up for scrutiny-the US Treasury. Then the boys can get on with their wonderful lives without this undoubted inconvenience.

The market’s response to this rubbish should be for the Dollar and Bonds to tank simultaneously, but it won’t happen to any extent. Perhaps just enough to get commentators thinking that these markets still have a collective mind. They don’t. The Bond vigilantes are now just another urban myth. With the carte blanche from the powers that Treasury is about to be extended and a little help from their friends, we can be assured that a bit of support for Bonds and the Dollar are well in hand. Stock prices after this round of manipulation, banning of short selling and other high jinks should only be of interest to the fairies and the odd garden gnome. But restoration of higher stock prices is vitally important for the institutions that will need to place stock to shore up their capital. They can’t do so at depressed stock prices. So this too is part of the plan that requires nothing less than the realisation of dream prices for the tainted mortgage backed bonds.

I remember pressing Tinker Bell into service when my daughter then aged 2 or 3 asked me how flowers bloomed. Not being prepared to risk an encounter with biology I did what Hank is doing and solemnly informed her that Tinker Bell sprinkled the buds with fairy dust and that made the flowers grow. I thought that was a pretty reasonable response to a very small child. Paulson thinks it is an appropriate response for grown ups like you and like Congress. It appears Congress absent just a few adults, agrees.

At the end of the novel, when Peter returns after a year in Neverland, it is revealed that Tinker Bell is no more. Fairies don’t live long, but they are so small that a short time seems a good while to them. Peter has forgotten her. Wall Street won’t forget Hank Paulson. They owe him their corporate lives.

Copyright © 2008 John Needham

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