Senate Banking Committee Testimony Addressing Economic Crisis

By The Greek:

Just when it seemed a Congressional committee might for once offer oxymoron, or the voice of reason, Hank Paulson stepped up and showed us why he is the Treasury Chief. Boy did he stand up!

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Oxymoron of oxymorons, Congress sounded like the voice of reason coming into today and through the introductory remarks of the Senators. Can you believe it, even Senator Johnson made some sense this morning in the prelude to the testimonies of Treasury Secretary Paulson, Federal Reserve Chief Bernanke and SEC Chairman Cox. Outside of Senator Schumer's dangerous sharing of Bernanke's worst economic fears, which should have stayed in the back room (to protect America from falling into greater panic), Congress actually offered a voice of reason today. And, the market agreed with Congress in the early going, as the Dow Jones Industrial Index was up modestly this morning; this after it had a distressing weekend of contemplation and fell on Monday.

Friday's announcement offered hope more than anything else, and that's probably why the market moved so favorably initially in response. We saw confidence in America's financial institutions falling, and America's institutions failing as a result. We needed some sort of support, and the Treasury acted quickly to provide it. Sure, the details need to be refined, but this looks plausible to me, especially if the feds can devise some means of containing any inflationary impact.

It was clear that the shotgun meeting that brought forth the Treasury and Federal Reserve's plan on Friday, left it needing some seasoning and perhaps substance and clarity. It was after all quickly assembled, though well-intended and thought out. However, after listening to the Senators, we recalled our own commentary from months past. We use to preach here about addressing the core problem, and that meant supporting home owners and mortgages, or the collateral assets that support the entire house of cards. However, the current root cause of financial market seizure is the illiquidity of these assets; we cannot prop up housing values, so this seems the best way to address the root problem.

Along a sensible line of reasoning, Senator Shelby said it best this morning, that before signing off on any huge burden for American taxpayers, and one prepared over an intensely pressured weekend and which calls for swift action by the end of the week, that some hashing out needs to occur.

Paulson's Comments

Promptly and powerfully, taking from his tough Wall Street training at Goldman Sachs (NYSE: GS), Paulson defended himself quite well right from the start. Before even getting going really, he noted that he was fixing a problem that began many years ago, before he got to Washington. Then he noted something that we pointed out in our articles over recent days, that the bazooka and expansion of powers at the Fed and Treasury came to be because he and Ben stepped up and took charge of a situation that frankly nobody else in Washington, and certainly not the Senate Banking Committee, was prepared to tackle. I would go as far to say that without these agencies and these men, our economy would be on its way to depression rivaling the Great one. Fred Mishkin confers, judging by his comments to CNBC this morning. The only problem I have with it is that they took a little long in foreseeing how things would develop. Foresight, we generally need more foresight!

Paulson pointed to the trouble with the American financial system, the seizing and ceasing of American finance in progress. And then Paulson showed exactly who is inside that kind frame he projects 99% of the time. It was quite a strong response from Paulson, noting that (and I'm paraphrasing) thank God for Fed and Treasury actions, for otherwise, our economy would be in far worse condition.

Bernanke, the Refined Voice of Reason

Then, Bernanke stepped up to the plate for his turn at the microphone. He very well explained why and how this intervention would help. He urged Congress to act in order to avoid major consequences from ongoing financial market constraint. In English, we need banks to be capable of lending, and we need investors or capital sources to have confidence in financial institutions. This action, in his view, would do that.

Bernanke also addressed some of the criticism about the plan, and this should not be missed by Main Street. Bernanke noted that he is not from Wall Street. He said that he is a professor, with no inclination now or ever to work on Wall Street, and that he also has no personal contacts of interest there (well he probably does now, but we get what he meant). In other words, this is not a save Wall Street screw Main Street solution.

What This Really Is Folks

If financial institutions are not functioning properly, every employer, every employee, every borrower and every depositor bears great risk of very personal future impact. We are not saving "Wall Street" here, but saving the American economy and the banks that lend to it, and that means you too. Just because you have a job today and feel separated from the goings on of this economy, does not mean tomorrow will not have you bankrupt, panicked and suffering; it very much might! These are not fear tactics, as one ill-advised naive-minded House Representative stated on the House floor this morning; that kind of statement is akin to calling Americans whiners entangled in psychological recession.

The Plan

Lenders have tightened lending significantly because of concern of coming under solvency stresses. Institutions have witnessed peers fail, and at rapid rates in some instances when the market sharks caught whiff of blood. Under such conditions, and even more so than under normal recessionary instance, lenders have incentive to batten down the hatches and wait out the storm, and in some instances, pray for survival. What that means for America is decreased opportunity for growth for many of America's businesses, especially its broad reaching small business sector. It seems that a way to get banks feeling like doing business again in this specific instance, is by taking illiquid assets off their hands once and for all, thereby freeing them up to raise capital more easily and to lend and do their business. More importantly, it may keep a lot of businesses from failing, thereby increasing unemployment and sending us into extremely tough times. So we help out the banks so they lend to your boss, they lend to you for your home equity project, they lend to your brother for his auto purchase, and they lend to your sister for her new UPS store she's starting up (NYSE: UPS). There's clearly some hope here that banks are not shell-shocked.

The Treasury will offer to purchase, via reverse auction through the newly created federal purchaser, the sick assets of financial institutions. Institutions will offer these assets through auction reaching across a vast group of firms. This mechanism should allow for competitive price setting, offering a price discovery tool that could further aid the market by providing better mark-to-market values. In other words, the most desperate sellers among our financial institutions will sell their worst assets. This should help free them up, or to "unclog the arteries" as the Fed Chief puts it. This will allow for free blood flow, encouraging a healthy body of U.S. economy.

Problems Addressed and Unaddressed

One problem that was addressed through the questioning was the risk of downgrade of the United States as a sovereign issuer of debt. Even though Bernanke sort of sidestepped the issue, by doing so, he also answered it. There is much concern that the United States could be downgraded, but let's be serious. Can you imagine Standard & Poor's (NYSE: MHP) or Moody's (NYSE: MCO) doing that? And, if they did, how long would it take for the general populous to burn down 55 Water Street, where S&P is housed? Not gonna happen... Even struggling, the U.S. economy and United States government remains one of the world's most reliable creditors on a relative basis.

The oversight question was addressed, as Paulson stated he welcomed it. This guy is from Wall Street; are you kidding me that he wouldn't want oversight? The last thing he wants is to bear personal legal risk here, and lack of oversight would place him at great personal risk. He plainly stated that the oversight question was not addressed in his own press release, because he viewed it presumptuous for him to do Congress' job for it. In other words, it's up to Congress to figure out how it will keep an eye on things, which makes perfect sense.

Nobody, not one Senator, addressed the inflation threat, unfortunately. I would have directed that question to the Fed boss, and he would have answered it very well I suspect. I think he might have said that there is risk, but that the risk of inaction here is far greater. Unfortunately the question remains overhanging, and a serious concern of financial markets. This is because, by seeking to help lenders, we may also drive offsets to capital flows, that being higher long-rates, a weaker dollar and again climbing commodity prices, including oil. It's truly unfortunate that among a stronger than usual line of questioning from the Congressmen, they missed this one.

In conclusion, we support this strategy, even so. Friction from lending restraint should be released, and inflation may lead to higher long rates, but we'll hopefully keep more lenders in operation, limit lost tax income and increased unemployment and more importantly hopefully avoid total financial market collapse (and the second depression). We'll maybe free up institutions to merge and to grow their businesses. We'll take a weight off the shoulders of the financial system. Our only problem with the plan is that it took this long to figure out that addressing the illness would be more effective than treating the symptoms. The Dow is down fractionally at hour of publishing, reflecting market uncertainty.

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