You have to like Hank Paulson. The Treasury Secretary grew up on a farm in Illinois. Many leaders in American history learned the value of hard work while planting seed and harvesting crop. George Washington was a farmer. Thomas Jefferson was a farmer and envisioned our country as a republic of farmers with a strictly limited federal government. That was when agriculture dominated the economic composition of the United States. Since then, the original federation of thirteen states has grown to fifty while the percentage of the citizenry employed in agriculture has shrunk exponentially.
Consequently, it’s rare today to see someone rise to national government from the farm. So even though Paulson has a fancy big city MBA from Harvard Business School and a personal fortune in the hundreds of millions from a sterling stint at the helm of Goldman Sachs (GS), we expect him to plainly possess the honesty, industriousness, and salt of the earth common sense that we romantically assign to farmers. Goldman by the way received a huge investment from Warren Buffett’s Berkshire Hathaway (BRK-A). Buffett is widely recognized for possessing those qualities in ample quantity.
So we eagerly wanted to believe Paulson and pal Ben Bernanke from the Federal Reserve when they promised to be transparent and subject to oversight in the Congressional hearings for the $700 billion Troubled Asset Relief Program (TARP).
In late October, I wrote about Paulson’s statement, “The program right now is for banks and thrifts.” I was alarmed to see his qualifier “right now.” It indicated to me that he was already thinking of a future where other types of institutions might dip into the bailout coffers.
I speculated that the precedent set by Long Term Capital Management’s bailout in 1998 would rear its ugly head again as hedge funds “too large to fail” will line up right behind Citigroup (C), American International Group (AIG), Bank of America (BAC), and Morgan Stanley (MS) for the Wall Street version of the bread line. In this case, the “dough” is taxpayer money. Anything to stave off a recession and a painful bear market right?
Turns out that Bernanke and Paulson have been less than forthcoming. Bloomberg News has sued the Federal Reserve citing the Freedom of Information Act to obtain records regarding the implementation of TARP. The Federal Reserve and the Treasury have been collaborating on a surprisingly leak-proof information embargo.
As a result, the public possesses only sketchy information about where the $700 billion is going. Only a few recipients of the relief funds have been disclosed. Even more troubling, we don’t know what kind of securities the banks or other recipients have pledged as collateral. What kind of deals are being made? What is there to hide?
Some say that the loans have to be made in confidentiality so as to shield troubled financial institutions from more panic selling of their stock, especially from rapacious short sellers. I say rubbish, this smells like the stuff Paulson used to spread around on his farm. The government has already imposed temporary bans on short selling of financial institutions stock (which I think was unconstitutional or at least inconvenient as I regularly hedge my investments with shorts); it could extend those bans to protect vulnerable banks.
My guess is that improper loans to hedge funds have been made. I hope I’m wrong, but the “too big to fail” rationale can be temptingly applied to gigantic hedge funds with trades and derivatives positions so heavily leveraged and so intertwined with mainstream financial institutions that failure would be too catastrophic for our overall economy. Bernanke and Paulson may have no choice.
The secret fear on Wall Street lies with impending but unknown hedge fund redemptions. This could happen if poor hedge fund performance compel already fearful investors to pull their money. In early November, I pointed to the distinct possibility that we could fall deeper in this bear market from heavy hedge fund redemptions. Paulson and Bernanke have already shown a reluctance to suffer pain and a willingness to do whatever it takes to avoid pain. They are merely compliant doctors we’ve ordered to keep the painkillers coming regardless of the risks of addiction or decreased efficacy.
There is some evidence surfacing that hedge funds are indeed struggling in this environment. Theoretically, hedge funds should do well or at least less poorly during market downturns. Whatever happened to hedging?
Hedge funds are the private domain of the ultra-wealthy. The average American taxpayer should not be getting into that business. Unfortunately, like Bernanke and Paulson, the average American taxpayer may have no choice.
