The most destructive legacy of the Bush era will be the damage done by dogma and patronage to the perceived competence and good faith of the US government, from the WMD in Iraq fiasco to the tragedy of Hurricane Katrina and now the appalling mess the Treasury has made of dealing with the implosion of the financial system. When the definitive history of this period is written, there is no doubt that the Lehman bankruptcy will be seen as the critical event that accelerated and propagated a systemic crisis, and a decision driven by ideological rather than pragmatic considerations. The ultimate cost of that decision will be measured in the trillions of dollars. Markets have been further unsettled by yesterday's volte face on the TARP by Hank Paulson, but as the whole scheme was deluded, good riddance I'd say. Despite the conspiracy theories, the Treasury grudgingly and belatedly realised that the auction process was simply unworkable. With contagion spreading to car loan and credit card receivables, the money is needed elsewhere and fast (cue AMEX becoming a bank holding company). From the off, the plan to rig the derivatives market was so complex and opaque that it bordered on the surreal.
On 30 September, I wrote: 'The simple solution is exactly what has been occurring in an ad hoc fashion this week...the US government provides a backstop on the riskiest assets, or simply injects capital directly, in return for an equity stake in the form of warrants or preferred stock. Simple, fast and transparent.' Better late than never. So now that $700bn is being doled out to all comers, and on amazingly generous terms compared to capital injections in Europe. The danger is that with Treasury credibility blown, Congress will see the money as a huge slush fund to dole out patronage to favourite causes. A $50-100bn chunk will undoubtedly end up paying for emergency life support for Detroit, but Chrysler may have to be sacrificed to save GM and Ford, because 11-12m annual unit sales is the new normal for the US auto industry. Thanks to ruthless UAW negotiation over the years, and chronically weak management, the burden of accrued healthcare and pension liabilities is simply unbearable, and will inevitably have to be slashed or assumed by government.
President-elect Obama needs to draw a lesson from this economic mess. No more Wall Street alpha males running the Treasury, ever. If war is too important to be left to generals, then the economy is certainly too important to be left to investment bankers. I would draw an analogy with Korean Airlines, who had a policy a few years back of hiring ex Air Force fighter pilots to fly their passenger jets, which on the face of it was reassuring. These guys flew supersonic jets for thousands of hours, how competent must they be to fly a boring old 747? Err, not very actually, because they retained an unhealthy appetite for risk taking which led to a soaring accident rate as the fighter jocks pulled stunts with their Boeings worthy of an F15. Meanwhile, my view in recent posts that markets risked re-testing the October lows is being vindicated on yet another spike in risk aversion, and it is now a question of whether those levels hold and form technical support. Nonetheless, the steady traction being gained by recent interventions in the credit markets means I still see scope for risk assets to surge higher in another dramatic bear rally through the year end. For the moment, the wisest course is to simply watch and wait.
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