Dec 29

Paulson and Sisyphus: Strange Bedfellows


Why would US Treasury Secretary Henry Paulson appear to be like the legendary Sisyphus?

As a reminder, as punishment from the gods for his trickery, Sisyphus was compelled to roll a huge rock up a steep hill, but before he reached the top of the hill, the rock always escaped him and he had to begin again.  The maddening nature of this punishment was reserved for Sisyphus due to his hubris and belief that his cleverness surpassed that of Zeus.

Perhaps the markets are playing the role of Zeus.  Of course, as an the former Chairman and CEO of Goldman Sachs, it is hard to imagine a lack of some degree of hubris.

With Citgroup’s and other banks’ recent action to add SIVs to their balance sheet, it is increasingly looking like the US Treasury’s plan for a master conduit of SIVs to rescue that market may go by the wayside.  (Of course, SIV’s must still face the burgeoning roll over of their Medium Term Notes — an event that will start in earnest in January.)

And, now the announcement of a sub prime mortgage rescue appears to have a similar approach to the Treasury engineered SIV plan.

When originally announced two weeks ago, I could not resist the impulse to answer the Wall Street Journal’s forum question:  “Will Bush’s mortgage plan have an impact on the housing crisis?”  Here’s what I noted then, and I would echo those thoughts today:

I don’t know what this does other than give servicers the legal wiggle room to delay repricing for five years and make it possible for folks to stay in their home for now. However, the ARMs will reprice and the rate is tied to short term rates which may be higher five years from now.

Also, this ‘moving of the chairs on the Titanic’ does not seem to address repricing of more exotic loans (e.g. Option ARMs) – but I guess we’ll see. And, I wonder if the interest at the new (not repriced) rate is forgiven (unlikely) or deferred (likely). If deferred, this will just add to the balance of the loan and this negative amortization will eat into most of the potential price appreciation. If forgiven, investors will be furious and lawsuits will descend like attorney manna from heaven.

Meanwhile, investors, including the banks may get less of a mark down due to a lower probability of foreclosures…but maybe not, depending upon what the bond market thinks.

My guess is that this looks a lot like what Paulsen came up with for the SIV problem – get the big guys together, try to delay the inevitable and get others to go along. The SIV problem is NOT going away and this ‘quick and easy’ fix has not even been effectuated at this point. In other words, this mortgage plan could end up being more smoke and mirrors than substance when it’s time to implement.

If the federal government wanted to solve the problem, they would set up an RTC like entity that would buy the mortgages, do the workout, while calming the worried financial markets and pass any losses to taxpayers…which may still occur.

This is starting to look like another Sisyphean effort.   The markets (Zeus) want transparency so that it can begin the process of correcting prior excesses.

This may mean mergers of large financial players.  It may mean further reorganizations of others.  And, it may mean other consequences which we all must face (including further declines of the value of the US Dollar).

To put the onus solely on the Fed (and their new liquidity auctions) for solving this problem is like fighting with one hand behind your back.  If you want Zeus to solve the problem, you will have to give him what he wants (transparency) and not a plan that will result in another Sisyphean result.