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Friday, March 1, 2024

The Paulson Doctrine

Here’s another interesting article by Roger Ehrenberg, of Information Arbitrage, on Paulson’s approach to the financial crisis.  

The Paulson Doctrine: An Uncertain Prescriptive for Uncertain Times

Unwittingly or not, Treasury Secretary Paulson has effectively created the Paulson Doctrine. The doctrine states that firms that he deems too big to fail (but we’re not exactly sure where the line is drawn: LEH? No. BSC? Kind of. MER? Maybe. AIG, FNM and FRE? Definitely.) get the U.S. Government (and the U.S. taxpayer) as new senior shareholders, while the others are either left to execute an orderly private markets Good Bank/Bad Bank restructuring (if they can, like Mellon in the late 1980s) or a hurried Chapter 11 Good Bank/Bad Bank restructuring (if they can’t: see BCS/LEH circa 2008). Sure, the headline reads that the Fed bailed out AIG, but was anyone other than Mr. Paulson pulling the strings? I doubt it. So what of this doctrine, and what does it mean for the global financial markets, the integrity of the U.S. regulatory regime and the U.S. taxpayer?

In the short run, the Paulson Doctrine helps the markets. It creates the liquidity-driven optionality only available through the U.S. Government’s philanthropy, protecting against wholesale liquidations that could further depress asset prices and start a daisy-chain of events leading to a radical marking down of assets globally. As those of us from Wall Street know, once there is blood in the water markets get pushed further and further away from intrinsic value, and the only way back is through securing of liquidity (which generally occurs at a market bottom after total despair has set in). So rather than a radical restructuring taking place in an accelerated manner, out of sheer necessity, the U.S. Government and their well-heeled central bank brethren have decided to slow the pace of the correction to forestall an extremely painful fall-out.

But is this a good thing? Well, given the position of the U.S. as the debtor to the world and the political and market power wielded by China and Russia, in particular, Mr. Paulson’s wielding of the Paulson Doctrine keeps these governments from dumping our dollar-denominated debt. We have little room to maneuver, thanks to President Bush’s budget-busting spending habits, our debt-fueled consumption party, lousy financial disclosure and sheer greed. This enables us to continue our profligate spending habits that got us in this mess in the first place. Better to defer pain for another day rather than sucking it up and squaring up, I guess. This is no different than the charades that are Social Security and Medicare – bail out Bill Gross, Putin and our other unfriendly financiers, and we’ll pay for it all later. While I fundamentally believe that the U.S. Government’s actions, particularly with respect to AIG, create real option value through the provision of liquidity, it sends a very, very bad message to those in dire need of a really, really good message: you make your own safety net. And that safety net is called prudent financial management.

You know who comes out looking really good in the mess of the last 96 hours? Barclays. They did exactly what they should do. Let the market come to them. Focus on their core goals and strategy. Put in an offer that gives them exactly what they need as a franchise for a price that implies a very short payback period and minimal portfolio risk. This is a company thinking about their shareholders. They didn’t assume an uncertain pool of opaque assets (see BAC/MER) to get what they really wanted (unlike BAC, who wanted the retail brokers but took everything else for a mere $50 billion). $250 million for the North American assets plus $1.5 billion for the headquarters building and two data centers. Kudos, John and Bob. Job well done. Ken Lewis? The jury’s out, and will be for a long time. But would I want to be a BAC shareholder right now? No, I wouldn’t.

I’m a pragmatist: the Paulson Doctrine has its place. But only if the market understands the rationale behind the doctrine and the breadth of its application. He is reacting just like a hedge fund manager whose illiquid asset portfolio is blowing up in his face. Investors (the U.S. taxpayer, in Mr. Paulson’s case) have no transparency. Market participants have no idea how to plan. Redemption notices are starting to roll in. And the actions taken have been entirely reactive and inconsistent. This is neither the way to run a bailout nor to manage taxpayer funds. We need more transparency and better disclosure from our financial institutions. And we need the same from Mr. Paulson.


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