MONDAY, OCTOBER 22, 2007

UP AND DOWN WALL STREET  

By ALAN ABELSON


Buddy Capitalism

AIN'T THE WELFARE STATE GREAT?

In times of dire need, it's always there, ready, able and willing to bail you out.

We are not talking about giving handouts to undeserving wretches who are starving, out of a job and sleeping on the grates because they lack moral fiber.

No, we're talking about rallying to the aid of the best and brightest among us, the risk-takers, who in their zealously altruistic pursuit of profits find themselves (temporarily, of course) in need of financial succor -- so they can continue to exercise their remarkable wealth-amassing skills that are so necessary if our free-enterprise system is to continue to flourish and Tiffany is to continue to prosper.

Happily, we have in the person of Henry Paulson a Treasury Secretary who has a keen grasp of how the financial world works, who understands how crucial bankers and brokers are to the comfort and well-being of this rich nation. He is able to make that judgment because so many of them are his bosom buddies, one of his treasured legacies from the many years he spent laboring in the vineyards of Wall Street.

Carpers and cynics who never met a payroll and, indeed, likely never did an honest day's work (you know the types as well as we do: politicians, journalists, that sort of lowlife) may snarl all they like about crony capitalism and worse. But decent, compassionate folk can only cheer the speed with which Mr. Paulson whistled up a $100 billion bail-out for a posse of banks that found themselves stuck on a sandbar when the sea of liquidity they have been so happily splashing about in suddenly went bone dry.

After all, who better than Mr. Paulson could appreciate that the lenders were in distress only because of their noble exertions on behalf of the public weal, their selfless dedication to increase the return on the pittance earned by the sweat-built nest eggs of the pensioners and kindred worthies entrusted to their care? Why else would they have fiddled with such an insidious device, ingeniously cobbled together in the 1980s by a couple of Citigroup bankers (now with their very own hedge fund)?

Dubbed Structured Investment Vehicles, or SIVs for the polysyllabically challenged, these novel instruments were designed to raise short-term money, mostly commercial paper, to funnel into higher-yielding longer-term investments (including various asset-backed securities, not a few of which have properly come to be known as "toxic waste"). Last time anyone counted, between $350 billion and $400 billion of SIVs were outstanding -- not bad for something that even many of the financial cognoscenti had never heard of.

Please, did we detect a voice back there muttering fe, fi, fo, fum? We don't know about the fi, fo and fum, but, sure, there were fees, but so what? Bankers have to eat, too, you know. But we guess it's typical of a society in which "disinterest" is commonly used to connote lack of interest -- instead of its true meaning of impartial, or untainted by self-interest -- to mistake unstinting generosity for unseemly greed.

What attracted so many big banks and so many big bucks to Structured Investment Vehicles, we must stress again, was a driving impulse to do the right thing. It was very much akin to the inspiration that prompted lenders of every age, stripe, size and degree of solvency to avidly embrace subprime mortgages. You might call it an excess of fiduciary fidelity. Or, you might call it something else which we can't print in a family magazine.

What threw the monkey wrench into the SIVs was, as you might have guessed, the recent turmoil in the credit markets and especially the seizure felt 'round the world in commercial paper, which, it turned out, was not quite as soundly grounded as the rating agencies had led us all to believe.

Folks with dough in these curious contraptions became understandably jittery when the commercial-paper market hung out a "No Entry" sign aimed specifically at SIVs. That raised fears of a run on the bank-sponsored entities, in turn, raising the even scarier specter of a wholesale dumping of assets that might make the recent disturbances in the credit markets seem like a church picnic.

Enter Mr. Paulson, who put the arm on a number of major banks, even some that had no exposure to SIVs, to set up a fund with the real catchy name of the Master Liquidity Enhancement Conduit to help out the needy banks by buying securities from them, presumably at a discount. The obvious intention is to reassure the world that everything's hunky-dory and keep the banks, poor sensitive creatures, from having to show those squishy assets on their balance sheets.

Our considered view is that the supposed bail-out is a typical bit of Washington flash: all show and no substance. For a second, more tempered, opinion we turned to Punk Ziegel's savvy bank analyst, Richard Bove. He calls it "a horrible idea" that "would do nothing to solve any subprime-debt questions, mortgage issues, bad bank-loan problems etc... It would not bail out any bad loans from anyone, anywhere...It will not solve the liquidity problems where the SIVs need the most help and it will not reduce the debt problems facing the economy." (Otherwise, Mrs. Lincoln, how'd you enjoy the play?)

He also is adamant that the Treasury has zilch business sticking its nose in the SIV mess: "The Treasury's primary job is to fund the United States government. It should not be involved in working out debt problems in the private sector."

Lest Mr. Paulson take umbrage at these mild demurs, let us reassure him that there's inevitably one in every crowd. Actually, make that two in every crowd, since we must confess we subscribe unreservedly to each and every one of Richard's complaints.

STEVE ROACH, WHO NOW sports the somewhat weighty title of chairman, Morgan Stanley Asia, doesn't sound off on how the world's turning with anything like the frequency he did for so many years when he was that's firm's No. 1 commentator on markets, the economy and the like. Frankly, we miss his level-headed, original and contrarian take.

So it was with no little pleasure last week, with the market celebrating the 20th anniversary of the Crash of '87 with a swoon, oil prices topping $90 a barrel and the bruised dollar under fresh siege, that we espied an e-mail from Steve bearing the title "A Subprime Outlook for the Global Economy."

As that suggests, he's less than sanguine about the economy, mostly because he sees real trouble ahead as asset-dependent U. S. consumers struggle to negotiate a post-bubble adjustment that's bound to stifle their insatiable yen to consume. And he doesn't buy the widely popular notion that the rest of the world will manage just fine no matter what happens here.

He notes that the bursting of the dot-com bubble seven years ago caused a mild recession but, more importantly, a collapse in business capital spending both in the U.S. and abroad. The subprime-mortgage fiasco, he warns, is only the tip of a much larger iceberg.

The consumer, who has indulged in the greatest spending binge in modern history, now accounts for 72% of our GDP. Steve reckons that's five times the share of capital spending seven years ago. Reason enough to suspect the impact of a sharp contraction in consumer spending could be considerably more pronounced than the damage wrought by the end of the capital- investment boom at the turn of the century.

Of the two forces that spark consumer demand, wealth and income, it's no contest which has provided the impetus for the mighty surge in Jane and John Q.'s spending. Since the mid-1990s, Steve points out, income has taken a back seat: In the past 69 months, Steve reports, private-sector compensation has edged up a mere 17%, after inflation, which "falls nearly $480 billion short of the 28% average increase of the past four business cycle expansions."

More than taking up the slack, however, has been the appreciation in housing assets. But with this source of wealth dramatically running dry with the bursting of the housing bubble, he sees no way that "saving-short, overly-indebted American consumers" can continue to spend with wild abandon. And for an economy like ours, so lopsidedly dependent on such spending, "consumer capitulation spells high and rising recession risk.''

Even a moderate slump in growth could prove strictly bad news for "the earnings optimism still embedded in global equity markets," and obviously for the markets themselves. Recent action of our own juiced-up stock markets, we might interject, strongly hints that such optimism is beginning to wear a tad thin.

No mystery how we got into this bind. Following the end of the equity bubble, scared stiff of deflation, central bankers opened the monetary floodgates and liquidity poured into the global asset markets.

As Steve relates, "Aided and abetted by the explosion of new financial instruments -- especially what is now over $440 trillion of derivatives -- the world embraced a new culture of debt and leverage. Yield-hungry investors, fixated on the retirement imperatives of aging households, acted as if they had nothing to fear. Risk was not a concern in an era of open-ended monetary accommodation..."

Steve plainly has doubts whether Fed chief Ben Bernanke's recent rate cuts can stem "the current rout in still-overvalued credit markets." He worries that the actions were strategically flawed in failing to address the "moral-hazard dilemma that continues to underpin asset-dependent economies."

And he asks, "Is this any way to run a modern-day world economy?" All those who think it is, please raise your hand, and then lie down and wait for the fever to pass.


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