Some people trust Michelin guides for their restaurant information. Some trust other surveys, critics and customer ratings posted on the Internet. It can all get pretty complicated.
For those of us with less thoroughly informed dining habits, though, life is simpler. Rule 1: If the menu items are illustrated with photographs, you are almost always in for some level of disappointment. And the corollary to Rule 1: This is especially true for desserts.
Few edibles can stand comparison with the lush imagery of a professionally produced photograph. The people who specialize in food photography can make mayonnaise tantalizing and transform a tomato into an object of desire. No self-respecting, real-life grilled cheese sandwich or bowl of chili can stand up to that kind of competition.
There is often a gap between image and reality in financial markets, too. Just recently, for example, concern about the prolonged high anxiety in credit markets prompted the U.S. Treasury Department to convene a meeting of the major banks in order to forge a private-sector solution.
The result was something called a Master Liquidity Enhancement Conduit (M-LEC), a $100 billion plan to revive the Special Investment Vehicle (SIV) market that has been moribund since the subprime mortgage crisis. SIVs issue commercial paper to fund their mortgage portfolios but there are few buyers these days. Much as young Dr. Frankenstein used lightning, the banks would use the M-LEC money to inject some life into the SIV market by buying up assets there.
It is hard to get a clear picture of $100 billion. If spread out like a carpet of dollar bills, it would cover an area of approximately 400 square miles, so you would have to use satellite photography. It is a lot of money.
From the picture we get of this $100 billion, it looks like a grand gesture on the part of the big banks; an effort to create enough demand to make the market think that it is again fully functional, filled with buyers and sellers. But, as usual, the real thing has trouble competing with its own image.
It turns out that the banks aren’t exactly coughing up the money themselves. The plan is to issue debt, in the form of these M-LECs, to investors who will actually provide the $100 billion. It is mighty complicated and indirect, but essentially the big banks are providing a form of loan guarantee — the M-LECs are a kind of co-signer agreement.
The gesture is somewhat less grand than if the banks had done it with their own money, but the overall picture still portrays a good thing.
Still, there is an element of self-interest that lingers like the taste of artificial ingredients in a disappointing dessert. It turns out that the $400 billion in SIVs debt instruments that are dragging down the markets were originally created as “affiliates” by the banks themselves — as an accounting artifice that allowed them to avoid showing them on their balance sheets. (Remember Enron? Off-books accounting entities were a favorite technique there, too.)
Citigroup, which was the main architect of the bailout plan, is also, coincidentally, the main architect of seven of the largest SIVs. And the other SIVs were creatures of the other banks and Wall Street financial institutions. In effect, they are using public money to bail themselves out of a problem they created for themselves.
Self-interest, of course, provides the heartbeat for financial markets. Nobody buys corporate bonds, T-bills or commercial paper because they find the process ennobling or believe that our culture and civilization are somehow advanced by the process. They buy these things to make money … for themselves. From an economic policy standpoint, there is nothing wrong with self-interest, as long as it does not endanger the public welfare.
The role of the U.S. Treasury in this is well-intentioned. By sponsoring the meeting, Treasury provided the banks immunity from prosecution under laws prohibiting them from collusion. This was something that they could not do on their own. And self-interest, by itself, is not a reason to reject a private sector solution to a market problem. M-LECs aren’t a perfect solution but they certainly beat the government stepping in to rescue essentially every investor and speculator, dumb and devious alike, in the mortgage-based securities market.
To most of us, M-LECs and SIVs sound more like characters from a discarded George Lucas screenplay than key elements in our economic policy. But they have a lesson for us. Banks cannot be allowed to continue creating “show me the money … but not the risk” balance sheets. Treasury Secretary Henry Paulson says, “I do think we’re going to need greater transparency,” and that regulators need better information on investment funds like SIVs. Well, do it then.
James McCusker is a Bothell economist, educator and consultant. He also writes “Business 101” monthly for the Snohomish County Business Journal.
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