Warren Buffett's Humbug

By David Stockman  NOV 17, 2010 2:20 PM

Contrary to the Oracle of Omaha, taxpayers should not be grateful for TARP, bailouts, or quantitative easing.

 


If Warren Buffett wants to tarnish his golden years emitting the gushing drivel that appears in today’s New York Times, he has undoubtedly earned the privilege. But even ex cathedra pronouncements by the Oracle of Omaha are not exempt from the test of factual accuracy. Specifically, his claim that “many of our largest industrial companies, dependent upon commercial paper financing that had disappeared, were weeks away from exhausting their cash resources” is unadulterated urban legend. Nothing remotely close to this ever happened.

The fact is, there was about $2 trillion in commercial paper outstanding on the eve of the Lehman failure. And it's true that funding of this short-term paper was highly dependent upon money market funds that suffered multi-hundred billion outflows after First Reserve broke the buck owing to its holdings of toxic Lehman paper. So it's accurate to say that the commercial paper market had seized up and that massive amounts of maturing paper had no ability to roll.

But those specific facts about the condition of the CP market do not remotely prove that the nation’s great industrial corporations were on the edge of an economic black hole or that Main Street would have experienced crippling waves of defaulted payrolls for lack of cash. Indeed, even a cursory review of the composition of the $2 trillion CP market as of September 2008 shows that the “blowup” was actually about losses on reckless bets by a few thousand money managers, not the availability of ready cash to millions of Main Street businesses. {FLIKE} In the first instance, well less than $400 billion of the total CP outstanding consisted of industrial corporation paper -- that is, funding of the kind that might have been ordinarily used to cover payrolls and similar operating expenses. But let some enterprising graduate student investigate the limited universe of investment grade industrial companies then accessing the CP market. How many of these issuers lacked unused back-up revolving credit lines at the banks -- for which they had been paying “standby” fees year in and year out for just such a contingency as the Lehman event seizure in the CP market? The answer is virtually none: The great industrial companies to which Buffett refers used CP because it was cheaper (even with 15 bps of standby revolver fees), not because they wished to put their enterprise in harms way every 45 days. Moreover, there is not a shred of evidence that any bank even threatened to default on contractual obligation to fund these back-up lines.

The next crucial fact is that the entire balance of commercial paper then outstanding -- some $1.6 trillion -- had nothing whatsoever to do with funding business payrolls or heat and light bills. Instead, it consisted entirely of the short-term liabilities of the shadow banking system -- funding that permitted the financial arbitrage profits on which the whole system was based.

The largest single piece was about $1 trillion of asset-backed commercial paper (CP-ABS). Said assets consisted of auto loans, student loans, credit card loans, and the like, which retail financial institutions had originated, securitized, and sold into CP-ABS conduits that they sponsored. The whole point to this money shuffle was that, on average, the wholesale funding that could be accessed through the CP-ABS market was cheaper than the retail funding banks could obtain on their own balance sheets. The result was higher profit spreads on the auto paper originated by the banks, not funding for the payroll costs of the army of clerks who processed the loans.

Because the securitized ABS market has now shrunk to a shadow of its former self, it can be definitively said that nothing was flushed down an economic black hole in the fall of 2008 or at any time since. Not one auto loan has even been denied and not one credit card authorization request has even been disapproved because the CP-ABS market disappeared. Instead, such loans are now largely funded and retained on the balance sheets of the banking system originators -- which, drowning in excess reserves anyway, haven't broken a sweat. What has disappeared are the arbitrage profits that banks were raking off from foolish money fund managers who have finally seen that the “enhanced yield” they were obtaining from CP-ABS paper was not evidence of a better mousetrap -- just their own cupidity.

The remaining $600 billion or so of CP outstanding was issued by non-bank Finance Companies like GE Capital, G-MAC, and CIT Group (CIT). Here’s where the urban legend gets positively malodorous. At the time of the crisis, these companies were knee-deep in the ancient scam of lending long and slow (i.e. illiquid) and borrowing short and hot. The resulting yield curve arbitrage generated fulsome accolades and bonuses for the portfolio managers and executives -- until the mullet money in the CP market violently scampered off the deck.

It was about this time that according to the public record, America’s number-one crony capitalist, General Electric’s (GE) CEO Jeffrey Immelt, put in his famous SOS call to Treasury Secretary Hank Paulson. The empirical basis for Immelt’s distress at the moment can hardly be gainsaid. GE Capital was sitting on upward of $700 billion in asset footings -- much of it of the “slow” variety, as bankers were wont to describe it back in the days when loans were actually underwritten. Against that financial glacier, GE Capital had about $80 billion of fast-flowing commercial paper that suddenly dried up.

The correct resolution, of course, would have been for GE’s shareholders and corporate bondholders to absorb the punishment they deserved. When speculators had only months earlier bid GE’s share price up to $40 and its bond yield to within a hair's breadth of Treasuries, they knew -- or could have known -- that GE Capital was scrapping the yield curve: It was disclosed in the company’s financials.

Whether such punishment would have been condign or not can be left to the moralists. It is likely, however, that a fire sale of assets, which would have been required in the absence of CP funding, would have wiped out several years worth of GE Capital’s vaunted profits. In the alternative, had GE issued 5 billion new shares to scrap up tens of billions of funding for the disappearing CP, the massive dilution required by its reckless financing methods might have kept its shareholders buried in single-digit stock price land indefinitely.

But what can be said with great certainty is that whatever the painful losses and/or dilution that might have befallen GE investors had Washington honored the company’s capitalist right to fail, there would have been no noticeable effect on Main Street or on the ability of American business to meet payroll. In a contraction mode, GE Capital would have issued no new loans for real estate projects, leveraged buyouts, or sale-leasebacks of already existing (and operating) industrial plants, machine tools, rolling stock, and aircraft. This is all about financial engineering, not new jobs or economic growth.

As it turned out, the probability that a sharp contraction of GE Capital’s footings would not have had noticeable impact on the macro economy was never tested due to the Washington’s alphabet soup of bailouts. Instead, Warren Buffett ended up with a call on GE that was stapled to a put to Uncle Sam. No wonder he's grateful.

But no taxpayer can be grateful. There never was a crisis on Main Street. The panic was in the US Treasury Department where the clueless Hank Paulson was swamped with calls from his crony capitalist buddies like Immelt and his counterparts up and down Wall Street, but especially at Goldman Sachs (GS). When Goldman’s stock price ticked $65 in the days after Lehman, Mr. Market was desperately trying to purge the reckless speculation and leveraged rot that had been building up in the nation’s financial system ever since the Fed discovered in the 1990s that it could print endless dollars and that they would be obligingly accumulated by the mercantilist overlords of China and East Asia.

Thanks to the Geithner/ Paulson/ Bernanke claque, the needed financial cleansing and purge never happened. Instead, we've just drifted deeper into a statist regime in which Uncle Sam backstops, stimulates, underwrites, and meddles with every aspect of our broken capitalist machine. Uncle Sam wasn't our savior in September 2008. By the panicked actions of a few desperate men occupying high offices, he was empowered to become our destroyer. Thanking Uncle Sam is fatuous under any circumstance. But to thank the men who brought on TARP, bailouts, and the lunacy of ZIRP and QE is pure humbug.




No positions in stocks mentioned.

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