Wednesday, October 22, 2008

Blame Paulson? I Don't Think So

It's becoming fashionable now to blame Treasury man Hank Paulson for allowing Lehman to go down and thus for precipitating the credit freeze and stock market plunge of the past month or so.

A Financial Times column today takes this logic one step further and blames Paulson's decision on Lehman for John McCain's alleged defeat. I say alleged because a bunch of polls show McCain closing — such as the AP poll and the Battleground poll, along with the latest IBD/TIPP poll. (Even while other surveys show Obama gaining.)

But back to the main point. Is Paulson to blame? I don't think so.

When I interviewed Paulson I asked him directly if his Lehman decision triggered the credit crunch. And he responded by saying that it was the British bank regulators that ruled out a Barclays' acquisition of Lehman. Therefore, there was no other place to turn.

Remember, when the Treasury and the Fed arranged a sale of Bear Stearns they had a buyer, namely JPMorgan Chase. Then the government stepped in to backstop $29 billion of bad Bear paper. But were it not for JPMorgan Chase, they couldn’t have done it. With Lehman there were no other bidders except Barclays. So what exactly was Paulson supposed to do?

Here's a second point. If the Paulson rescue plan of putting capital into banks, purchasing toxic assets, and guaranteeing short-term inter-bank loans is so bad and ineffectual, why are all the key credit spreads plunging? The three-month LIBOR dollar rate has dropped 128 basis points. The so called TED spread, which is LIBOR minus the T-bill, has declined 213 basis points. And the two-year swaps spread has dropped 56 basis points. These are key metrics that strongly suggest the money markets are defrosting and banks have resumed lending to one another.

In response, the U.S. dollar is soaring and gold is plunging. I read those two indicators as improving credit barometers. What's more, commodity prices across the board are tanking. The bubble has popped. Oil is down $5.50 today to $66.76. Retail gasoline is $2.86. These are huge consumer and corporate-profit tax cuts.

And all of this reflects the recovery mustard seeds that will after a time bloom into a new bull-market expansion. The CRB futures index has dropped from over 450 to 250. This means corporate profits, which look bad right now, are gonna look much better in the quarters ahead because commodity input costs are coming way down. And of course, the cost of food and energy will benefit consumer pocketbooks.

Today's a bad day for stocks on profit worries — which I think are overbaked. But the psychology is fearful and we'll have to live with that for a time. Nonetheless, the message of the credit markets along with the dollar supports Paulson's plan. And while the commodity plunge in the short-run may be a signal of weaker growth around the world, in the medium-term the tax-cut effect of lower raw materials will lead us to recovery.

Excesses are being wrung out of the system. That’s the nature of free-market capitalism, and it includes short-run pain. But when the dust clears, the seeds of the next business-cycle expansion will flower and bloom.