Critics: Indecision on bailout rattling financial markets

Wednesday, November 19, 2008

WASHINGTON -- Financial markets hate uncertainty, but that's what they're getting from Washington.

The Treasury Department's frequent, scattershot revisions to the $700 billion financial bailout have badly shaken investor confidence, and experts say the confusion could delay the lending revival necessary for an economic recovery.

Treasury Secretary Henry Paulson has repeatedly surprised lawmakers and financiers with reversals of earlier statements in the six weeks since Congress passed the package.

Last week, Paulson officially abandoned the initial centerpiece of his pitch to Congress: a plan to buy troubled assets that have clogged bank balance sheets. Stocks plunged on the news, with investors saying they had based business decisions on Treasury's insistence that the program was on track.

And Monday, Paulson said he would not ask Congress for the second half of the $700 billion. That dashed hopes he would follow through on a plan he had announced five days earlier to use the money to ease access to home, school and auto loans.

It was the latest in a series of gyrations that have heightened confusion in markets already rocked by a global financial crisis and grim economic news.

"Markets react very badly to uncertainty, and Treasury and Paulson are not making decisions in such a way that uncertainty goes down," said Mauro Guillen, director of the Wharton School's Lauder Institute. "This is only going to exacerbate the problem."

The recent decision not to seek the second $350 billion is "very counterproductive" because it intensifies the inevitable market uncertainty surrounding the coming political transition, he said.

Paulson has defended his leadership, saying flexibility is necessary to deal with changing conditions.

"If we have learned anything throughout this year, we have learned that this financial crisis is unpredictable and difficult to counteract," the secretary told a House hearing Tuesday. "There is no playbook for responding to turmoil we have never faced. We adjusted our strategy to reflect the facts of a severe market crisis."

Treasury's fits and starts have stirred already-shaken markets and made it harder for financial institutions to take calculated risks, said Wayne Abernathy, a former assistant treasury secretary now serving as executive vice president of the American Bankers Association.

In a series of interviews, former Federal Reserve and Treasury officials, economists and policymakers criticized Treasury's erratic approach to the bailout program. They said it's spreading confusion even before the bailout program has had time to produce economic benefits for most consumers and businesses.

A Treasury spokeswoman did not return calls seeking comment.

Robert Eisenbeis, a former Atlanta Fed economist now with the hedge fund Cumberland Advisors, likened Treasury's piecemeal approach to water torture and said it hasn't helped business or consumer attitudes.

Because "scare tactics were used to stampede a vote" on the bailout legislation, Eisenbeis said, Treasury's turnabouts suggested "a lack of understanding of what the problems were to start with."

"If the program has morphed so rapidly, it really implies something about credibility," he said.

Paulson, on Capitol Hill on Tuesday for a hearing of the House Financial Services Committee, was lambasted by lawmakers for his stewardship of the program.

"You seem to be flying a $700 billion plane by the seat of your pants," Rep. Gary Ackerman, D-N.Y., told him. "It seems to be the second-largest bait-and-switch scheme that history has ever seen, second only to the reasons given to us to vote for the invasion of Iraq."

Critics who say the government response to the crisis has been haphazard point to policy changes including the decision to prop up insurance giant American International Group Inc. a day after Lehman Brothers was allowed to file for bankruptcy -- the biggest ever.

They also cite last week's announcement that Treasury would abandon its asset purchase plan after an official testified Oct. 23 to "rapid progress."

By displaying "a repetitive underestimation of the systemic risk in the financial system," Treasury has made it harder for market participants to trust even good news coming from the department, agreed Brian Bethune, economist with IHS Global Insight.

Treasury's insistence on a closed-door process, and its frequent surprise announcements, have contributed to instability in the banking industry, Abernathy said. He said earlier consultations with industry leaders might have helped avoid some of the stumbles.

He described frantic meetings following Treasury's Sept. 18 announcement that it would insure money market mutual funds, which compete with banks for deposits. Concerned about a massive shift of capital out of banks and into money funds, Abernathy and colleagues persuaded Treasury officials to guarantee only money that had been invested before the announcement.

"That's a good example of something a little conversation with us (before the announcement) would have solved," Abernathy said. "It does feed uncertainty, and it does feed lack of confidence."

Both Abernathy and Sen. Charles Schumer, D-N.Y., criticized Treasury's decision to pressure nine large banks to take direct injections of capital. The move was intended to prevent banks that took the money from being stigmatized. But critics say it pressured banks that didn't need help to take the money to maintain their competitive positions.

Schumer also questioned Paulson's promotion of the asset purchase plan at a time when many legislators and economists had concluded that direct injections of money would work faster and better than buying up bad bank assets.

"Even on those nights when we negotiated it, it was clear to many of us that the auction or the asset purchase hadn't been fully thought out," Schumer told reporters last week.

Treasury's objections to cash infusions seemed to fall away after Oct. 11 meetings with world economic powers, Bethune said. And he said credit markets have started thawing thanks largely to coordinated actions that followed that summit, including the infusions and higher deposit insurance.

But those actions helped interbank lending by addressing an immediate problem -- fears about other banks' solvency -- and have had only an indirect effect on the flow of credit to consumers and small businesses. Access remains limited to loans for homes and cars, which drive consumer spending.

Bert Ely, a banking industry consultant, said investors are already shaken by the drumbeat of news about rising unemployment and cratering retail sales.

"I wonder to what extent all the zigzagging feeds into negative sentiments and negative perceptions about how things are going," he said.

But with credit markets beginning to thaw while the broader economy flounders, even the most effective government actions will have few immediate benefits, warned John Dearie, a former officer of the New York Fed now serving as executive vice president of the Financial Services Forum, an industry group.

"There is a lag between when you start to see improvement in financial conditions and when that improvement affects the broader economy," he said.

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