The $700 Billion Quagmire

Today, Hank Paulson and Ben Bernanke will try to convince Congress that the proposed $700B government bailout is necessary and must be acted upon immediately. They must also sell their idea to the people on Main Street. This is not an easy task as all parties are skeptical.

I may have a unique perspective on this debate as I am a 25 year Wall Street veteran with a Main Street upbringing. My career specialty was focused on high yield/junk bonds. In good times non-investment grade companies raise money to propel their growth or for private equity firms to buy companies using both equity and high yield bonds. Upon the issuance of these new securities, Wall Street sells and trades them. The buyers of the bonds are money managers, mutual funds, insurance companies, banks, and hedge funds. The function of trading junk bonds is easy until a hiccup tempers the market. We saw this happen in 1991 during the S&L Crisis, in 1998 with the Russian Crisis, and in 2001 with 9/11. In 2007, we once again had jittery markets as the mortgage crisis and the LBO fiasco came under siege. During each of these periods, money managers hoard cash and big time Wall Street traders hide under their desks. The result is limited liquidity for the trading of bonds and the curtailment of capital markets activities. Without a functioning bond market, companies cannot refinance debt coming due or raise capital to buy equipment to help their companies grow.

The current crisis is very similar to the above periods of time except it is much larger and much more serious. If this crisis continues, corporate America will suffer, Wall Street will be frozen and most importantly, Main Street will be poorer. We need to resolve this problem immediately. The $700B Fund may only be one solution and it may not be enough but the Government needs to start somewhere. Congress and Main Street cannot appreciate the complexity of the job which will be created by this Fund.

The new Fund will need to sift through many balance sheets and analyze a multitude of esoteric securities. Mr Paulson understands that the government cannot propose a cookie cutter approach to buying this debt. There is not one price or one structure that works for all distressed securities. Every situation will be different and each seller will have its own nuance. Should the government take an equity position in companies from which it buys debt? Maybe. Should the government partner with a hedge fund to buy a certain block of debt? Maybe. Should the government become a secured lender of an overleveraged company it is bailing out? Maybe. Should the government force a restructuring by negotiating with bond holders? Maybe.

My point is that this is serious business and there is no simple answer. The most important role the government will have is to hire the most sophisticated and knowledgeable professionals to help them with this $700B Fund. There is discussion about the government hiring a handful of money managers to help with the purchase of these distressed securities. This approach may create conflicts of interest as large money managers may have other funds competing to buy the same assets. I think the better approach would be for Mr. Paulson to hire a swat team with Wall Street esperience who can allign themselves with the interests of Main Street. The average person may feel comfortable if the managers of the fund will have a compensation package tied to the profits generated for the taxpayers through the purchase of securities in this new bailout Fund. If assets need to be bought at artificially high prices, then a preferred equity position may need to be taken in the company. If mortgage-backed securities can be bought at a price to ultimately generate adequate returns, then that will also be acceptible. I can guarantee you that any Wall Street professional working for an incentive to make the taxpayer's money or certainly not to lose them money, will work hard to please those on Main Street.

This debate will continue this week but Wall Street needs to meet Main Street but either way we are in crisis mode and confidence needs to be restored and the capital markets have to function normally to avoid an economic implosion.