March 26, 2008
Pension Benefit Guaranty Corporation's New Policy
Along with discussion of Bear Stearns, the WSJ's opinion page has a helpful discussion of another moral hazard problem: the Pension Benefit Guaranty Corporation. The PBGC is a government safeguard against shortfalls by company pensions. The PBGC is funded by "premiums paid by employers,assets from failed pension plans, recoveries from bankruptcies and returns on invested assets." The difficulty for the PBGC is that its funding does not meet its obligations, so in order to remedy the problem the PBGC has decided on a new investment policy that will more heavily invest in equities. Unlike some sovereign wealth funds, the PBGC does not select stocks or bonds or actively manage its own portfolio, relying instead on professional money managers and market index funds. The PBGC believes its new strategy will both obtain better returns and reduce risk through diversification. Still, the WSJ warns that the PBGC strategy may create more risk, and in any event it still leaves the PBGC vulnerable, which could potentially mean a government (read: taxpayer) bail-out. The WSJ asks: If we are even going to have a PBGC, why not demand higher premiums? The reason is, I suppose, that there would be a great outcry over the burdens placed on small businesses, similar to what has happened with the planned (but not yet realized) imposition of Sarbanes-Oxley's 404 to smaller companies. However, the important difference between the two scenarios is that in the case of unfunded pension liabilities, taxpayers ultimately bear the risk of failure; in the case of potential losses due to the decision not to apply 404, investors bear the risk of failure (and can price accordingly).
Posted by Paul Rose
March 25, 2008
The Fed, the Treasury and the Bear Stearns Deal
Two government units, the Treasury and the Fed, are negotiating the JP Morgan buyout of Bear Stearns. This should give us great pause. First Paulson has agreed to write a $29 billion credit derivative swap on Bears risky mortgage backed securities for free. In essence he is granting JP Morgan what would have been the fee on the swap, a sizable amount. The deal, unless offered to all potential buyers (and we do not know who Paulsen had included in the selective group of offerees), stops any competitive bidding market for Bear Stearns. The Treasury has, in essence chosen the buyer. Second, Bernanke is setting the price. With Treasury offering up a cash induced to do the deal at issue is how the inducement is split among the lucky players -- what do the Bear Stearns shareholder get of this largess? Bernanke apparently did not like the price at $2 a share and negotiated for $10 a share for the Bear Stearns shareholders, giving the shareholders a larger piece of the Treasury's surrogate cash grant.. So, after the Treasury choose the price, the Fed has chosen the price. Moreover, he delayed telling Bear Stearns about his intent to lower the discount rate on funds that investment banks can now borrow (this also is new) from the Fed until after the contract was initially inked. Bear Stearns could have used the window to borrow money to keep afloat a bit longer to negoitate a higher price or to encourage other bidders. This heavy- handed manipulation of a buyout of the country's fifth largest investment bank ought to raise eyebrows all throughout the financial community. Do we want Treasury and the Fed using such a heavy hand to structure the operating side of the financial markets? I do not. What's next, one has to wonder? The feds had better develop a principle fast for when to get into the business of restructuring financial institutions beyond the caterwauling of "impeding doom" by wall street insiders. The feds will find that appeals to them to "do something" by anyone facing financial loses will now step up considerably. What a mess.
March 24, 2008
Treasury, Abu Dhabi and Singapore Agree to Basic Principles for SWFs
The Treasury Dept. and two of the largest and mosty active SWFs have agreed on some basic principles for sovereign wealth investment. The press release from Singapore is here. The principles are essentially the those of the framework set out by Treasury Undersecretary Robert Kimmitt in his recent Foreign Affairs article "Public Footprints in Private Markets". I think the Treasury has struck the right tone with SWFs thus far, and demonstrates that at least some SWFs are willing to act more like fiduciary investors as long as they are treated like other investors. The key investor that must come to the table, however, is China. While Singapore and Abu Dhabi are important SWF investors, China's SWF is the bigger concern because of China's greater economic and political importance.
Posted by: Paul Rose