The most recent iteration of the government’s “rescue plan” for the banks is terrible policy — for starters, it can be easily rendered ineffective by traders betting against the banks and financial companies. Unbelievable! Moreover, the piecemeal way that it is being communicated to the market is only the latest such communications fiasco, and is inexcusable in the area of banking policy, where solidity and stability are the things that must be communicated above all.

The WSJ reports on current bank recapitalization plans and illustrates how government policies continue to be publicly flapping in the wind: “the government could wind up holding as much as 40% of Citigroup’s common stock. Bank executives hope the stake will be closer to 25%.” Statements about the government’s rescue plans appear to be conflicting and often seem often at odds with what is actually taking place. This is a messy policy and PR situation which looks like it could get even worse. It is an inexcusably bad performance by Treasury Secretary Geithner.

There is a modest benefit to the idea of the government owning common stock, in that the government will wind up in the lowest rung of the capital structure, implying that the preferred and debt layers above are money good. The trading implications of this move are dreadful, however, giving the shorts a big win that could actually develop into a cascading and catastrophic situation of serially wiping out bank values. Nationalization would have done that; this partial plan may turn out to be only a way station on the road to the serial destruction of dozens of financial companies (by using a very simple strategy) that we have discussed. Cramer, whom we acknowledge is often unreliable, is largely correct in this matter, since he agrees with us:

If you are a short-seller, don’t you come in with guns blazing today after an initial lift in the bank stocks and show the government who’s boss, especially because the government communicates its plans through a few reporters in a chaotic and uncertain way, enabling the sellers to control the debate? The next 24 hours should be crucial for the short-sellers — aided, no doubt by Professor Roubini and Meredith “Big Splash” Whitney, who need to show that only full nationalization that wipes out any chance for the common is the way to go.

Whitney recommended shorting Citigroup last week, and I figure that’s a kind of “perma” recommendation. Roubini has become the shorts’ best friend, and this man — who has probably never come close to running a bank and has come a lot closer to running his debit card through an ATM — can come out quickly and say not enough. Maybe he really rocks everyone’s world and says all preferreds must be converted to common or be canceled.

You could come in with the ProShares UltraShort Financials double short and lay all over the common, just long enough so the press says, “That didn’t work, only full nationalization will do.” All of this is made relatively simple by the woefully overmatched Tim Geithner, who is so used to making calls discrediting Treasury and Bernanke and making his own elegant solutions look good that now he is without game plan. He can’t blame the Treasury — he is the Treasury. He can’t blame Bernanke — the Fed chief’s the only one with ideas and an action plan…

I am confident that the common can be broken by shorts who are still totally in control because the SEC has not restored the uptick rule. I just think we ought to at least suspend the ideology and make it clear that nationalization is a big win for the shorts and frame the debate that way. I mean, does anyone think that George Soros is long and talking about the destruction of the banking industry?…

The best way to play things short is to short both the common and the preferreds. If you can convince the government to dilute the preferreds, it is the win of a lifetime. And yes, if I were still in the hedge fund business I would be short both and writing how much I love Roubini and his terrific, practical plan based on a banking system in Sweden that’s the size of the banking system in Ohio.

Appallingly, details of the plan are still being dribbled out in the press on a piecemeal basis. AP: “Regulators provided some details on that program Monday. ‘Any government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory’.” This is gibberish. It is certainly no way to run economic policy or the Fed or Treasury to be improvising in such an amateurish way, long after the skeleton of a reasonable plan (Paulson’s, with a continued infusion of preferred stock as necessary) was already in place.

We sketched the simple outline of a much better and more workable plan just the other day (see last paragraph). As we feared, the administration seems to be letting ideology trump good business. It seems to think that this mish-mash of a plan, the main value of which is that it can be explained as not “bailing out shareholders”, will stanch the bleeding in bank values. As of now, we’re betting on the shorts. Amazingly, we’ll just have to keep watching and waiting; this latest “plan” isn’t the last word, since it can be easily trumped by bad players in the market (eg, they’re killing GE today, which is trading in the $8′s).

This entry was posted on Monday, February 23rd, 2009 at 6:30 pm and is filed under business, Democrats, General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.