I missed this until now, but a Paul Volcker, et al., editorial in today's Wall Street Journal is required reading. The authors essentially argue for a new Resolution Trust Corporation, a government vehicle that can buy up toxic paper on the market, provide liquidity and keep credit markets moving while the current crisis is worked through.

The trouble, of course, is that this approach requires immense political will and foresight. It will end up costing "serious money", as Volcker says, and serious can be loosely translated as somewhere north of a trillion dollars. And all of that will almost certainly have to come from the U.S. taxpayer.

The alternatives aren't very appealing, and they're getting worse every day. But the status quo isn't much of an option, as the most powerful quote in the piece shows:

The pathology of this crisis is that unless you get ahead of it and deal with it from strength, it devours the weakest link in the chain and then moves on to devour the next weakest link.

Precisely right. Precisely. It is time to get strong. But who in Congress or the Administration has the smarts, perspective and tenacity to make it happen -- and do it in an election year, no less?

--------------------------------------------------------------------------------

The original OpEd is here, and Roger Ehrenberg has a thoughtful take here.

To be somewhat less serious than I have been of late here, here is some lovely eye-candy of the venture capital business in the U.S. Check out the following two cartograms from the current issue of Nature (and click for a larger version):

Funny Jon Stewart segment on the recent financial bailouts. I especially like his "The CNBC octabox!" comment. Cute.

Somewhat more seriously, this issue continues to spin out of control and needs to be explained to people. Right now. Because the Stewart show is a good barometer of a common view of what's going on, and the common view is, "Screwy and indefensible bailouts all over the map". And they are that, of course, but there are also few good alternatives, unless you're fond of watching global markets collapse. Expecting voters to have that figured out for themselves is, however, indefensible and stupid.

I was recently re-reading Frank Partnoy's excellent 2003 book Infectious Greed (yes, we both borrowed our names from a 2002 Alan Greenspan speech). It remains remarkably prescient with respect to the current crisis, having nailed the origins, the motivations, and the likely consequences of the move to highly levered, structured finance as a foundation for the global banking system.

Here are some of his suggestions from the book for trying to arrest the damage:

1. Treat derivatives like other financial instruments. The current system permits "regulatory arbitrage", and it needs to end before more damage is done to a teetering and badly broken system.
2. Shift from rules to standards. Over-specific rules permitted people to game the system by playing to the letter, not the spirit, of regulation. At the same time, rules are instantly self-obsoleting, as they they locked in stone and market moves on, while the regulatory regime doesn't.
3. Eliminate the oligopoly lock of gatekeepers, especially credit-rating agencies. This one's pretty much self-explanatory, and I feel equally passionate about its correctness.
4. Encourage informed investors to bet against stocks. We're going the opposite way on this one, but we need more, not less, short-sellers. While it has become marginally easier to short-sell in recent years, it is still more difficult and costly than going long. That should not be the case, as it means that when inevitable corrections come, they are savage.

Good ten-year-old paper I hadn't seen before from Wharton evaluating the options for resolving problems in banks (and banking systems). Despite being a decade old, it has some solid reading as we work through the problems in the U.S. and global financial system.

The following paragraph on the RTC experience during the S&L crisis struck me in particular:

Total cost of the Thrift Crisis has been estimated in the neighborhood of $150 billion. Regulatory authorities were clearly unprepared for the magnitude of the Thrift Crisis. Costs were multiplied by initial inaction and bureaucratic inefficiency. There was a steep learning curve which by the 1989 creation of the RTC began to level off. Unlike countries that subsequently experienced similar problems, the US was fortunate that the thrift problem was small in relation to the total size of the financial system.

Sound familiar? It should -- except for the last sentence, which is, unfortunately, not true in the current crisis.

Be sure to read this too from the conclusion:

If there are lessons from the experience, several come to the surface:

1. Costs of intervention are generally larger than anticipated;
2. Interventions aimed at preserving the current institutional structure generally do not achieve the expected outcome;
3. The only sure resolution appears to come from confronting the insolvency directly and addressing its financial implications, no matter how large.

Regulators, however, often delay action in the hope of a turnaround. If the regulator is lucky, a change in the aggregate economy will remedy the financial imbalance. However, regulators are rarely lucky, at least in recent history. Resolution options available to regulators only permit them to delay the effects of a massive asset valuation change on bank structure in the hope of a return to financial viability. If they do not set off a series of counterproductive incentive effects, they may offer both the regulator and the bank manager time to shore up balance sheets and improve profitability. But, they offer only a little time and often require considerable luck. If the banking system can not correct its problems in short order, as was the case in the US Thrift Crisis, or if the economy continues to deteriorate, as in the Scandinavian case, or if the losses are too large, as in France, the policy will not achieve its end. On the edges these policy options may offer some hope to sustain the institutions’ lending capacity and consumer confidence for a short period of time. However, in the end, all of these options are no replacement for sound bank management and a sound balance sheet.

As of moments ago, we just blew through a Dow round-trip for the Bush Administration on the Dow. The Dow closed at 10,578 on January 22nd, 2001, and we are currently at 10,512, for a -0.6% decline overall, or -0.07% decline compounded annually.

To put it in a broader presidential context, Bush now has daylight between him and Jimmy Carter in having secured the spot for third-worst all-time compound annual returns for a U.S. president. He now trails only Richard Nixon and Herbert Hoover since 1929.

Both men's records currently look (relatively) safe, however. The Dow would have to fall to around 7,500 by inauguration day for Bush to out-do Nixon, and it would have to fall to 1000 before Herbert Hoover spot at the top of the pops was at risk. In other words, he needs to be careful what he wishes for.

For my old chart of presidential Dow returns, check here.

[Update] The market is flipping and flopping so much today from positive to negative that rank positions keep changing. Bush and Carter are now neck and neck, depending on when you check.

Oh, now John McCain is suddenly swinging with both fists on capital markets? He just said he thinks SEc Chair Chris Cox should be fired because he allowed naked short-selling and that is driving the current crisis? Un-be-frickin-believable.

First, it is the height of irresponsibility for a politician to grandstand so clumsily when the market is as fragile as it is right now. It shows a remarkable lack of financial sophistication and market smarts on the part of John McCain, and I didn't have much confidence in either from him in the first place (and that does not make this an Obama endorsement, because he has done diddly to convince me he gets this either).

Second, this has nothing to do with naked short-selling. Repeat after me: The trouble is not with short-sellers. The trouble is not with short-sellers. The trouble is with an over-levered financial system built on a house of cards comprised of under-collateralized toxic paper that was applauded all the way up by "housing is the American dream" nutters who couldn't see that vast expansions in thinly-traded credit are a path to economic ruin. Focusing on the short-sellers will lead to completely wrong and counter-productive non-solutions to the current crisis.

Unbelievable. Truly.

Full text, such as it is, of President Bush's first real statement on the current crisis.

The American people are concerned about the situation in our financial markets and our economy, and I share their concerns.

I’ve canceled my travel today to stay in Washington, where I will continue to closely monitor the situation in our financial markets and consult with my economic advisors. I spoke to Secretary Paulson this morning, and I will meet with him later on today.

In recent weeks, the federal government has taken extraordinary measures to address the challenges confronting our financial markets. We’ve taken control of Fannie Mae and Freddie Mac — the home finance agencies — to help promote market stability and to ensure they can continue to play a role in helping our housing market recover. This week, the Federal Reserve acted to prevent the disorderly failure of the insurance company AIG — a development that could have caused a severe disruption in our financial markets and threatened other sectors of the economy. Yesterday, the Security and Exchange Commission took action to strengthen investor protections and step up its enforcement actions against illegal market manipulation. Last night, the Federal Reserve, in coordination with central banks around the world, took a substantial step to provide additional liquidity to the U.S. financial system.

These actions are necessary, and they’re important. And the markets are adjusting to them. Our financial markets continue to deal with serious challenges. As our recent actions demonstrate, my administration is focused on meeting these challenges. The American people can be sure we will continue to act to strengthen and stabilize our financial markets and improve investor confidence. Thank you.

As many have pointed out, it reads like a clumsy press release, not like someone trying to explain and/or inspire. And to continue to implicitly cite naked short-selling as a major factor here makes my eyes bug out. Truly.

While Yale won't announce its endowment performance results for a few months yet, a Yale paper has initial figures on it, and it looks a little weaker than expected. David Swensen has apparently managed to eek out single-digit returns, but lags Harvard for the first time in years. We don't know yet whether it's high or low single-digits -- and either is admittedly way outpacing the market -- but this will be interesting to watch.

More here.

While it has a somewhat extreme title, this segment from CNBC Europe with a UBS economist is fairly clear-minded and useful. The gist: Governments have the balance sheets to solve this problem, if they choose to do it.

The numbers are amusing in this ABC News piece, but the idea is right: The current financial crisis and the massive layoffs in the financial services industry are transforming Manhattan real estate.

"Five years ago, if you were an investment banker that meant big bucks and automatic entry. And today it is a dirty word," said author Holly Peterson, the wife of a multi-millionaire investment banker and the daughter of multi-billionaire financier Pete Peterson.

[via ABC News]

House Financial Services chair Barney Frank (D-MA) is pushing harder than anyone else for more financial market regulation, plus talking about a possible government vehicle. So, whether you like the man and his often nonsensical posturing or not, you sort of have to watch this interview on Charlie Rose last night.

A few people have asked about my compound annual Dow returns for U.S. presidents, so I whipped together a quick and dirty live table.

We're now into the blame game, and it seems obvious that a major chunk of the blame for the current mini-round of the ongoing financial crisis is being accorded to short-sellers.

Tonight we are hearing about new disclosure rules for short-sellers, new bans on short-selling certain financial stocks in certain jurisdictions, strong pushing for a reinstatement of the uptick rule, John McCain saying deranged things about naked short-selling, and pretty much everything else short of suggesting that short-sellers be tossed into creeks to see if they float. I'm sure that's coming, of course.

As an aside, my current favorite smart-aleck comment on the crackdown came just now on Twitter from my friend Dick Costolo:

SEC expanding short-selling restrictions to prohibit yelling within 20 yards of a ticker symbol & exercising puts w/out saying "simon says"

The trouble is, blaming short-sellers works, as does, at least sometimes, banning short-selling. First, short-sellers are easy targets -- people who want things to go down, especially things that you own, must be bad people. Blaming them gives you political, financial, and rhetorical power.

Second, to the extent that people are keeping money out of the market because they are petrified of short-sellers, convincing them that less short-selling is going on (even if it isn't) is an easy way to get more capital back into the market. Granted, nothing has changed, but it's a fun superstition, sort of like sacrificing the odd virgin into a nearby volcano. Or tossing a supposed witch into a shallow creek.

The trouble is, of course, short-selling remains important. They are usually the best-informed traders in an issue, as repeated studies have shown. Their ability to bring prices in line is lost, or at least muted, and that can make subsequent price moves even more wild.

At the same time, you can still make money from stocks going down, even in those issues that have had short-selling banned. I can still buy puts, or write calls on stocks, both of which are bets the stock will go down. And if I don't like options I can buy something like the UltraShort ProShares Financials ETF, which goes up (down) twice as much as the Dow Jones Financials Index goes down (up). Inside said index is, of course, Morgan Stanley (at a 1.2% weight), Goldman Sachs (at a 2.3% weight), etc. I'm shorting the stocks that I'm not allowed to. Ooooh! (And this does raise a sort of zen question: If shorting financial stocks is wrong, does it follow that shorting the UltraShort Financial ETF is good? Just curious.)

This moment too shall pass. Eventually volatility will fall, banks will deleverage or merge or fail, and we will see the requisite studies showing that short-selling wasn't the problem, plus that market quality deteriorated in stocks in which short-selling was banned. It's as predictable as the politicians piling on. Too bad no-one cares in the rush to be seen having found someone to blame.

In a predictable twist tonight, SEC Chair Chris Cox has said he is going to follow the U.K.'s FSA and institute a temporary ban on financial short-selling. If true, and if it weren't such a stupid idea, it might be funny, like the U.S. doing a half-way step to Pakistan's goofball policy of disallowing market declines. Up with markets!

But even if we dismiss price efficiency, consider the practical consequences of making it impossible to short financials (and don't even get me started about disallowing all shorting): What happens, for example, if you're running a long/short quant fund with billions of dollars and hundreds of positions? Do you give the money back now that you can't trade on the short side of your fund? Do you push all the short trades through ETFs? Do you abandon the entire financial sector? And who do you sue when your fund blows up because you're not sector neutral? Short-only funds are, of course, now, turned into commercial real estate companies.

Absurd. Bad enough to have idiot financial services busting themselves and markets with 30x leverage built on a tissue of toxic CDOs, but now we have frantic and destructive rulemaking to prevent over-levered nitwits from crumbling.

More here.

We have had a remarkable day today in New York and in markets around the world, and it has seemingly turned into an equally remarkable night. According to reports, senior Congressional representatives began meeting at 7pm tonight with Ben Bernanke and Hank Paulson, having decided that the initial financial shock and awe campaign hasn't been enough, and so now the five words that should scare any sane, thinking person: Congress wants to do something.

Call it RTC 2.0 if you like, but this is going to be something awfully big. Early numbers are in the hundreds of billions of dollars, and it will likely involving directly purchasing mortgages from over-stressed banks and lenders.  That is, of course, much easier said than done with mortgages collateralized and syndicated to a thin sheen across the ownership landscape.

Nevertheless, there is remarkable political will to do something, and to do it before the November elections. Granted, there are hold-outs on each side, but at this early stage I'd say we're looking at an RTC 2.0 something-or-another far earlier than most of us thought it would ever happen.

I should be happy, I suppose, but I'm mostly depressed and dismayed. While something is necessary, it's tragic that it has had to come to this, and the political and economic fallout will be gigantic and long-lasting.

More here, and as news breaks.

Speaking of Pakistan's self-imposed no-market-declines rule, all's well in the land that bad news forgot. Consider this quote from a securities dealer in Karachi concerning the current global crisis:

"Global financial turmoil has not and cannot affect Pakistan, thanks to the floor which is in place," said Asad Iqbal, managing director at Ismail Iqbal Securities Ltd.

Gosh, I hope Hank Paulson and Ben Bernanke are paying attention. Asad is onto something here.

[via Reuters]