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No rain without pain

Looking for a analogy to what I was watching on TV – Im referring to the events in Washington and the great debate over US Treasury secretary Henry Paulsons $700bn plan to rescue the US banking industry prior to it being scuppered by the Republican party earlier this week – the best I could come up with was a witch doctor in Africa performing a ritual to end a drought.

It hasnt rained for over a year, the wells are drying up and the few small fields at the edge of the village are little more than a dust bowl. The handful of goats and sheep that are left have been reduced to tottering skeletons.

First we must round up all the animals and sacrifice them to the rain god, the witch doctor declares.

The chief looks doubtful but hes desperate and with tears welling in his eyes he agrees.

And now we gather all the little children and sacrifice them too to bring on the dark clouds and the-life giving rain, says the witchdoctor.

The chief looks desperate. The children? he asks, hoping he has misheard the witch doctor.

Yes, the children, says the witch doctor. There can be no rain without pain.

Where have I heard that before? wonders the chief, and calls the village elders together for counsel. He is uncertain of the witch doctors expertise but is unsure of himself too.

Trust me, says the witch doctor. You are the wisest of the wise and like me understand the ways of the gods.

The elders, not wishing to appear foolish, agree. Its better to do something rather than nothing. Besides, the consequences of doing nothing seem catastrophic.

And so to the since scuppered – at least for the time being as I write this – Paulson plan. Like the witch doctors sacrifices I dont understand the science.

Does Paulson want to buy up all toxic mortgage loans at a higher price than the market, with tumbling asset prices, would warrant?

The idea then would be to sell them back to investors, possibly at a profit, when the housing market recovers.

That way banks could use the money offered by the state-backed price to repair their balance sheets and hopefully in time US taxpayers would get their money back and some more too. But what if Paulson is confusing cause and effect? What if the losses that banks are sitting on actually reflect a sea change in the value of their collateral and that the US housing market will recover at a lower but a more sustainable level of activity?

Is that a silly idea? Well, at a recent Treasury Committee hearing Mervyn King, governor of the Bank of England, was scathing about the idea that the BoE should follow the US Treasurys example of buying mortgage securities
from the market.

He apparently sees the mortgage funding crisis as a symptom of a deeper malaise in the banking system namely that its undercapitalised and offered no hope at all to those looking for some sort of fix for the mortgage securities market.

In his view raising mortgage funding in this way is relatively new and lenders should simply return to generating mortgage funds through retail deposits.

If thats the case, we may see Paulson turning to the sacrificial altar, but this time round he may end up on the stone. And following the Republicans rejection of the proposed $700bn deal on Monday this week it seems, at least for now, that we are all doomed anyway.

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