Paulson Plan

Friday's dramatic 263-171 House vote to pass the "Emergency Economic Stabilization Act of 2008" and President Bush's signature a few hours later raises a question:  Will it work?

I think it will, but a lot depends upon how well Treasury's reverse auctions go over the next year or so, how quickly our housing market revives, and how quickly confidence is restored in our financial institutions.

For those reverse auctions to succeed, Treasury will have to set high enough prices for "troubled assets" so the financial institutions that hold them will be willing to sell them, but not so high that the taxpayers lose money in two or three years when Treasury starts selling those assets.  This won't be an easy task.

For the housing market to revive, banks are going to have to start creating mortgages and investors around the world will have to be willing to buy mortgage backed securities (MBS) again.  Even quite credit worthy homebuyers have not been able to get mortgages recently.

It really wasn't a surprise when Wall Street didn't have a big rally after the Paulson plan passed the House earlier today.  Wall Street had moved on to the next trading opportunity.

In one of the best-ever Washington-related examples of the common Wall Street saying of "Buy on the rumor, sell on the fact," by the time the legislation was passed, traders had pretty much assumed that it would be approved and were focussing on other issues.  Many of the people who had been the bill's most ardent supporters the past two weeks started to talk about what else would be needed, how this bill only dealt with part of the problem, other economic issues. 

Traders had traded early in the day on the possibility that the bill would be adopted.  When the possibility was high earlier in the day, the Dow was up.  Once the possibility was over, that is, when the bill actually was adopted, the Dow moved down and closed lower. 

If it wasnt already, the 159,000 drop in jobs reported this morning should put the Paulson plan over the top in the House of Representatives later today.  This is the apparent direct connection to main street that's been missing so far.  Today's report provides the political cover any Republican or Democrat needs to vote for this bill.

(Question: Does anyone doubt that the vote was intentionally scheduled to occur after the jobs report?)

So what will happen next?

1.  The Paulson plan will not end the economic woes of the past few weeks. Anyone who thinks the situation will immediately turn around when the bill passes is going to be suprised and disappointed.  I suspect that markets have already assumed it will be enacted and have moved on.  Yesteday's 349 point drop in the Dow may have been a case of this version of "buy on the rumor; sell on the fact."

A quick update from my post from earlier this week about the Bush administration's absolutely terrible communications efforts on Paulson-Frank-Dodd: It looks like they finally started to get it.

Bloomberg reported yesterday that the business groups that had been largely silent finally got involved this week.  And the administration finally realized that it getting out in front not only was not helping, but it may have actually be hurting, so it changed tactics and stayed below the radar screen.

Approval ratings for Congress have been falling the past week, presumably because those who were sampled were not happy about the House's failure earlier this week to pass the Paulson-Frank-Dodd plan.

But I thought the majority didn't want the plan.  If that's really the case, shouldn't Congress' approval ratings be rising?