Ill today ... Congess botch the botch job ... the irony of the Republican Rebellion ...WaMu no more ...

Short blog this moring as I have a horrible cold - stiff neck, sore throat, runny nose and I'm going to moan about it all day ... mkts rallied nicely yesterday on the expectation that the bill was going to be passed but are now lower again because the plan is bumping up against what looks like a fledging Republican rebellion. 

It all looked good when Senator Dodd said last night that they had an agreement in principle and that Congress would act expeditiously ... in fact, the "agreement in principle" is apalling ... it includes the govt taking an equity stake in participating banks, stronger oversight of the Treasury Secretary's use of the funds, modifying govt made mortgages and drip feeding the funds into the scheme rather than making one upfront payment ... in otherwords, is far removed from what Paulson wanted and in all likiehood would massively reduce the already questionable chances of the plan succeeding ... they all sounds reasonable, but the reality is these measure will screw up the plan. 

The whole idea is about creating a transparent market in these illiquid securities. But making equity sacrifice a condition of participation in that market will just act to put banks off participating. It therefore risks preventing the scheme from getting off the ground. Similarly, drip feeding the cash to the plan in installments will prevent the scheme being properly independent from political interference. 

Of course, its not clear Paulson's plan will work. Liquifying the toxic part of their balance sheet is important but it won't be the final chapter in this crisis if the banks remain undercapitalised afterwards, which looks likley. And the assumption that the banking system will go out and recapitalise itself in the private sector flies in the face of historical experience where only the public sector has been able to recapitalise banks. Given the magnitude of the plan and the fuss it has created, Paulson's plan may yet go down as the biggest botch job of all time. But Congress botching the botch job is even less encouraging ...

So since Dodd's optimism equity markets have fallen back again, and Asia is trading softer overnight. Not because market thinks that we have a double botch on our hands, but because a section of the Republican party, increasingly emboldened by public cycnicism - welfare for the rich - appears to be staging some sort of a rebellion ... 

... Senator Shelby has apparently received a letter from "leading economists in America" too, saying the plan is premature and would not help. Banks should be failing before the government gets involved apparently ... Nobel Prize winning Robert Lucas of rational expectations fame is among the strongly libertarian leaning list of economists, game theory guys and behavioralists arguing that the government has no role in interfering in what is a private sector affair. 

Meanwhile the House Republicans, led by Eric Cantor and appalled that any tax payers money is being used at all, have thrown a spanner in the works with an alternative mortgage backed insurance plan which they argue wouldn't put the taxpayer at risk. They want a system put in place to charge premiums to mortgage-backed security holders which would finance insurance on those securities. I haven't seen any details on this yet but although the self-insurance idea along FDIC line is an interesting idea I can't see how it will solve the immediate problem, which is to recapitalise the banking system.  

But what sticks out is that most people, including the politicians, don't understand what the plan is. They think it's some sort of $700bn net injection into the financial system when it's actually a $700bn swap of liquid assets on the governments balance sheet for a bunch of illiquid assets on the private sector balance sheet at a price close to, but probably below those assets' economic value.  

The irony is that the $700bn net injection plan - which this isn't - would recapitalise the banks and would therefore probably work, while the $700bn market creation plan - which Paulson's plan is - doesn't recapitalise the banks and so probably won't. So the rebel Republicans are trying to vote down the one that won't work because they think its the one that will ... 

Washington Mutual went down last night with JPM taking over their deposits and their branch network. They now become the biggest US bank by deposits as well as by exposure to the unregulated $60tr CDS market ...

Lots of the talking heads on CNBC were asking how the stock market could be rallying yesterday while the credit markets remained frozen - the TED spread was unchanged on the day, but spiked as high as 337bps early on. As anyone who is actually involved in markets, rather than just being a clever sounding pundit knows, one market is usually a view on another. Gold stocks, for example, are a view on the gold price. But it doesn't work the other way - gold doesn't care about what gold stocks are doing. So at turning points you often see the two behaving differently, with gold stocks rallying even as gold continues to fall because the equity market is in effect making a judgement that gold is going to rally. That doesn't always mean it's right, but it's what you're seeing right now. The stock market is a currently a view on the credit markets, and the view of the stock market right now is that if the Paulson plan is passed the credit markets will unfreeze ... that may or may not be the correct view and I'm still not sure that this plan will work because it doesn't address the issue of capital inadequacy, but that's why the stock market isn't waiting for the credit markets for permission to rally at the moment.