Time for government to get out of the way of a recovery

Now that the stock market seems to be signaling that the recession has bottomed, perhaps the demagogic bashing of bankers, insurance executives, hedge fund managers, auto executives and even ordinary businesspeople will cease.

Yes, the auto companies, some big banks and investment banks, and American International Group Inc. messed up big-time, and the government felt that it had to jump in to save the day. But now it's overkill, and the government is messing things up, making investors nervous and perhaps keeping them out of the game.

That will only slow a recovery.

The most glaring examples of this were the congressional hearings during which auto executives, and later top officials from major banks, were lambasted. Or when executives from AIG were pilloried for accepting the deferred compensation they had been promised for helping unwind the New York-based company's financial mess. Or when President Obama criticized mutual fund executives for resisting the deal with Chrysler LLC of Auburn Hills, Mich., even though they were fulfilling their fiduciary duty.

WAKE-UP CALL?

There are signs that the administration has realized that continuing to play hardball with business executives and investors is unhelpful. The Department of the Treasury, after telling General Motors Corp. it could not offer a better deal to unsecured bondholders than just 10% of the equity of the new (post-bankruptcy) GM, finally relented and allowed the company to sweeten the deal enough to get the majority of bondholders to go along.

We hope the slight concession to the bondholders in the bankruptcy of Detroit-based GM is a recognition that government highhandedness could be expensive in the future.

Indeed, government actions appear to have scared off the private investors the Federal Deposit Insurance Corp. and Treasury Department's Legacy Loans Program needed to make viable the latter's plan to relieve the banks of their toxic assets.

The plan envisioned a public/private partnership whereby private investors, such as mutual funds, pension funds, insurance companies and hedge funds, would buy the troubled assets from the banks with the government providing guarantees against losses.

However, potential investors have expressed reluctance to participate in the program, fearing that the rules might be changed after the fact if the investment returns were high enough to be politically embarrassing.

The investors also likely are concerned they might be pressured into returning some of the profits, if they are successful, as the AIG executives were pressured into returning their bonuses — or that they might be hauled before Congress for a verbal public flogging.

They may also have been discouraged by the “roach motel” aspect of the Troubled Asset Relief Program, in which reluctant major banks were pressured to check into the program and then told they would have to satisfy onerous after-the-fact conditions in order to check out.

This reluctance on the part of investors to participate in the Legacy Loans Program is the most obvious sign of the cost of the government's words and actions.

RATE HIKE LIKELY

But the government's cavalier treatment of the secured Chrysler bondholders and unsecured General Motors bondholders, and efforts to force banks to renegotiate mortgages and to give bankruptcy judges the power to change mortgage terms, raise questions about the sanctity of contracts in the current administration, and likely will raise interest rates for all borrowers for the foreseeable future.

Such an increase may be hard to discern against all of the economic background noise, but there is the potential for one as the actions have raised the apparent level of risk to any fixed-income investor, and such investors will seek higher yields to offset that additional risk. The higher yields investors are now demanding on U.S. Treasuries may in part reflect that added risk premium.

Politicians and government officials should remember that demagoguery often has associated costs.