Archive for September, 2008

Holy *%$# … Bailout defeated, Market collapses

OK, I was wrong. Really wrong. I was sure politicians would approve this bailout bill, no matter how publicly unpopular it was. The short-term risks of not doing something seemed too enormous – a complete freeze of the credit markets and the subsequent collapse of the economic system that relies so heavily on that free flow of credit.

But apparently, there’s one other short-term risk I didn’t consider strongly enough: The fact that every last one of those 435 members of the House of Representatives are facing elections in a month and could be tossed out on their rear ends if they piss off their constituencies.

To put it mildly, the financial markets didn’t take too kindly to news of the plan’s defeat. Even with a pretty widespread short-selling ban in place, the Dow Jones average fell more than 700 points, while the Nasdaq plummeted more than 9 PERCENT!!!!!

So now what should you do? Well, here are my thoughts.

  • I obviously would never give specific investment advice here, but if you have money set aside and a long-term time horizon, putting some of that money to work doesn’t sound like a bad idea. I put an order in for a small amount of an S&P index mutual fund. But that’s been my strategy every year – put a little more money into the market during the bleakest time of the year. In general, you want to be buying when everyone is selling. As I’ve said in other posts, this situation could definitely end up being Armageddon and/or the next Great Depression (at some point, the American empire will collapse just like every other one in history), but that bleak forecast is probably not the most likely scenario. And even if it is, having a shoebox full of cash stashed under your bed won’t do you that much good. Eventually, at some point, I’d begin to look at the riskiest, hardest-hit sectors as possible places to invest – Homebuilders and real estate, financial institutions, etc. – but I’d wait awhile to see how things shake out.
  • While dipping a toe in these scary investment waters, I’d also hedge my bets a bit just in case things get appreciably worse. Personally, I’d spread out my money to separate institutions if I had to make sure my bank accounts were within the $100,000 FDIC insured level. Obviously, there are stronger banks and weaker banks, but in a crisis, it’s tough to be certain of the difference so there’s no harm in being prudent. Also, the government last week guaranteed against losses in money market funds for one year, but to be extra-safe, I’ve pulled money out of those accounts and into plain-Jane savings accounts.

It’s odd: I don’t agree with the free-market, deficit-hawk politicians who have opposed this bill and blocked its passage (I believe that we have no choice but to act), but on some level I actually admire them for sticking to their principles. The lessons of The Great Depression and subsequent crises suggest otherwise, but they could be right that we need to suffer the consequences of our actions and take the full extent of our medicine if we are truly going to cleanse the system. A bailout plan poorly executed will only make it worse down the road.

However, I still think the risk of inaction is too high, and that these politicians will look at the market and economic fallout of their No vote over the next couple of days and then pass a bailout plan that is very similar to the one they rejected.

After all, this decision wasn’t just about principles, but about politics. And the politics could change very quickly if the electorate realizes that The Powers That Be weren’t bullshitting when they warned that Wall Street blood would pour onto Main Street.

One $700B bailout coming up…

OK, the market’s up big. The bailout plan is about to be unveiled. What does it all mean? Here are my immediate thoughts.

  • Of course, the bailout plan is coming. Talk earlier this week that Democrats or hard-core free-market Republicans would torpedo the agreement was totally asinine. Very few politicians in their right minds would say no to this deal and risk being seen as the ones who put the final nail in the economy’s coffin, creating nightmarish scenes of bank runs and bread lines. What is smart and totally predictable is for politicians to raise a lot of hay and ask a lot of questions, so they can a) try to get things added or subtracted from the bill which they find disagreeable and b) blame others if the deal doesn’t work. This week was truly the American political system working as it always does, with plenty of good, bad, and ugly (or at least messy).
  • One of the last sticking points to getting to a compromise on the bill appears to be related to the Democrats wanting the ability for bankruptcy judges to amend mortgages for primary residences. I’ve said in earlier posts that I don’t think a lot of people understood what they were signing (or were deliberately misled) when they entered into these adjustable-rate mortgages and bought houses they couldn’t afford. So I do feel like it’s OK if we help people stay in their homes even if they were the ones who made bad decisions, as long as we are talking about primary residences – and not second homes or investment properties. However, I also feel this country has for too long encouraged an unhealthy focus on home ownership as being a key element of that mythical American Dream, a subject I will soon expound upon in a future post.
  • There is now talk that Nancy Pelosi and the Democrats want to bring another stimulus package up for debate in the House as early as tomorrow. Please don’t. The first stimulus package didn’t work, and this one won’t either. Again, I understand their political appeal, esp. when Congress is authorizing hundreds of billions to help bailout the banking system, but these stimulus packages offer about the same benefit as energy drinks provide for someone who’s woefully short on sleep. The rush ends way too quickly and the problems end up being worse than before. If we’re going to further burden our already troubled balance sheet, it’d be so much better if we take any money for a stimulus package and use it to help displaced workers acquire new skills or go back to school, or if we used it to invest in our country’s deteriorating infrastructure, or for public transportation projects, or alternative energy development. (anything that will increase American employee productivity or lead to real, lasting tangible benefits, neither of which stimulus plans accomplish).
  • The announcement of the bailout package will hardly signal the end of the story. The details haven’t yet been revealed, but I can assure you if the process goes down anything like the S&L crisis of 20 years ago, there will be plenty of bumps along the way. I’m assuming whatever deal gets signed into law will leave a lot of leeway for the Treasury Dept. and the Federal Reserve in figuring out how to handle the situation, but Congress will be watching closely and they ultimately control the purse strings. Whichever candidate takes over the White House will probably be preoccupied with this issue for at least the first year or two of their term. Plus, financial institutions aren’t the only ones that will be needing financial assistance from the government, esp. if the credit markets don’t unfreeze very soon. I expect the next industry expecting a handout will be the automotive industry, which is struggling badly and loaded with debt. And because Michigan is such a key battleground for the November elections, it would be in their interest to come a-callin’ to the government kitty as soon as possible. (Actually, speak of the devil, the House just passed a $25 billion loan package for the auto industry. Ugh.)
  • Again, I wish I could say with certainty that this bailout package will solve our problems over time and that we’ve seen the worst of this crisis. The problem is, we are dealing with unprecendented events. The world is a lot more complicated than it was in the 1920s and 30s. The world’s economies are more intertwined, and the financial instruments at the heart of this mess are much more complex. I expect a prolonged global slowdown, with the only good news being that we may be further along the road than a lot of other markets, including the high-flying emerging economies that will likely see sharp downturns.
  • The market is up big today on the news of the impending announcement, but we’re nowhere near where we were even last week when the bailout plan was first bandied about. As investors start to realize what a long, hard slog this is going to be, I believe the enthusiasm will wane very quickly (let’s not forget we’re still working under the ill-advised SEC short selling ban, which is surely keeping the market at artificial levels). Even if we’ve seen the market lows this year (something I am not totally convinced of), we won’t revisit our old highs for a few years.

Public skeptical of the bailout? But of course …

We’ve been told for so long that everything is OK with the economy. Nothing to see here, they’ve said. McCain calls the economy fundamentally strong; his economic adviser calls the American people a bunch of whiners; Greenspan says we are nearing the bottom of the housing meltdown; Barney Frank dismisses the problems at Fannie Mae and Freddie Mac as overstated.

One day, I’ll have to compile a hit list of all the pollyannish statements that have been uttered by our most exalted political leaders and economic experts. The lack of recognition of our numerous budding problems – by people of all ideological stripes – has been astounding.

And yet from this same cast of characters, now all we hear about are warnings of ‘economic catastrophe’. They talk of a ‘long and painful recession’ and raise the specter of The Great Depression.

Part of the reason for the 180-degree shift in tone and language is due to the public’s negative attitude toward the proposed bailout plan, which seems to have surprised many leaders.

But is a skeptical public really that surprising? People go without health care, this government looks the other way. They lose their home or job, we look the other way. Regular Americans constantly work harder for less and precious little is done to help ease their burdens.

Yet as soon as a bunch of a rich bankers find themselves in trouble – trouble that was mostly self-inflicted – the government comes running to their aid with hundreds of billions of dollars. Of course the public is skeptical. They have every right to wonder if this is just another example of the concerns of the wealthy and connected coming before those of the average constituent.

I understand the public’s skepticism, but unfortunately the situation is dire and needs to be addressed. The free market is a very powerful and efficient beast, but it isn’t perfect. Imbalances can arise. Behavior and sentiment can move to extremes. And rich bankers left to their own devices can bring an economy to its knees.

McCain strikes a pose …

So McCain wants to put politics aside in order to solve the economic crisis …

Feh! Maybe I’m too cynical, but I can’t even imagine a more political tactic.

McCain just gave a speech saying he wants to suspend his political campaign and postpone Friday’s presidential debate until Congress agrees on legislation to solve this crisis.

That’s just silly.

Look, there is some urgency here to get an agreement accomplished. They may be moving more slowly than some would like, but Congress is already doing the work that needs to be done, . They’re asking the hard (and, yes, sometimes silly) questions that should be asked when we’re talking about spending hundreds of billions of dollars to bail out a paralyzed financial system. Compromises on both sides have already been made, and the debate going on now is all a healthy part of the American political system.

I’m sure advisers of both presidential candidates can adequately inform the Senators of the proceedings and keep them abreast of ongoing developments. McCain and Obama, as party leaders engaged in an intense political campaign highlighted by frequent public speeches, already have all the opportunity in the world to help steer debate and policy on this issue (something Obama has done much better than McCain has to this point).

There is just no crushing need for the senators to actually be physically on the Hill.

We may indeed be in a serious economic crisis, one that could get appreciably worse if steps aren’t taken relatively quickly, but this is no 9/11, which McCain referred to in his speech. We haven’t been attacked. No one’s been killed. If we can’t act for a few days or a week or two, it won’t really matter. It’s almost as important that a solution is designed smartly as it is that it is done quickly.

McCain’s insistence that the country’s political cycle needs to be put on pause so that we can address and solve this crisis strikes me as overstating the urgency of the situation.

As such, it also strikes me as an overtly political move by McCain, and maybe even a stall tactic signaling he’s not quite ready for the debate. Of course, even if that’s true, Obama and his campaign can’t even hint at any of those things without sounding petty, so perhaps its also a good political move on McCain’s part.

It ultimately all depends on how the American people view this tactic: As a leadership move that goes beyond politics, or as the worst kind of political grandstanding.

Linehan has coached his (second-to)-last game for the Rams…

It astounds me, but my ‘Please Fire Linehan’ post from two weeks ago is still getting the most traffic on my blog. It seems people care a lot more about a crappy football coach on a crappy football team than the potential collapse of the stock market and U.S. economy … Seems about right to me!

Since people are so interested, I figured I’d milk the topic with another post. So, here it goes: My prediction is that Coach Scott Linehan either resigns or is fired this week. *(See revised note/prediction below)*

For the third straight Sunday, the St. Louis Rams were totally embarrassed, with division rival Seattle Seahawks doing the damage this time (final score: 37-13). Coaching changes mid-season don’t happen often, and my prediction is fueled more by wishful thinking than actual conviction, but I just can’t see how the relatively new ownership (they inherited the team from their mother) can allow this travesty to continue.

Before this latest debacle, the Rams had let up a per-game average of 40 points and scored 8 points. They’ve gained 184 yards per game while letting up 482 yards on defense (this week was virtually the same story).  They have highly touted coordinators on both sides of the ball – Jim Haslett on defense and Al Saunders on offense – but I seriously believe the team would lose to many Top 25 Division 1 college teams.

Some of my St. Louis friends and family want Linehan to stay because they think this year is a lost cause and that his atrocious coaching will provide the most likely path to the No. 1 pick in next year’s NFL Draft. But I could care less whether we get the no. 1 or no. 3 or no. 5 pick; One player alone is not going to make a difference, and our draft picks have been awful anyway.

I just want to be able to watch watchable football again … and that’s just not gonna happen with Linehan at the helm.

*[Updated note (9/22): I forgot this next Sunday is the last game for the Rams before their bye week (against the 3-0 Bills, gulp). If any changes are going to be made mid-season, that would be the most likely week to do them. So this is my new prediction: Linehan gets one more game, and then the bye week becomes the bye-bye week as the coach either resigns or is fired.)

A Bill We’ll Be Paying Back For Generations …

Ok, so I’ve admitted that the government probably had to do something to stem the financial crisis.

Now I’m going to talk about all the ways this bailout could – and probably will – go wrong (with the caveat that all the details still haven’t been worked out).

  • Everyone talks about how this plan will be reminiscent of the government’s ultimately successful strategy to create the Resolution Trust Corp. (RTC) in 1989 to help resolve the Savings & Loan banking crisis.  Numerous difficulties arose during that bailout as more than 2900 institutions and $900 billion in assets ultimately had to be rescued, and yet the cost and complexity of this current crisis will easily dwarf anything seen in the S&L crisis. The bad loans in question are larger in scope, broader in reach, and more intricate in design. Deciding which assets to buy, how much to pay for those assets, and how to get rid of them will be extremely delicate matters, and if we have learned anything about government, mistakes will be made in the process.
  • The plan will certainly cost U.S. taxpayers a lot of money. Some optimists are talking about how the government could end up making money from this deal if they’re able to pick up these assets at very distressed levels and then sell them back at higher prices once things settle down. Such a scenario is possible but highly doubtful. What is much more likely is that the U.S. balance sheet, already drowning in foreign debt and facing enormous future liabilities caused by a troubling demographic shift (e.g. Social Security), will continue to deteriorate. This will lead to higher inflation, a higher deficit, higher taxes, a weaker dollar and ultimately, a large transfer of wealth to other nations.
  • This bailout, even if successful and profitable, will once again institutionalize the concept of moral hazard into our economy. This is something I’ve talked about before in this blog, but economic moral hazard basically means that people will take on too many risks if they believe they will be bailed out if things go bad. There are folks, including me, who feel that the S&L bailout is one reason why the financial system got so quickly back into trouble. The Glass-Steagall deregulation of the industry didn’t help, either. I hear a lot of people say our current predicament is too critical and dire to spend time philosophizing about moral hazard, but that’s a circular argument which will never lead to addressing the issue.
  • That’s why it’s so critical the government makes sure all institutions that need help suffer some kind of repercussion as it designs and implements its plan. And when the dust settles, government should begin modest re-regulation of the financial industry to try and ensure this level of risk-taking doesn’t happen again. Finally, the government should go hard after people who committed crimes during this period, and take back some of the billions in ill-gotten gains from those bad apples. No need to play the blame game immediately, and you’re never going to get back all that money (thinking about the multimillion-dollar bonuses many of these guys got over the past several years is a bit sickening), but people as well as institutions need to realize that overly risky behavior could lead to punishment down the road.
  • The one thing we do know about the current plan is that the SEC has declared all-out war on short sellers (investors who sell borrowed shares in hopes of buying the stock back at lower prices and pocketing the difference). The agency has banned short selling on 800 financial-related stocks and forced large short sellers to disclose their positions. I hate this. It frankly disgusts me. It’s something a country like China would do (and has done). I’m a long-only investor, but short sellers are an easy scapegoat – they provide liquidity in the market and often correctly point out flaws in companies and business models. However, I do understand that confidence can make or break our financial system, and plummeting stock prices caused by unchecked short selling certainly threatened to exacerbate the crisis. So, while this ban sets a very bad precedent, I suppose I can live with it as long as it is a very temporary measure. In the end, the ban will only work if time and some breathing room was the only thing the market needed to stabilize. If this bailout isn’t sufficient and we have even more serious systemic issues, then this market rally will be only a temporary reprieve – stocks will fall again and the problems will begin anew as soon as the ban is lifted.

All Clear? Hardly …

The SEC has banned short-selling on financial stocks. The Treasury has guaranteed money market funds and is cooking up plans to spend hundreds of billions of dollars to buy distressed assets and save troubled banks. The market has rebounded huge, taking back all of this month’s losses.

So are we all clear??

Hardly.

I think in the short-term, the moves have bought the financial system time to gather its senses, to take a breath. That’s a good thing, and clearly the ban on short selling is doing a lot to move prices higher (I’m going to write about the numerous, potentially devastating long-term ramifications of all these decisions in a following post).

Something needed to be done. We took out our previous lows and got that panicky sell-off I talked about in an earlier post. The potential for blood on the streets (Main Street as well as Wall Street) was very real. A functioning economy ultimately rests on people’s confidence in it, and widespread panic can cripple the health of such a system to the point where it takes years to recover.

But even if you stabilize the system with these moves, you’re still going to be faced with most of the same issues: A moribund housing market, a stretched-to-the-limit consumer, a weakening job market, a credit crunch, a global slowdown. It will take time and a lot of pain to resolve these issues. Anything we do will at best ease some of that pain, while there’s a very real risk we end up doing something to make the problems last longer than they otherwise would.

In sum, the government may have just put a floor in the market with these moves, and at least temporarily prevented a disastrous widespread panic that could have led to another Great Depression.

But I also think we’ve seen most of the short-term stock price gains we’re going to see (maybe we see another 5-10%).

And the medium-term future for the economy AND the market still doesn’t look particularly bright. We’re going to be stuck in this economic morass for some time to come, and the market will continue to reflect that reality.


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