Posts Tagged 'bailout'

The dagbuzz for 3/2/09: (Abuse, Co-Dependency and Fear of Change)

Today, I discuss codependent, abusive relationships, and our general resistance to change. Deadman understands the deal. He, too, just wants to relive the good old days and focus on things that will always stay the same, like the Middle East conflict.

Image: Chris Brown And Rihanna: Back Together For No Good Reason

Chris Brown And Rihanna: Back Together For No Good Reason

Image: Obama will sign spending bill despite earmarks      (AP)

Obama will sign spending bill despite earmarks (AP)

Image: US takes another crack at AIG rescue

US takes another crack at AIG rescue

Image: Clinton Pledges Gaza Aid

Clinton Pledges Gaza Aid

Predictions for ’09 (and a review of my ’08 calls) …

In my most recent question column earlier this week, I asked for readers’ predictions for the upcoming year … aside from Genghis bravely predicting that Obama would become POTUS, I didn’t get too many responses.

So I’m going to ask for your predictions again, while repeating some of the predictions I made and adding a couple of more, before I revisit some calls I made this year.

First, the predictions for 2009. I’m sticking mostly to economics, with a few foolish forays into other areas (I was going to make a call that Prophet would finish his Top 10 2008 Albums list next February, but I see now he’s picked up the pace):

Economy

  • Unemployment, now at 6.7%, surges past 9 percent and falls just short of double digits
  • Gold now at about $845-$850, revisits all-time highs at $1000 an ounce, probably later in the year
  • Obama puts alternative energy initiatives on back burner at first, but then gets more involved as light crude oil, now at about $36 a barrel, rebounds first to $55-60 in short-term and then approaches $90 sometime next year. Gas prices again become a political issue.
  • ‘Class’ replaces ‘race’ and ‘immigration’ as the next big battleground in America. We see several examples like the factory sit-in we saw a couple of weeks ago. At least one of these protests turn violent and leads to a fatality. Unemployment benefits get extended again, and numerous other populist measures, including foreclosure relief, get passed by Washington.
  • The market has another down year, probably more than 10%, but stages a pretty decent rally early in the year, with the Dow hitting 10,000 again. IPOs remain few and far between, but Facebook does end up pulling off one of the few big new public stock offerings of the year next fall. The stock does well in the short-term, leading to another mini-rally.

Politics

  • The Obama inauguration attracts more than 3 million visitors, and the combined TV audience for his speech exceeds that for the Super Bowl, drawing more than 100 million viewers. There is at least one announced assassination attempt that is thwarted.
  • Biden was right after all and some terrorist organization or rogue state tests Obama’s resolve by the summer. We have the first attack on U.S. soil since 9/11 and it’s possibly a multi-city attempt that mimics the chaotic action in Mumbai. (Please god I hope I’m wrong on this one).

Sports

  • The Panthers meet either the Patriots or the Colts in the Super Bowl and win it all.
  • The Red Wings win the Cup. The Celtics repeat. (These are huge guesses).
  • The Yankees win the division, but flame out in the first round of the playoffs. Girardi is fired by the end of October. The Angels get to the World Series and play the Dodgers in an all-SoCal World Series. Angels win. My beloved Cards come in 3rd place in the NL Central division, which the Brewers win.

So should anyone listen to me? Probably not. My track record this year for predicting events was so-so. I was generally dead-on with economic trends, as I have been very negative for over a year now. On February 11, before I started blogging, I wrote an email to Jim Cramer, stating that we are heading into a ‘severe economic downturn that will last longer than most people are predicting,’ adding:

We are still in the early throes of this current crisis. We still haven’t seen any bankruptcies. Foreclosures and defaults have been at a minimum. The job market has only just begun to show signs of strain. The pain will of course spread to the rest of the world, which is wallowing in our debt and weak dollar, causing a global slowdown. Much more damage will be done, many more shoes will drop.

In a July post on pessimism, I predicted 50% odds for a multiyear recession, and 10% chance for a depression, fairly bold but probably not high enough odds for either. When the Lehman bankruptcy occurred on Sept. 14, I warned this wouldn’t be the end of the story and a systemic collapse was possible. When the Treasury first presented its bailout plan, I said there would be bumps along the way and that other industries would quickly be lining up for money, including the car manufacturers.

When it came to the financial markets, the record was much more mixed. I probably made my best call of the year on July 4, calling oil a bubble about to pop on the exact day it hit its high price for the year ($140+). Despite talk of new rules against speculation and for offshore drilling, I also correctly pointed out that the main reason for oil’s fall would be a rapidly weakening global economy. However, in that same piece, I said there’d likely be one more big run higher and that oil was not going to be heading to $50 anytime soon (It’s now in the $30s. Oops).

My calls for short-term bottoms and tops in the stock market were generally correct, but often early by a matter of days or even weeks, which makes a huge difference if you actually wanted to trade on the information (which I would NEVER recommend, as you have probably realized by now I like to talk out my ass a lot).

For instance, on Oct. 8, I called for a short-term bottom in the market, but it didn’t start happening until the next week. In a follow-up post on the 13th, I thought the rally could have some legs (somewhat true) with the Dow possibly hitting 11,000 (way untrue), but that we would revisit our earlier lows ‘in the next few months, if not sooner’ (true) and that we’d hover around the Dow 8K-9K for a year or more (to be determined).

I didn’t make many political calls, but wasn’t so impressive here either. In July, I predicted an Obama victory and said ageism would prove to have a bigger impact than racism (hard to judge the latter call, but I think it was a pretty good one).

On Sept. 3rd, I said McCain’s Palin could backfire but was the only thing he could to generate even a trace of the excitement of the Obama campaign.

On Sept. 24th, I called McCain’s announcement that he was postponing his campaign to focus on the economy as ‘just silly’ and ‘annoyingly hyperbolic.’

When the bailout was being debated and strongly questioned in Congress, I said it would surely pass; It was vetoed. To be fair, after the bill was vetoed, I did correctly predict a new bailout proposal ‘very similar’ to the rejected one would pass.

And in sports, the only prediction I made was a hopeful and ultimately correct one that St. Louis Rams Head Coach Scott Linehan would be fired after the bye week. Unfortunately, Linehan’s firing didn’t lead to ‘watchable football’ as I had hoped.

OK, now it’s YOUR turn. Go out on a limb. Make some calls. Trust me, if you’re right, you’ll look like a genius, a seer, a visionary. And if you’re wrong, no one will remember (at least not ’til I revisit these predictions next year)

What goes up, must go down …

I believe in balance. In yin and yang. I believe in cycles. In symmetry. I believe big wild parties end with big, nasty hangovers. I believe that what goes up, must come down.

Unfortunately, our government does not agree.

I have railed time and time again on this blog about the scattershot and shortsighted nature of our economic response so far to the current financial crisis. In short, and with few exceptions, said strategy has consisted of spending as much money as possible to bailout and stimulate every sick, depressed segment of our economy, with a particular focus on those segments that cater to the rich and connected.

The policies of the incoming Obama team will only accelerate this process, albeit with a more tilted and welcomed focus on some of the not-as-rich-or-connected folks. There is talk of a new $1 trillion stimulus package being created early in the Obama presidency.

The Fed is fully aboard the stimulus party as well, yesterday slashing the fed funds target rate to basically zero and committing to buying mortgage assets to ensure long-term borrowing rates move lower in an attempt to stabilize and boost the housing market. There is even talk that the government will FIX interest rates at a certain level to ensure they accomplish that goal, though for now it appears the mortgage market is responding to the unprecedented stimuli.

Look, no one likes to see suffering. People out of work, going bankrupt. Home prices falling. Factories closing. Cities failing. It’s nasty, nasty stuff. For politicians, it tends to lead their own unemployment. And for economists, it’s a scary scenario as well, because it almost always results in deflation, a pernicious problem that tends to have long, strong roots once it sets in.

But did the Fed or government do anything when times were so good, when the price of housing was soaring to the moon and consumers were levering up to the hilt and taking on dangerous levels of debt???? Aside from nominal increases in interest rates, I don’t remember any concerted effort, and certainly nothing approaching the desperation we’ve seen recently, to try and tame the animal spirits and gently guide the economy into a soft landing.

In my opinion, you can’t have it both ways. You can’t have bubbles without crash landings. We have stemmed the worst of the credit crunch and liquidity crisis – interest rates have fallen, banks are lending a bit again (at least to each other). It is now time to let the market work its way through this mess and find its equilibrium level. Yes, it will likely overshoot on the downside, just like it did on the way up. Yes, it may take longer to find that equilibrium level than we’d like. But you gotta take the yin with the yang.

I’m not saying we should sit on our hands and watch helplessly as the economy craters. By all means, spend money to reinvest in our roads and infrastructure; on new technologies, including alternative energy; on education, including the retraining of displaced workers; on strengthening the country’s safety net to ensure that those hit hardest from the economic collateral damage don’t suffer unduly.

But realize that all this profligacy will have consequences down the road. We are already staring down the barrel of the worst demographic situation in decades – as the baby boomer generation is getting ready to retire en masse, placing a huge burden on this country’s resources as they move from being net producers to net consumers.

When times were better and tax revenues were flush, our government did nothing to reduce our budget deficit in any meaningful way or address long-term systemic issues threatening the economic health of our nation, like Social Security and Medicare. Yet it now has no problem dramatically increasing our country’s burdens and obligations in order to try and avoid the bad end of the business cycle.

The only thing all this spending will do is take away the oomph from any subsequent recovery. We’ll see a weaker dollar, higher inflation, bigger deficits, and higher taxes down the road. At least some, and maybe a lot of this money will be misplaced, leading to bubbles and wasted investments in other unforeseen areas.

But frankly, the prospect that most of this stimulus will be wasted, a misguided attempt to set an artificial floor on the economy, is actually not the worst-case scenario (though it is the most likely). My biggest concern is that the stimulus works too well and our animal spirits are revived before they’ve had a sufficient chance to reset. If that happens, we’d only be setting ourselves up for a bigger, more painful crash down the road.

ENOUGH!!! …

I’ve had it.

This country has been on engorging on a cheap credit binge for the last decade, stuffing itself on the sugar highs and empty calories provided by ultra-low interest rates and fancy derivatives and zero-down mortgages. Now the chickens are coming home to roost, and everyone is looking for a way to get their butt saved.

It’s bad enough that Congress already spent $150 billion earlier this year on a fiscal stimulus plan that did nothing but allow us to buy IPhones and XBoxes for a few more months. The American people now want more, and it looks like Congress is going to give it to us with another huge stimulus package. It’s money we can’t afford right now and which won’t do anything but provide another very temporary boost to an economy and consumer that needs to retrench for an extended period of time before they can begin to reflate.

But spending money one doesn’t have is the American way. Just ask the country’s beleaguered homeowners now drowning under onerous interest payments, the folks who were too busy picking out Ikea furniture to read the fine print of those adjustable-rate, no-doc mortgages they were signing.  They, too, are soon going to get plenty of help from our friends in Washington.

You see, everyone says we need housing to rebound in order for the economy to recover, so by god, we are going to make the housing market rebound, even if it means the government has to buy up all those nasty little mortgages and restructure them, as Senator John McCain has so magnanimously offered to do (and to hell with the free market and the natural laws of supply and demand).

But really, who could possibly blame the American people for wanting to be spared the pain of an economic downturn?? They’re just following the lead of our most esteemed industry and financial leaders and watching with green eyes as the government tosses around hundreds and hundreds of billions of dollars like so much loose change.

How fitting that the first ones at the government trough were the Wall Street pigs who cooked up this unhealthy smorgasbord slop and fed it to the ravenous, greedy (but mostly unsuspecting) crowd of American consumers.

Oh, it may seem unseemly that the ones largely responsible for creating this mess would be the first to come begging for help, but The Powers That Be knew the financial system that Wall Street had so cleverly manufactured was so fragile that many of these banks couldn’t fail. They knew that the pyramid scheme would have to be unraveled slowly or the entire economy would shut down.

So in order to prevent exposing the rot in the system to the public, regulators forced Bear Stearns into the hands of the relatively well-capitalized JP Morgan Chase, guaranteed the losses with a $29 billion loan and then lowered interest rates in an emergency session.

But that was just the start. You know the rest of the story. The scope of the problems became obvious, and it was clear the cancer had metastasized to every corner of our financial system. Housing in particular was a disaster, so we nationalized Fannie Mae and Freddie Mac (which should never have been privatized in the first place, as one of the only things scarier than capitalism gone mad, is capitalism with implicit government backing gone mad ).

AIG, too, needed help since it had gotten caught insuring a lot of these failing institutions, so we rescued that firm with $85 billion (and then watched as some of that promised money was immediately spent on a lovely sales retreat, replete with a $23,000 spa bill).

And yet all that government assistance still wasn’t enough, so the Treasury and the Fed went to Congress and pleaded for another $700 billion, and only after getting that pork-laden package passed have they begun figuring out exactly how they are going to use that money to save our banking system and economy.

It is all just so very frightening, but the last straw for me was reading an article about some of those poor, poor folks in the hedge fund industry who are now hoping they’ll also see some of that bailout money. Treasury Secretary Paulson insists the money is just for banks and thrifts, but that ‘plans could change’.

You’ve got to be kidding me!!

I mean, for crying out loud, it was only a decade ago when the government and a bunch of banks bailed out a hedge fund company named (ironically enough) Long-Term Capital Management.

Long-Term Capital, with its use of insane leverage (at least 25x) in highly illiquid, poorly regulated financial instruments, including some of the very same derivatives and mortgage-backed securities that are now causing us grief, was in many ways Version 1. 0 of the current Wall Street mess. And yet we ultimately learned very few lessons from that clear early warning sign (This Working Group document has some great background on the LTCM debacle as well as a number of generally ignored conclusions and recommendations).

Frankly, we missed a golden opportunity to increase supervision and disclosure requirements to help rein in some of the industry’s excesses.

Even worse, the LTCM bailout (and the subsequent lowering of interest rates by then-Fed Chairman Easy Al Greenspan) helped fan the flames and foster the environment that we now find ourselves in by encouraging more ill-advised risk taking while institutionalizing the idea that the government will always be there to cover up for our mistakes.

But there is a price to be paid for that largess. Eventually, we’re going to have to pay for this misguided philosophy. I’m just worried that it’s too late, that we’ve dug ourselves into a hole so deep it will take a generation or more to climb out of.

So it’s time to stop the capital injections and bailout plans, the incessant pumping of liquidity into the markets and the careless printing of money, the debt issuance and the interest rate cuts. We’ve done enough to unfreeze the markets and prevent a systemic collapse. It’s time to let the brutally effective corrective mechanisms of capitalism take care of the rest.

As Obama said during the most stirring moment in his Denver keynote convention speech:

‘Enough!’

You’re kidding, right?? ….

So yesterday I wrote about how the Senate was making the bailout plan bigger but not better in order to get reluctant legislators aboard.

Oh man, you have no idea. It makes me want to cry.

According to the WSJ, A bill that was originally 3 pages is now more than 400 pages. Among the useless ‘sweeteners’ tacked onto the plan:

  • Economic development credit to American Samoan businesses
  • 50% tax credit for some expenditures on maintaining railroad tracks
  • 7-year recovery period for motorsports racetrack property
  • Special expensing rules for film and TV productions
  • Income averaging for Exxon Valdez litigants for tax purposes
  • $10,000 tax credit for training of mine rescue team members
  • Deduction for income from domestic production in Puerto Rico
  • Increasing cover of rum excise tax revenues to Puerto Rico and the Virgin Islands

AND MY FAVORITE …

  • Exempting children’s wooden arrows from excise tax

YOU’VE GOT TO BE KIDDING ME!!!!

McCain says all the time that if he becomes President, we will know the names of the politicans who try to push their own pet earmarks. It’s one of the things he says that resonates with me.

I know people say this is the way Washington works. It’s how laws get passed. Give and take. You scratch my back, I’ll scratch yours. Gotta please the constituents … That’s bullshit.

It takes a lot for me to get outraged at something our government does. I’m as cynical as they come. But how dare these politicians use this moment, this time, with the economy on the edge of collapse and the financial fate of millions of Americans on the line, to muddy up an already outrageously expensive plan with such useless additions.

Let’s get something straight: These changes do not make the plan better. And they weren’t needed to get this deal passed. Politicians who voted against the bill were already worried that their ‘No’ vote pushed a teetering economy over the edge, and many of them were looking for a second chance to make amends. A couple of small, but relevant, changes to the plan would have provided all the cover they needed.

All this additional pork is a travesty of the legislative process. And if the candidates really mean it when they spout the word Change like it’s some kind of magical Buddhist mantra, it’s the kind of crap they’ll try to put a stop to when they get elected.

Is this a better bailout … or just a bigger, badder one?

So now the Senate is going to try its hand at passing a bailout plan. I’d make a prediction that the bill will almost certainly be passed by both chambers of Congress, but I apparently am a lot better at sports and market predictions than political ones.

The Senate bill seems extremely similar to the one rejected by the House earlier this week, save for a few sweeteners thrown in to try and mollify the politicians who thought the the original plan either did too much to blow up the deficit and prevent the market from self-cleansing (Republicans) or not enough to help lower- or middle-class Americans (Democrats).

Unfortunately, most of these ‘sweeteners’ really aren’t so sweet. Instead of exemplifying the wonderful compromises that can be created when a messy political system works its gridlocked magic, many of these proposed changes are just more sour examples of a broken Washington that encourages myopic legislation.

For instance, let’s take a look at perhaps the most controversial addition to the bill: Modification of the current mark-to-market accounting policies now in place that force banks to price their assets at current market levels.

This is a complicated issue, but mark-to-market basically forced banks to take huge writedowns on the mortgage-backed securities that are at the core of the current crisis and still mostly rotting away on balance sheets throughout the system.

Critics say the mark-to-market rule has a couple of main problems: 1) Banks which are forced to take writedowns must raise more capital and curb lending to satisfy reserve requirements or face insolvency, which only helps contribute to the spiraling meltdown 2) Mark-to-market leads to inaccurate or unnecessarily overstated writedowns, since in many cases the market for these mortgage securities is non-existent or in a state of unusual distress.

These critics say that if mark-to-market stands while the bailout plan is implemented, banks will be less likely to sell their bad assets to the government at low prices because that will mean they will have to book huge losses on the rest of their balance sheets. These critics instead want these assets to be valued by bank regulators … the same regulators who had little to no idea of the problems being created by the housing bubble.

In my opinion, getting rid of mark-to-market would be a big mistake. Marking to market ensures that banks take their lumps and move expeditiously to shore up their balance sheets. Japan’s decade-long retrenchment has lasted as long as it has partly because banks refused to face up to current realities. A report from a Credit Suisse analyst put it best: “Which information is more relevant, what you paid for an asset in the past or what it’s worth right now?”

This may be one of the worst changes, but almost all of the other ‘sweeteners’ in the Senate version of the bill will raise the total cost of the plan while producing, at best, unclear benefits. I fear that the cost of this bailout package will soar past initial estimates, and younger generations will be paying for this mess for decades to come.

Among the other changes being discussed in the Senate bill:

  • Temporarily raising FDIC insurance to $250,000 per account. This is a mostly cosmetic move designed to bolster people’s confidence in banks and keep them from moving funds out of the system, esp. with regards to smaller institutions. Alas, if a lot of banks go under, the FDIC won’t be able to afford the increased coverage and will have to borrow more from the Treasury. Ugh.
  • Relief from the alternative minimum tax, or the AMT. Call me biased, but this is a good idea. The AMT has gone far beyond what it was originally intended to do, which was to make sure that very rich folks do not use deductions to avoid paying their fair share of taxes. Because it hasn’t been indexed to inflation, the AMT now affects millions of middle-class Americans, including yours truly. But whether AMT reform makes sense or not, relief won’t come without a price (and stop me if you’ve heard this one before): An even bigger deficit.
  • The creation or extension of a slew of tax breaks, including an R&D credit for businesses, and local and state tax deductions for individuals. Some of these deductions do encourage desirable behavior, such as the purchase of solar panels, but I’m sure some of them will end up being as stupid as our ethanol subsidies, and all of them will come with a cost.
  • A mental healthy parity law, which requires certain health insurance companies to provide the same coverage for mental illness and addiction as they do for physical illness. OK, this may be a fine and worthwhile legislative initiative, but it has absolutely no place being added to a bailout plan.

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.

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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