Let the Automakers Die and Revive TARP's Original Mandate

By Eric Roseman

Since September 1, the S&P 500 Index has now crashed a cumulative 39% - the worst decline since 1931 for common stocks in the United States. The MSCI World Index over the same span has been pummeled more than 45% - its worst year since 1974. The latter benchmark was created by Morgan Stanley back in 1969. There isn't one index in the world that has posted a gain in a miserable 2008.

Tale O' the Tape: Unprecedented Losses

Declines of this magnitude in a short period of time have probably destroyed the most wealth worldwide since the Great Depression.

Spectacular Loss of Wealth: The End for a Generation of Investors

This bear market is already in the record books with stocks defying the norm of a 30% bear market decline. And combined with the ongoing breakdown of credit markets, it's far worse than anything anyone alive has ever witnessed.

In all likelihood, the current generation of investors will not return to the stock market for a long time, if ever.

Over $6 trillion dollars of stock and bond market wealth has literally evaporated globally this year. Throw in the huge losses in real estate, mortgage-backed derivatives, credit default swaps and leveraged loans, and the figure is probably well north of $10 trillion dollars thus far.

Auto Industry, TARP Uncertainty

With the auto industry now the "bailout flavor of the month" in November, investors are fretting over the possible demise of one or possibly all three U.S. automobile manufacturers. The Big Three have seen their respective stock prices virtually annihilated in the last few months, with GM trading at the same nominal price as during the Great Depression.

Conservatives in Washington are balking at an auto industry bailout and investors are worried that any delay in helping Detroit will result in the collapse of the industry, hundreds of thousands of jobs and the long chain of suppliers tied to the ailing auto sector.

Chrysler, General Motors (GM) and Ford don't deserve a bailout; all three companies have bled billions of dollars in cumulative losses over the last 25 years and a rescue will only postpone the inevitable - bankruptcy.

Combined with Treasury Secretary Hank Paulson's reversal on TARP (Troubled Asset Relief Program) last week, the stage for another market crash has arrived again this month as stocks threaten to violate the October 2002 lows. The Dow Jones Industrials Average bottomed in October 2002 at 7,286 or just 267 points below Thursday's close.

Paulson doesn't want to create a special SIV or Structured Investment Vehicle to pool toxic mortgage-backed securities after all. Now the Treasury wants to keep its powder dry with the remaining $400 billion dollars of the initial $700 billion in TARP funds to bailout any other systemic threats to the American economy.

Instead of dealing with the problem - which is largely a spectacular lack of counter-party confidence among banks - Paulson is actually extending the bear market.

Banks Need to Dispose Toxic Assets

Paulson, in my opinion, is making a big mistake. The government should create a special fund or company dedicated strictly to buying troubled or illiquid bank assets.

In the absence of such a plan - originally cheered by investors last month - the markets have no grasp as to which banks hold toxic assets, ultimately delaying the cleansing process for badly damaged bank balance-sheets. Confidence won't return to counter-parties until banks and lending parties fully understand what other institutions continue to hold on their balance sheets.

The Battle Against Deflation

The only dose of positive economic news lately is that Hewlett-Packard reported solid third quarter earnings - largely the result of aggressive cost-cutting. Yet this news didn't help the market, either. Unemployment claims hit 1982 levels for the latest period reported on November 20 and more companies are warning of weaker revenues in 2009.

Wholesale inflation and the consumer price index plunged in October as commodity prices tanked. Since peaking at $147 a barrel in July, crude oil prices have plunged 67%. Other commodities have also crashed, including the grains, base metals and the precious metals. Commodities have collapsed at exactly the same time demand for goods have fallen of a cliff.

Deflation, not inflation, is now a war the Federal Reserve and other central banks must win in order to safeguard the financial system from total collapse. At this point, investor capitulation seems to be near with massive selling engulfing the markets since November 5 and Treasury bond yields at multi-year or multi-decade lows.

One way to restore investor confidence is to finally let Detroit die a quick death. The industry is a lousy business model and propping up bad companies with good taxpayer money is a total waste. The resultant demise of Detroit's biggest industry would be painful, but supporting these money-losing enterprises is the wrong policy. We all know more money will be required in six months, a year, whatever.

Let the Big Three crash and revive TARP's original mandate by removing the uncertainty plaguing bank balance-sheets.

Comments

[Steven Hansen:]

the government's banking industry action plan is flawed. WaMu, wachovia, etc should have been closed and their depositors assets moved to other banks. then their remain toxic assets sold off for the crap it is.

with tarp and the current plan, the toxic assets and other toxic baggage is being accumulated into the big banks. in other words, it is remaining on the banks books - and the taxpayers are now on the hook.

this will not end well.

2008 Nov 25 04:33 AM

[PeteK:]

Automakers will never die.
They file chapter 11,
and REBORN again.
Looks like none of them wants to
reborn again yet.

2008 Nov 25 05:59 AM

[Mister Jimmy:]

The "Sovereign Society"?!?!? Poster children for the self-centered hypocrisy that has caused this entire mess. Listen to their mission statement "We've identified the safest and most private nations around the globe, where our members can find the best offshore banks, tax havens, legal structures, insurance vehicles, investment opportunities and tax management solutions." In other words "F**k America. We're all about gettin all the benefits, but avoiding paying for it".

2008 Nov 25 12:30 PM

[sickofthehype:]

Here's what the auto bailout is really about:

info.detnews.com/video...

SCREW 'EM ALL.

2008 Nov 25 02:14 PM

[Mister Jimmy:]

Consider that GM and its employees have themselves paid billions into the Federal treasury over the company's 100 year history. Also consider the two world wars and cold war that GM technology and products helped win over that time. An on-going restructuring, underscored by world-class products, has been underway at GM. It was thrown off-track by a financial industry that caused a world wide crisis because of ITS products, namely mortgage backed securities. So, in spite of all of this, many say GM does not deserve Federal loans? GM not only deserves these loans but, based on the above, I dare say it might be owed to the company.

2008 Nov 25 05:22 PM