How Treasury Created the Crisis: An Interview with Jeff Saut

Mike Norman, anchor, HardAssetsInvestor.com (Norman): Hey everybody, and welcome to HardAssetsInvestor.com. I'm Mike Norman, your host. Well, what's in store for the economy and the stock market and all the markets? Here to discuss that is Jeff Saut, chief investment strategist at Raymond James. Jeff, thanks a lot for coming on the show; I appreciate it.

Jeffrey Saut, chief investment strategist, Raymond James (Saut): You bet.

Norman: Well, by all measures, we have gone through an extraordinary period. There have been comparisons with the 1930s, [and] in many ways it has even surpassed that. Certainly a scary time, just about in any asset class with the exception of the safest – U.S. Treasuries – and recently even the U.S. dollar.

Just give me your overview: Right now, a lot of people say that there's more to come. We've seen the bursting of maybe one or two, perhaps three bubbles, but there are other things out there that are going to trip up any nascent recovery if we're even going to get one.

Saut: Well, I came into the year thinking that we weren't going to have a recession in 2008, and I thought the weak dollar was going to create a boom in the tradable goods sector, which is larger than the housing sector, and I had to shift views a couple months ago because of what I considered to be some wrong-footed reactive – rather than thoughtfully conceived proactive –plans that came out of Hank Paulson and some of the powers that be.

Norman: Are you talking about specifically the $700 billion bailout? What specifically now are you talking about?

Saut: Well, I think it started with Fannie Mae and Freddie Mac – not that they didn't need to be bailed out – but it was the structure of the plan. Historically when the government has stepped in to bail out a company in this country, they have left an equity stub so that the shareholders could share in the survivability and the long-term recovery. In this case, after telling both domestic and international investors for months that Fannie and Freddie equity was good money, he totally wiped them out.

Norman: I totally agree with you, and I also questioned it at the time, because don't we want to encourage risk? When Treasury did that – and it did that unilaterally – it just said, we're going to step in now, we think you need help, and by the way, anyone who's an equity investor, you're wiped out. And as soon as they sent that signal, instantaneously it went out to every other investor out there who maybe held bank shares, that the Treasury could come along at any moment, decide you need money, and wipe you out. I thought that was a terrible plan.

Saut: It was a terrible plan, and my phone lit up with calls from international investors that we deal with saying, how could any rational investor put any capital at risk knowing that if it went the wrong way they could be wiped out by the government?

Norman: And besides, we're talking about bank stocks here, which are the quintessential widow and orphan stocks, usually the most conservative sort of stocks you'd have in your portfolio. To punish people that have taken a risk in something that "was not really risky," it sent a bad signal. But haven't they revised that? Now, I think, in some of the new investment they're putting in there, is [there] the possibility for investors to earn a return?

Saut: Yes, but that was after letting a primary Treasury deal go bankrupt with the spin that it was too expensive, and then in the same week that they let Lehman go under, they bailed out AIG to the tune of $85 billion. And again, the international community said [to me], how in the world can the powers that be let a primary Treasury dealer go under?

Norman: It doesn't make any sense. You would have to think that Paulson knew the ramifications. So let me ask you this question: Was he under such political pressure – because there was an outcry about the other bailouts, about the Bear Stearns, about the AIG – do you think he succumbed to that pressure and said, I'm just going to let this one go because if I don't, it's just going to be too much to handle?

Saut: No; I think he made a reactive, rather than a proactive, decision and I think it was wrong-footed. That's when you started getting the knock-on effect with the money market funds freezing and redeeming at less than 100 cents on the dollar, and that's when the politicians came to fore. I wrong-footedly thought that they would rise to the level of statespeople, and obviously that was wrong. We've been in a mess ever since.

Norman: I totally agree with you on this, and what I find fascinating is that there wasn't a lot of coverage. There were some articles written after the fact that came out. I think one was in the Financial Times, one was in the New York Times, talking about letting Lehman go down. But it seemed like up until that point, yes, it was a crisis, it was a bad situation, but it was being managed. And as soon as they let that happen, that precipitated the very systemic crisis that they were trying to avoid, right?

Saut: I think that's right, and the Europeans got so disgusted you saw something happen that hasn't happened since the Brentwood agreement in 1944. The U.S. has always been the focal point of the bailouts, of Mexico, of Russia, of the Thai baht. And the Europeans got so disgusted with the lack of leadership and the wrong-footed decisions that they took the reins in their hand and bailed out their financial complex, but they did it the right way – with equity.

Norman: Earlier, we talked about this policy blunder, and I totally agree with you [about] letting Lehman fail – a primary dealer regulated by the Fed – under the office of the controller of the currency. I find it outrageous that [Ben] Bernanke [Federal Reserve chairman] was in New York recently. He gave a speech at the [Economic Club of New York]. He was asked the question, "Why didn't you give Lehman a loan"?

He said it didn't have enough collateral for a loan, yet the Fed is lending to the Korea Development Bank; it's lending to practically every central bank on an uncollateralized basis.

The question now is, do you think they realize that was a big mistake and now have things changed in the sense that policies … in the beginning it was kind of like here or there – whatever works; we'll do it here, we won't do it here. But do they have in place the right plan now?

Saut: I think they're moving that way, I'm not sure that they're there yet, but I do think they're moving that way. The idea of granting swap lines to Singapore even though Singapore doesn't need it … the thought is the money is going to trickle into Indonesia and some of the other places that do need it: to South Korea as you point out, to Brazil and to Mexico. You had a growth freeze if you will, a dollar shortage if you will, and I think the fact that the Fed is being proactive and expanding its swap lines … I think it's actually a good thing, you can see that.

Norman: Let me ask you about those swap lines though, because if the Fed didn't do that, we would have seen perhaps a super spike in the dollar. Clearly against some of these emerging currencies, some of them might have disappeared altogether. Isn't it in the interest not only of the Fed but of America, and also of our trading partners … because let's understand, most central banks around the world hold assets in dollars, they have liabilities in their local currency, but if we use policy that makes the dollar go up, isn't it a plus-plus-plus?

I know you don't like it from the export side, but look, it restores American purchasing power, it gives those countries that rely heavily on exports a competitive advantage which perhaps they need right now – we see it with the decoupling how they're getting hit. It also mitigates inflationary pressure, it raises the asset value on the books. Wouldn't it have been better for everyone if they let the dollar go to where it should have gone?

Saut: History will tell the tale there. I think the dollar had gotten ahead of itself; I think it was creating problems internationally. Yes, it mitigates some of the inflationary pressures, but I don't think we're fighting inflationary pressures right here. I think we're getting a whiff of deflation over the next nine to 18 months, so I think that actually gives the Fed the ability to expand its balance sheet even more, with more proactive…

Norman: It's already doubled it, more than doubled it; extraordinary. Let's just look at the stock market, which clearly has been in a rough period. It tends to look ahead. I don't think anyone is going to disagree that the actual data, the economic numbers we're going to see through probably a while, is going to be lousy. But the stock market looks ahead, it tends to bottom in the middle of these periods. Do you think we're maybe putting in a base? Do you think we might be in the clear?

Saut: I wish I could say that I thought we were. I do think on a short-to-intermediate-term basis you put in a capitulation/panic low on Oct. 10. I think you put in the psychological low on Oct. 24, which didn't come in anywhere near to breaching the Oct. 10 low. I [thought we'd probably be] OK going into Thanksgiving, [even] the first part of December, and then I think the markets are going to try and ponder how severe the recession's going to be.

Norman: How [did] the election play into this in terms of policy? Let's just talk about policy. Do you think we're going to get another stimulus?

Saut: [Since] Barack Obama [was] elected president, I think you can almost bet on that. Historically, stimulation packages have not been all that effective.

Norman: So you think that we're going to have to transition this without any additional help … there's been a lot of government action both via the Fed and the federal government right now.

Saut: Yeah, there's been Herculean action to prevent the natural cessation of the business cycle, and that's why we're in the fix that we're in right now.

Norman: All right. Jeff, it was great having you.

Comments

[Phat:]

Thanks for the interview. good stuff.

2008 Dec 19 05:49 PM

[Long Silver...:]

If you read Rothbard's "The American Great Depression" you will see some very familiar fact-patterns: Federal Reserve inflation of the money supply in response to the 1920-21 recession, followed by 6-7 years of boom, followed by the big bust. Then, massive government intervention under Hoover to intervene in the markets (picking winners and losers), which tended to aggravate things further as the law of unintended consequences took over...

2008 Dec 19 07:57 PM

[john s. gordon:]

unless you're a friend of hank you don't get no bailout.
> jack

2008 Dec 20 08:15 AM

[Freedoms Truth:]

Long John Silver: Let me add the recent study by UCLA economists who conlcuded that FDR's New Deal added to the great depression.
The greatest market risk we face is more govt meddling creating unintendend consequences.

2008 Dec 20 12:59 PM

[auto44:]

Statespeople??????????... The dopes we elected and that chair commities that oversee financial institutions. Surely you jest.

2008 Dec 20 02:48 PM

[auto44:]

Great english!!!!!!!!!!!!!!!...


On Dec 20 08:15 AM john s. gordon wrote:

> unless you're a friend of hank you don't get no bailout.

2008 Dec 20 02:54 PM

[auto44:]

Like tying on a good drunk, it feels good at first but the hangover takes time to get over.


On Dec 20 12:59 PM Freedoms Truth wrote:

> Long John Silver: Let me add the recent study by UCLA economists
> who conlcuded that FDR's New Deal added to the great depression.
>
> The greatest market risk we face is more govt meddling creating unintendend
> consequences.

2008 Dec 20 02:57 PM

[kingaj12:]

OK, nice discussion about the screwup with FNMA and FMAC and Lehman - pretty lobvious by now, frankly.

But what is the problem with stimulus plans? That point seemed to go by pretty quickly.

Facts are facts: we are short 1.5T annual investment from the collapse of the mortgage backed security market. In 2007 MBS financing was around 2.5T, in 2008 it is 800B. This is 10% of US GDP -- a big number.

The stimulus packages announced by US and China add up to (coincidentally?) about 1.5T.

Does Jeff Saut have a thought about how we get through a 10% decline in net investment year on year until the asset securitization market recovers?

2008 Dec 20 05:26 PM

[pedroperez:]

Bernanke and Paulson were not prepared to handle their jobs.

In term of damage, they have been the biggest global wealth destroyers.

While de economy was already in recession, Bernanke was fighting inflation.

This two persons really ruined our country and almost the rest of the world.

2008 Dec 20 08:35 PM

[James Brumley:]

Amazingly, neither the Fed nor the Treasury has figured out that both agencies need to be pro-active rather than re-active. If you're waiting for undeniable proof of a problem, then it's too late to prevent it. How have they not figured this out yet?

2008 Dec 21 12:33 AM