Will Obama's Change Provide the Economic Remedies We Need?

Obama: Change to Come?

Friday, the last trading day with the Bush Administration in command, was marked by new lows in the terribly ill banking sector. The Troubled Assets Relief Program [TARP] became law on October 3, 2008. Since then, the Philadelphia Bank Index [$BKX] has declined by an astonishing 55%.

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In fact, the financial sector as a whole is now trading near its 1995 levels when the problems from the 1980s banking crisis were still being digested.

The primary reasons for this fiasco are: continuous rule changes and lack of any policy follow-through, absence of any transparency of how the funds are being spent and finally an understanding by investors that even $700 billion will be insufficient to patch the gigantic and growing hole in the banks’ balance sheets.

With the 2009 S&P 500 earnings per share expected to decline to $40, even an 800 level in the index produces a P/E of 20, a fair value at best. Of course, the key is how fast the earnings will recover in 2010 or 2011. Right now the market is clearly saying that it does not like the Paulson approach to stopping the bursting of the financial bubble and that the earnings recovery is still far away.

We agree with those experts’ predictions which state that the financial system needs about $1.5 trillion more to patch up this deflating bubble. But every week, it seems that there are new problems. For 2008, bank losses related to credit cards were $28 billion. In 2009, as more people lose their jobs and run out of savings, the number is expected to grow to $100 billion.

A bigger problem yet is the coming mortgage rate reset for hundreds of thousands of homeowners. While the Subprime tidal wave is largely over, the majority Alt-A and the Option Adjustables resets are still to come in 2009 through 2011. And the effect on the economy can be just as large if not larger and more painful than the subprime crisis.

With enormous job losses experienced over the past few months, homeowners are now in a much worse shape to be able to absorb an increase in mortgage interest rates. Many of these same homeowners cannot take advantage of today’s low mortgage rates since the value of their homes is now less than their mortgage. Seemingly, it is a trap with no way out. If the government does not intervene directly, the only answer for many is foreclosure.

With so much change promised, what does President Obama have in store for us?

The $825B spending package unveiled by the House last week was a disappointment to us. It offers little in tax cuts, but a lot in social giveaways to states. The much promised infrastructure spending on highways, transit and energy is just $148 billion.

Instead, most of the spending is for immediate social needs such as unemployment benefits, insurance and health care. While this money will be spent quickly, we doubt there is much of a sustainable stimulative effect to the US economy (perhaps it will help the Chinese economy?!).

We doubt that the plan will create 3-4 million jobs, 90% of which are supposed to come from the private sector. If such a promise is to be fulfilled, much more money will be needed for direct infrastructure, technology, transportation, industry investments or in form of tax cuts or investment credits for businesses.

In addition to this proposed emergency spending, the second $350 billion installment of the TARP has been released to the new president. As Bernanke first suggested a few months ago, the money is most likely to be spent in setting up a $1 Trillion Bad Asset Bank (AGGREGATED). This appears to be a measure of desperation since the financial sector recapitalization efforts to date have failed to work.

Similar to the Resolution Trust Corporation [RTC], this government bank would swap good assets (such as cash and treasuries) for toxic assets that appear on the banks’ balance sheets. Banks get cash; taxpayers get toxic assets with questionable value.

So far, that is the recap of the change that is coming with the new Administration.

By improving the balance sheets in the financial sector, they hope that confidence in the financial system will recover and that bank recapitalization will succeed. Is this going to work? We believe eventually it will, although it will take a lot more than $350 billion and much more time than most people hope for.

The reaction of the broad market to the Obama Administration “innovations” remains muted. Yet gold and other precious metals stocks began to demonstrate remarkable outperformance compared to the rest of equities at a moment when it became clear that Obama won.

This is convincing evidence that inflationary policies of the new Administration are, as expected, bullish for gold.

Comments

[AllStreets:]

Good article. I too am very disappointed in the focus of the stimulus plan and the new TARP spending. I hadn't heard anything about a "Bad Asset Bank," but, surely, that's the most objectionable idea I've heard since the housing/credit crisis started. Your comment "Banks get cash; taxpayers get toxic assets with questionable value" is right on. You should have added "property owners get nothing." The whole approach of saving lenders only is wrong, unfair and ineffective because it leaves the homeowners out and it does nothing to help the values of the underlying bad assets, the devalued properties. Who will the recapitalized banks lend to? Not the demolished property owners. The same can be said for the commercial property owners who are sinking fast and won't be able to refinance their balloons.

While it might not restore home values quickly, a fairly constructed extraordinary program of direct lending from the federal government to borrowers and lenders to relieve excess mortgage debt from properties, and some credit card debt, and for downpayment funds, could stop the slide and restore lender and consumer balance sheets and income statements sufficiently to allow more normal lending to resume and an economic recovery to begin. Such a program is The AllStreets Bailout Plan described at www.themortgagenews.in....”

Jan 19 11:17 AM

[CautiousInv...:]

Count me in among the citizens disappointed with the structure and composition of the proposed stimulus plan.

The level of tax relief may or may not be appropriate; there is honest disagreement as to how much it should comprise. There is agreement however that its effect is quick and fairly effective.

If we include schools and along with infrastructure spending on roads, bridges, water and energy, it comes to about $200 billion. In campaign rhetoric, this was to be the backbone of the spending portion of the package. And it should be as these monies have different effects on employment and spending multipliers.........be... than the other type of spending that dominates the proposal. Once again, promises and politics.

TARP 1 was required but as we all know it was poorly executed with no goals, no standards and no reporting. It was poorly handled and the next tranche will be as well as it will be spread over too many fronts: banks, the bad asset bank and relief for foreclosures. As it stands, TARP funding of $700 billion is inadequate and not focusing it only dilutes the effort.

Lastly and with respect to the bad asset or aggregator bank, it should not just take toxic junk and save existing shareholders. Everything should be marked to market, and if the bank is insolvent the bank should be taken over by the reincarnated RTC and existing shareholders should walk away with zilch. The new RTC would then facilitate mergers and an orderly sale of assets.

If the public is going to fund this agggregator, then exisiting shareholders should take a haircut along with holders of preferred shares and bonds, if required. This will further increase write-offs, but it will be cheaper than rescuing members of the existing capital structure. To a degree, this was what was done in Sweden.

Jan 19 12:35 PM

[Firat Ünlü:]

"Instead, most of the spending is for immediate social needs such as unemployment benefits, insurance and health care. While this money will be spent quickly, we doubt there is much of a sustainable stimulative effect to the US economy (perhaps it will help the Chinese economy?!)."

Edu, Health and Welfare at around $300b could be long-term should the economy not recover if you look at what they are really spent for.

Jan 19 01:49 PM

[Yohei:]

The $825 Billion House spending package is pork, pure pork, pure and simple. It is not intended for the nation's good but to buy political support.

Disgusting.

Jan 19 10:10 PM

[bobbobwhite:]

The gov't and recipients well-used "disconnect time" between bailouts given and results expected is protecting the gov't/Wall Street banks for now, but when more and more time goes by and nothing really improves, it will be seen by all for its full and total boondoggle value.

We are sadly in the harsh middle of a "never trust the gov't" period that may go on for quite a while, as it is as fully deserved as it is pathetic.

Jan 20 01:04 PM