Wednesday Outlook: Commodities, Emerging Markets

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Here’s that India story.





I woke up yesterday morning earlier than usual because something was troubling me. It’s this so-called bailout. I don’t understand it.

The devil is in the details and we just don’t know them. It’s troubling.

Option A. The government decides to buy distressed debt securities from banks and others at their current market value. If this is the case, it seems to me these institutions have no incentive to participate.

Option B. The government pays the MTM [“marked to a model”] market value creating a bailout of epic proportions.

Which option is contemplated?

In the latter circumstance, the government would take its time in selling these securities, hopeful that time will cure and increase their value. This would lessen the taxpayer liability but create a historically significant Moral Hazard.

Now the pressure for all this comes from the reality that these pricing structures are a sham and lie to carry these securities on balance sheets at MTM levels. The pressure to change this comes from investors knowledgeable of this deceit and by the FASB [Federal Accounting Standards Board], with the latter forcing these institutions to mark these securities to market. The latter organization has, given overwhelming pressure, extended the deadline for doing this by roughly one year.

It was commonplace for many financial institutions over the years to carry many conventional mortgage products on their books at cost. There wasn’t anything unusual until derivative mortgage products, abetted by fee-conflicted and misguided rating agencies and monoline insurance firms, started to litter the books of financial institutions.

If the government takes these securities from banks at their MTM value, a huge taxpayer liability is created not to mention another government agency run by inept bureaucrats.

But, what would happen if these institutions were allowed to keep these securities on their books at some form of “modified” MTM values? The understanding would be that they’d be worked off over time with no similar new issues created and issued. In this case a large taxpayer bailout would not take place and no new government agency is created.

These institutions would be hamstrung going forward in operating their businesses but others would step-in to fill the void. That’s what happens in capitalism.

More importantly only a limited Moral Hazard is created.

What am I missing here? Post your comments or email me: [e-mail].

Perhaps one answer is the problem is much larger than us commoners know. It’s said there exists $65 trillion [with a “T”] of CDS issues floating about without any knowledge as to their worth. After all it would take a lot for certain politicians to be speechless [think Chuck Schumer].

It must be that they know something we don’t.

Have a pleasant day.

Disclaimer: Among other issues the ETF Digest maintains long or short positions in: SDS, QID, SMN, SDP, SIJ, IEF, DGP, GLD, EFA, EFU, EEM, EEV and FXI.

Comments

[Scared Stiff:]

This whole thing has Bush Administration con job written all over it-- the sense of panic, the secrecy, the political pressure... all with most sensible people wondering, "what am I missing?" What are the chances this is nothing more than W waving his middle finger at the public, picking up a few extra trillion dollars for his cronies on the way out the door?

2008 Sep 24 07:21 AM

[unfaire:]

The problem I have with the current bailout plan is as follows.
The financial institutions have knowingly (or, at least, they closed their eyes while they are doing so) lent money to people who could not afford the mortgage (who may have knowingly taken advantage of the situation or may have been lured into) to buy houses. Now, these people are bankrupt because they cannot pay their mortgages. And, these institutions are also bankrupt because of the non-performing debt. Now, here comes this bailout plan that takes the taxes paid by people, including those who owe money to these institutions, and give them to these institutions. With the new personal bankruptcy laws, these people would still have to pay up their mortgages to enrich these institutions or the bureaucracies (they never refund the tax money to the people; they only take a little less).
This simply doesn’t make sense.
There are two liquidity crises: One is the financial instruments that had bundled these mortgages in them had become much less valuable than their intrinsic worth and that causes these institutions to cease operation. Another is the people who are or about to be bankrupt whose rank are increasing because of the liquidity crisis of the former. They feed onto each other and thus our current financial death spiral.
The current bailout plan may temporarily halt the former but not the latter. Eventually, the latter will come around the make the situation even worse.
The reality is that the economy of the country as a whole would not be stabilized until the financial situation of most of these people have recovered to a level somewhat equivalent to that before they are falsely lured into buying something they could not afford. This takes a long time.
The other reality is that $700 billion is a lot of capital to get the economy going and why should we waste them on some worthless financial papers. The sensible thing to do may be is to do nothing and let all those institutions holding these worthless financial papers to fend for themselves, even bankruptcies. Let the bankruptcy courts and the new owners of these “toxic” instruments to work out what to do with them. In the meantime, inject this $700 billion into the economy to get it going again. Just think $700 billion can pay one year’s salary to 14 million people at $50,000 each. “Helicopter” Ben should be spraying this money on the healthy companies not to the deadbeats.

2008 Sep 24 07:42 AM

[cshrclrd:]

If it was a birdnest on the ground, then Warren Buffett would not be buying Goldman Sachs, would he.

2008 Sep 24 07:51 AM

[cshrclrd:]

Sorry, If it was NOT a birdnest on the ground (low hanging fruit).


On Sep 24 07:51 AM cshrclrd wrote:

> If it was a birdnest on the ground, then Warren Buffett would not
> be buying Goldman Sachs, would he.

2008 Sep 24 07:52 AM

[Shiv Kapoor:]

Dave - this is Brilliant; my all time favorite post on any blog. The pictures tell an interesting tale. Loved the walk through Sam Stovall's economic cycle. What is going on in the financial services sector is history in the making. If United States is unable to quickly start the healing process, there is no secular force in the world which can withstand this crisis. I can sing on about the China secular story, or the Indian one, or even Russia and Brazil for that matter; but to survive and prosper, the United States financial crisis must first start the healing process.

Can you do a piece about which sectors out-performed after the LTCM collapse, the Asia Contagion & the oil shock? I believe there are interesting parallels to learn from in all these historic events. Of course this situation is absolutely unique and its outcome will depend on governmental action and how the public reacts; but the prior events do provide an interesting indication of how people might respond. Could be a flight to staples, health-care and utilities. I still think there are compelling catalysts for global growth (Materials, Industrials & Energy), but this overhang is huge, because to grow one must first have access to capital - which seems to have evaporated from the system.

2008 Sep 24 08:32 AM

[z06kenny:]

Scared Stiff? I am thinking you are "Scared Silly".

2008 Sep 24 09:26 AM

[Internet2k4:]

Personally I think trying to bail out at the level of these funny instruments is a big mistake. The real problem is the real estate market from which any valuation of the exotic asset packages has to be derived by the Suspender Boys who invented them. The only way to fix this is to inject liquidity into the underlying RE market and let the chips fall from derivative investments on that basis. I think the evil ways of the GSE management has clouded the fact that they're probably the most effective tool for moving government money into the problem assets and helping your friend Chucky save the house. I'd rather Up-Chuck than go blind.

2008 Sep 24 09:41 AM

[sieraromero:]

Why and What is the financial crises that is going to put us over the brink, if the government doesn't bail out the current corrupt and greed filled system? If we need all of these bailout measures such as no shorting and the hundreds of billions of borrowed taxpayer money and the hundreds of billions more they say they need immediatly or the system will collapse. WHY is the market indeces trading near their highs? Why won't Bernicke and Paulson answer the questions in the hearings in a straghtforward and meaningfull way, so that the average taxpayer and congressmen can understand! The problem is that nobody knows how bad this can get and that only the problem must appear to be solved in the short run and forget about what this is going to entail in the long run and that there isn't time to consider or understand the consequences of doing due dilligence on this matter!

2008 Sep 24 11:14 AM

[Scared Stiff:]

Kenny, of course it's far fetched. But I think it's hard to deny the parallels between the way the administration is handling this, and, say, the attack on Iraq. At the very least the $700 billion price tag is just the very beginning.

I do think, however, that putting a ton of new power and cash in the hands of the people who, literally within hours of publicly saying "Everything is just fine!" were saying "The end is nigh!" would be an unforgivably stupid mistake. Clearly, anything Paulson says from here on must be taken with a grain of salt.

2008 Sep 24 11:16 AM

[metoobail:]

If the slumping house market forms the basis of the current problem - $700 billion could be used to buy the current house inventory of about 4 million houses at about $200,000 per for a total of $700 to$800 billion - then burn the houses. banks are now solvent and can loan, people will need houses. Will that solve the problem??????

2008 Sep 24 11:38 AM

[dc1:]

Loved the pun on "MOO" :-)))))

2008 Sep 24 12:31 PM

[Internet2k4:]

Metooball, No less a man than Bill Gross brought up just that solution - maybe half seriously.

www.pimco.com/LeftNav/...

2008 Sep 24 12:45 PM

[Winston Smi...:]

Bill Gross: "One of the wisest men I know has this serious but admittedly impractical solution: have the government buy one million new/unoccupied homes, blow them up, and then start all over again. Absent that, he’s not quite sure what to do, nor am I, with the exception of the next paragraph’s proposal..."
Wiseman indeed and I like it. Why not limit supply in housing and give the unemployed a construction job?

2008 Sep 24 01:13 PM

[NOWHEREMAN:]

Sheer unbiased "blank". The Pigs have escaped their sty, but instead of trying to round them up but instead of trying to get them back in, all I see is jibber jabber about whether it was the farmers fault or maybe even the carpenter's, ooops I know "the Butler did it".

Deniability is what is going on on Capitol Hill.

After I voted for it, I voted against it. Gore invented the internet.

2008 Sep 24 02:51 PM

[David Fry:]

Most folks are pretty steamed up about this and I've gotten a lot of emails. Surely, given what we do, we're not alone and there's much more to come.

Thanks everyone for sharing your thoughts.

2008 Sep 24 02:58 PM