Profiting from the $700 Billion Bailout

It’s difficult to tell whether the levels of irony are odd or even. America, the bastion of market capitalism, is on the verge of nationalizing its banking industry. The $700 billion price tag comes out to about $7,000 per American household.

The Bush Administration attempted to muscle the bailout package through Congress with a panicky threat, reminiscent of the build-up to the Iraq War:

Do this now or something terrible will happen!

Once bitten, twice shy - Congress is taking a few days to mull over its options. Headlines from the business pages trace the outline of the general response:

"Congress Condemns Bail-out,”“FBI Investigates Companies at Heart of Meltdown,” and “US Lawmakers Express Anger,” etc.

Online financial forums (where I go to get a gauge of market sentiment) have been equally negative:

“We will become slaves to foreigners.” “The fat cats who scammed the homebuyers should be put into labor camps.” “Lynching is becoming quite attractive.” Etc.

A Los Angeles Times poll found that 55% of Americans reject the idea of bailing out the banks, even if the collapse of the banks will seriously damage the economy.

Venezuelan President Hugo Chavez couldn’t help putting the boots in. Chavez, who called Bush “the devil’ during his 2006 General Assembly commented dryly:

I nationalize strategic companies and get criticized, but when Bush does it, it’s okay. Bush is turning socialist. How are you now, comrade Bush?

And it’s not just politicians, malcontents and socialists digging in their heels on the bailout package. Hedge fund operator, Eric D. Hovde, who also owns the investment bank Hovde Capital, has come out with guns blazing in an Op-Ed piece in the Washington Post:

Looking for someone to blame for the shambles in U.S. financial markets? In my view, there’s no need to look beyond Wall Street and the halls of power in Washington. The former has created the nightmare by chasing obscene profits [$62 billion in 2006 bonuses] and the latter have allowed it to spread by not practicing the oversight that is the federal government’s responsibility.

For the first time since Pearl Harbor, it appears that almost everybody agrees. Bailing out the banks just feels wrong. The problem – and it is a big one – is that nobody is quite sure what will happen if the U.S. government doesn’t write this check. Or rather, I think they do know what will happen, and don’t want to deal with it.

Doing nothing will probably catalyze a global recession and sink the Dow to 8,000 or lower. Tens of millions of people around the world will lose their jobs and their homes, triggering a surge of inflation that will make the U.S. dollar worthless.

It would take a foolhardy giant to look the American people in the eye and say:

This is going to hurt a lot, but eventually (it could take a decade) you will recover and be better for it.

It's much easier to put them to sleep for a few a more years with a massive injection of cash and wait for the next bubble.

Oh, speaking of “cash”. Guess what? The U.S. government doesn’t have any. So how is it going to pay for the $700 billion bailout? The same way it always does, by printing money. The only thing I can see with absolute certainty is that the “bailout” is going to cause a significant further devaluation of the U.S. dollar. That creates an opportunity, and there are a few ways of playing it.

One is to buy PowerShares DB U.S. Dollar Index Bearish (AMEX:UDN).

click to enlarge

UDN is designed to rise as the U.S. dollar falls relative to its performance against the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. As you can see from the above chart, UDN has outperformed the DJIA by 8% over the last 10 days as this banking crisis has heated up.

Of course, finding a way to short the dollar is not the only way to take advantage of this situation.

A good friend of mine has provided me with another example:

He spent C$1 million on a house in Canada in 2004. At that time, a Canadian dollar was worth $0.77. Last week, he sold the same house for C$1.55 million. A Canadian dollar is now worth $0.94. Therefore, in U.S. dollar terms, he turned $770,000 into $1.46 million in three years.

In the meantime, house prices have decreased 20% in the Los Angeles area. Where do you think he’s going shopping? Hint: the zip code of his real-estate agent is 90210.

These volatile markets are causing sleepless nights for many investors. But history teaches us that even in the midst of the worst storms, there are always opportunities. In this case, finding ways to safely diversify away from the U.S. dollar is a good strategy.

Disclosure: None

Comments

[bbzz24:]

'Doing nothing will probably catalyze a global recession and sink the Dow to 8,000 or lower. Tens of millions of people around the world will lose their jobs and their homes, triggering a surge of inflation that will make the U.S. dollar worthless.'

HAHAHA....
How is this going to happen? Aren't the problem assets only home/auto/credit card loans made in the U.S.? The worst that could happen is contraction in credit (acutually good) and contraction in manufacturing in China/Japan in their export industries. The latter can trade with themselves more: cars for toys and rice.

2008 Sep 25 05:58 AM

[logicalthought:]

You've got at least one thing backwards: doing nothing would trigger a "surge of DE-flation."

2008 Sep 25 06:23 AM

[sieraromero:]

Doing nothing will indeed be painfull in the short term. Very painfull. It will also be the best thing that could happen to the US in the long run. It would be the best thing possible for our childrens children. We wil however, accept the easy way out and do the bailout and prolong the eventual devestation that will only get worse over time. We are to soft and greedy to do what is right for the long term benifit of our country and our future generations!

2008 Sep 25 10:25 AM

[irondoor91:]

Re: logicalthought. You are correct and that was what I observed when reading through the piece. I haven't thought through all the ramifications of the bailout yet (who can know the future?), but at some point the government is going to own a lot of homes. Until the average price of those homes (now around $215,000) declines to 3x the median family income ($50,000) there is not going to be stabilization. That would be with stabilized employment, which isn't happening. In addition, we know that the free flow of mortgage money is shut down now and if banks are going to avoid this disaster in the future, they have to demand more downpayment, higher FICO scores, higher income to debt ratios, etc from borrowers. It seems to me that all those good people are probably already in homes. Why would they want another one? Do you really believe that there are millions of folks just sitting around in apartments with $40,000 in the bank, no credit card or auto debt and good secure jobs who are patiently waiting for home prices to come down? I don't know of any, but maybe somewhere in Iowa. Not in California, Nevada, and Florida where the problems are. People are leaving those states for financial survival.

2008 Sep 25 11:04 AM

[puddytat:]

Let me speak up here. If the US has 700 billion to boot around why not spend it on infrastructure, roads, bridges, hospitals , schools, universities etc. That would yield tens of thousands of jobs and have a solid foundation for generations to come. Conversely taking 700 billion and putting it into a black hole will put a debt and tax burden on the American people for generations to come. I am a Canadian and am outraged at the audacity of your president to suggest a bailout is the only way. NOT. Give the money back to the people... don't give them a giant bill they will never ever be able to repay. I just don't get your leaders today. Rob from the poor to give to the rich and tell us that is far to complicated for us to figure out and just trust us. You gotta be joking right??

2008 Sep 25 11:15 AM

[puddytat:]

Let me speak up here. If the US has 700 billion to boot around why not spend it on infrastructure, roads, bridges, hospitals , schools, universities etc. That would yield tens of thousands of jobs and have a solid foundation for generations to come. Conversely taking 700 billion and putting it into a black hole will put a debt and tax burden on the American people for generations to come. I am a Canadian and am outraged at the audacity of your president to suggest a bailout is the only way. NOT. Give the money back to the people... don't give them a giant bill they will never ever be able to repay. I just don't get your leaders today. Rob from the poor to give to the rich and tell us that is far to complicated for us to figure out and just trust us. You gotta be joking right??

2008 Sep 25 11:15 AM

[CoverIsBetter:]

So your friend's house appreciated a half million Canadian dollars.So what? What does that say about our current financial crisis? Nothing. If he wants another similar Canadian home, guess what. He will have to spend a bunch of millions of Canadian dollars. (And then lose them all when their asset bubble pops)

So the exchange rate changed. That is completely a separate issue which you poorly explain by mentioning a home that nearly doubled in value in its home currency. Exchange rate arbitrage is totally overrated. Try moving just 100 miles within the US and see what I mean.

2008 Sep 25 11:52 AM

[Market Insight:]

Good article.
I agree with what Hedge fund operator, Eric D. Hovde has said. Wall stret and the banks responsible for this mess should not be bailed out. Secretary Paulson has some serious conficlt of interest here between bailing out his wall street buddies and the best interest of the tax payers.

2008 Sep 25 11:54 AM

[omanmike:]

George Bush has fooled the Democrats once before and that got us into a needless war, which I call BLACK HOLE NO. !. Now he is at it again and the Democrats are caving in again. How stupid can they be? BLACK HOLE NO. 2 will be bigger and move the country into a depression. No matter what congress does the market is headed for a 40% dip, but not right away. However, the US dollar will weaken and gold will rise as they did when the bailout was announced.

2008 Sep 25 05:18 PM

[wcrxlp edit...:]

There are three thousand community banks that are capital starved or near capital starved.

When Wall Street absorbs the $700 billion, Main Street banks will pay dearly to maintain their capital ratios.

It makes more sense to distribute the $700 billion to American community banks so they can lend for local transactions or the local banks can use it to recapitalize Wall Street.

2008 Sep 25 08:13 PM

[JCC:]

It is obvious to most that when you arteries are clogged, the blood doesn't flow. When you have blocked arteries it is an emergency, and to avoid a heart attack it is critical to get the blood flowing, which implies the use of a stent or open heart surgery. A complete blockage will result in a heart attack or worse. Time is critical, and the required correction is an emergency.

Analogous to your vascular system, the financial markets are the arteries of the economy. Analogous to your arteries, when the financial markets are frozen, the monetary supply does not flow. This creates an emergency situation where it is imperative that we restore the monetary flow.

In today's environment it is critical that we on an emergency basis thaw the financial markets thereby enabling the required monetary flow. There is not a lot of time to react. Waiting too long will create a severe recession or a depression.

2008 Sep 25 11:53 PM

[mbr:]

The author forgets the counterparty risk in currency ETFs. Where are the ETF's funds deposited? In this situation I would look twice or more...

2008 Sep 26 04:21 AM

[mbr:]

Instead of funding the losses of incompetent or corrupt bankers why not let them go bankrupt? Creditor financial firms of a bankrupt financial firm would get repaid of what would be left after non-financial creditors have been repaid. Financial firms should know better than others where to put their funds. In the event non-financial creditors are not repaid for their full deposits after using all available guaranties, a federal fund would finance the difference through a long term loan. Surviving financial firms would also get help from this fund. The obese US financial system would be at long last trimmed to service, not itself, but the producers and the consumers. /Show more...

2008 Sep 26 04:22 AM

[Flaca7:]

www.silver-info.com/mo...


On Sep 25 11:04 AM irondoor91 wrote:

> Re: logicalthought. You are correct and that was what I observed
> when reading through the piece. I haven't thought through all the
> ramifications of the bailout yet (who can know the future?), but
> at some point the government is going to own a lot of homes. Until
> the average price of those homes (now around $215,000) declines to
> 3x the median family income ($50,000) there is not going to be stabilization.
> That would be with stabilized employment, which isn't happening.
> In addition, we know that the free flow of mortgage money is shut
> down now and if banks are going to avoid this disaster in the future,
> they have to demand more downpayment, higher FICO scores, higher
> income to debt ratios, etc from borrowers. It seems to me that all
> those good people are probably already in homes. Why would they want
> another one? Do you really believe that there are millions of folks
> just sitting around in apartments with $40,000 in the bank, no credit
> card or auto debt and good secure jobs who are patiently waiting
> for home prices to come down? I don't know of any, but maybe somewhere
> in Iowa. Not in California, Nevada, and Florida where the problems
> are. People are leaving those states for financial survival.

2008 Sep 26 04:30 PM

[Neal Vander...:]

When banks start closing it's too late.

2008 Sep 27 06:22 PM

[dbjn:]

If the credit crisis is real why not get $700b by cutting 5% waste in each government department and slashing some of the lifetime benefits and goodies our inept leaders have awarded themselves? Most Americans have seen salaries and benefits cut, why not these clowns that allowed this mess to happen?

2008 Sep 30 02:54 PM