-777.7: Where Do We Go from Here?

Today was an amazing day.

I truly did not expect the house to kill the bailout bill.

Neither did the market, as the Dow dropped 777.7 points, the worst one day decline since the 1987 crash.

The leaders of the country played a stunning game of political brinkmanship, with the majority of Republicans voting against the bill, in part due to a stridently partisan speech given by Nancy Pelosi.

Blame is to be had on all sides.  The Democrats tried to attach amendments to the bill having nothing to do with the crisis which would instead satisfy their backers, such as passing laws forcing boards to have union representation. 

The Republicans were no better.  Tonight on CNBC's Fast Money, a Texas GOP Congressman who voted against the bill offered several so-called free market solutions to the credit crisis, one of which was cutting capital gains taxes, a mind-boggling display of economic cluelessness and/or craven ideological and political pandering.

The White House also deserves more than its fair share of blame.  For so long, the mantra from Bush and Co. was that the economy was fundamentally strong.  The Bush's administration's disdain and contempt for others who were not onside bred suspicion and hostility, such that the White House no longer has the moral suasion to lead when leadership is most required.  Given the administration's lack of credibility, it is not surprising Congress would be highly skeptical of the White House, especially when the original proposal appeared to abrogate the constitution.   

However, the reason why the House failed to pass the bill was that constituents were overwhelmingly against it.  Representatives in swing states voted against it, fearing they would lose their seats in November.

Well, democracy is messy, and The People may have sealed their own fate.  C'est la vie.  Whatever one might have thought about the bill, the markets - both stocks and credit - certainly hated it. 

It may be that over the long run, a purging of the markets cleans out so much that is wrong in finance today.

Or, maybe it will induce a terrible crash and reductions in credit with tremendous ramifications throughout the broad economy.

There has been talk in certain quarters of another 1930s-style Depression.  That will not happen.  There are too many structural stabilizers in the system to prevent such a catastrophe.  But we could experience a sharp recession.

If we do have a significant economic contraction, this is the recession we should have had after the collapse of the Tech Bubble.  At the time, the authorities - particularly the Fed - made a conscious decision and implemented policies to avoid a severe recession, particularly Alan Greenspan's decision to lower the Fed funds target to 1% and keep it there, but also fiscal policy and the decision to give Americans a massive tax cut without any reductions in spending.

The primary effects of these policies were to push the pain further into the future, and to create even bigger problems in the housing and debt markets.  Now, the chickens have come home to roost, and the problems are far worse than if we had just taken our medicine during the early part of the decade.

So what to do now?

First, the market usually does not bottom the day after it closes on its lows.  Thus, it is highly unlikely that today was the low.  Expect lower levels.

Second, it is my guess - and I strongly emphasize the word "guess" - that a near-term bottom is approaching in terms of time.  In terms of return, I have no idea.  I have no clue if the near-term bottom is 200 or 2000 points away.  My intuition tells me that we are going to hit a bottom sometime within the next two weeks.  But that does not mean there will not be some acute pain before then.

Next, we are working without a net.  Washington has no credibility on Wall Street at the moment.  Despite the platitudes on the television from the politicians tonight about getting a bill done, there is no reason to believe them, nor is there any reason to believe it would be effective.

Now, I do not think that Paulson's plan would have stopped the rot in the system, but I do believe that it would have cushioned the fall.  However, the effect of Paulson's bill may have been to prolong the adjustment process, spreading the pain out over time.  It may be that we go through a traumatic period, but a shorter one where the excesses are purged quicker.  If so, then that will ultimately be good for the market and the economy.

Finally, in a bear market, the most important thing is to protect your capital.  If you are long and cannot take the pain, get out.  There will always be opportunities in the future.

However, the lower we go, the higher the future returns will be.  Every drop in the market decreases the values of stocks and increases the potential returns from investments.

You have to decide where you are on this risk/return spectrum.

I am very, very short at the moment.  I covered a small portion this afternoon and will be looking to cover further into weakness.

I also intend to start adding to long-term positions.  I believe that some stocks are getting to levels where historically, they have been doubles or triples a few years out.

But in the meantime, we are in unchartered waters.

Comments

[herbert hoover:]

The bottom will be reached when we have Americans sneaking across the border to work in Mexico. It's not that far off

2008 Sep 29 10:11 PM

[thedozer:]

You have some good points... but if the Paulson plan would only delay the recession... that's like Obama saying the price of gas isn't the problem only that the spike was too abrupt???? boob job

we should start over on our monetary policy and entitlement programs.

we should cut EVERYTHING that doesn't adhere to our principles of: Life, Liberty and the pursuit of happiness

no more social security, senior prescriptions, no child left behind... you name it...

GIVE ME MY DAMN COUNTRY BACK

2008 Sep 29 10:21 PM

[GKM:]

We were going where we are the whole time - the bailout was just a cover for one more rally to sell into except that everyone knew it. We would have sold down to this level in any event - it was just a matter of time.

We actually aren't in uncharted waters. The market is where it has been 3 times before. The difference this time is that a bunch more stock has been distributed (as was the purpose of the previous 3 times) and people will likely think that this is a good buy once again. They will be wrong but who am I to stymie charitable contributions.

Looks like we should maybe get a 1 or 2 day pop here.

2008 Sep 29 10:34 PM

[freeAgent:]

I'm glad that it appears we're going to get this over and done with as quickly as possible. Sometimes it's best to endure intense short-term gain rather than continuing to ignore a festering disease.

2008 Sep 29 11:29 PM

[freeAgent:]

Oops, gain = pain.

2008 Sep 29 11:30 PM

[Steven Hansen:]

Toro .... olay. this article pretty much sums up my feelings.

you must be thinking a five to ten percent economic downturn. that equates to a lot of jobs. i know we have a economic safety net in place to prevent a depression, but the whole system is so stretched that you cannot totally discount anything.

finally, TARP may have been an unintentional trap. with a weakened and recessing economy, business and consumers might be getting loans that will erode their financial health as their income falls.

2008 Sep 30 01:24 AM

[Shiv Kapoor:]

The package was not passed by the house and while there are chances that it may come to pass in the coming weeks, the risks to the downside have increased significantly. It is by no means the end of the world; the bill might come up for re-consideration and the Republicans might see sense. If this does not occur, an alternative will be proposed; that something significant is required is widely accepted. It is important to look at the proposed solution, based upon which the likelihood of passage into the late stage of the economic cycle can be evaluated. This may simply be a better buying opportunity but until better information is available - caution is key.

2008 Sep 30 01:31 AM

[MarvinMBA:]

Its important to save main street instead of wall street brokerage houses...the supply and demand for the toxic paper will eventually reach a equilibrium without a bailout....what the country needs now is to get M1 on the move upward and that requires a return to fundamentals...reduce taxes, lower energy prices, adequate jobs for whoever wants to work. This is the Main Street Bailout that will help the average faimily.

2008 Sep 30 01:49 AM

[Mbuna:]

"Next, we are working without a net. Washington has no credibility on Wall Street at the moment."
That may be true but ultimately it is beside the point. The point is that Wall Street has no credibility, period. The only way that Washington can change the lack of credibility on Wall Street is to nationalize it. That may bring in another set problems, hehe, but if you want change....
Otherwise the bailout is doomed to failure anyway because too many people are trying to hold on to the Titanic thinking they cannot or simply will not live without it. That is hardly creative thinking. Personally I think we are going to find out what we can live without and it may not be pleasant.

2008 Sep 30 02:34 AM

[Mr.G:]

It was good the bill did not pass - I believe it the system is going to give itself a well deserved enema and once complete and the bottom is found the market will return back to bull instead of bear -as long as bernanke and the treasury provide the liquidity on the way down for banks who are healthy and are reeling from the side effects of the bearmarket it isnt the end of the world - I believe the sooner the better because the longer it is put off the greater the chances of it causing greater and greater damage to the long term economic outlook of the US

2008 Sep 30 04:32 AM

[Rogelio:]

How about a bailout for American public: let everyone refinance to a long, long term of mortgage in regardless, the value of the house, credit, and income, as long as they willing. Anyone who has a mortgage now, let be allow to refinanced into a 40 years, 50 years, 60 years, 70 years, 80 years, 90 years or even 100 years mortgage at a low interest rate. However long it takes, as long as it is refinanced into a more affordable mortgage payment. This way, people will not walk the house they don't have to pay too much for monthly.

So long as people are paying their mortgages, banks are not losing money on papers. With this, people are happy, and banks are happy. Of cause, we could put some restrictions on this type of loan to prevent some fraud and abuse. This is minor concern compare to what benefit it will reap.

2008 Sep 30 05:11 AM

[Schweizer:]

The American system is working. When one branch of government attempts to wrestle power from the other, using "Emergency" as a context, and suggests they use taxpayer money to confiscate taxpayer homes in order to save the economy - thank goodness the other branch said "NO."

No one wants the stock market to crater, but this vote was correct.
www.youtube.com/watch?...

2008 Sep 30 07:32 AM

[Jason Rines...:]

Schweizer, you are absolutely correct. We have been here before in America. There are no short term solutions. Why? Because there has been a decade of easy money built on credit and multiple scandals of the stewards of money. Our entire economic system is going back to Save and Invest. Our nation was built upon Judeo Christian value system with Liberty first (personal accountability) and Equality second (equal treatment for all).

These values flip-flopped over time but pain will correct improper thinking about Equality first (everyone is to blame and no one is) instead of Liberty.

A government focus on Equality makes it easier for those in power to manipulate the system in 'fairness'. This whole era was simply was the world's biggest swindle, nothing less, nothing more. History rythmes. Expect this house of cards to fall and decent leadership to emerge from the financial ashes and rebuild. Start of the next Bull, 2013.

2008 Sep 30 08:25 AM

[OldLimey:]

Great to see the American people beginning to take their country back. It was an inspiring day for democracy and, insofar as markets are allowed to get on unimpeded with repricing still grossly inflated assets (not just in the US, but around the world) a turning point in the recovery. That recovery will doubtless be painful, but it was always going to be.

2008 Sep 30 09:17 AM

[moonbat1775:]

What are the odds it would fall 777.7? Take hope. What if it had been 666.6?

The plutocrats have been served warning, is my guess.

Still a lot of work to do, though.

2008 Sep 30 10:39 AM

[Smarty_Pants:]

Things are just getting started to the downside. The systemic imbalances will take a long time to unwind. At best the market will be stuck in a trading range until excesses are wrung out. At worst, further falls to come.

Best approach to take: Live within your means, save as much as you can, avoid debt, help your neighbors over the rough spots. This will begin building a capital base that the economy can grow on without going into massive amounts of debt.

Recovery will take a lot of time. Keep slugging.

2008 Sep 30 10:55 AM

[thedozer:]

smarty_panyts,

well put my man... companies that grow too large too quickly risk failure.

why can't the same hold true to an economy? it does

Draw back, draw down and hold on

2008 Sep 30 02:11 PM

[JCC:]

Good points – Certainly the email to congress was heavily against the bill, partly because It had been sold poorly. It was presented as a “Bailout” when in reality it is an economic rescue plan. John Q Public, did not understand that this was about his future. Remember that the unemployment level in the Great Depression reached ~35%, and it took 10 years to recover.

I suspect that many constituents will change their mind when they see their 401K. More will change their mind when layoffs start to grow. Many more would support it if they knew that it was intended to prevent a ~35% unemployment rate.

Some congressional representatives have lost the ability to think. Instead they espouse principles that cannot be violated (almost like commandments).

But here is the bottom line:
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 30 03:29 PM

[Witzy:]

JCC
I like your ananlogy, but let me add an additinal metaphor to it. The blood that has been flowing for too long is laced with sugar (debt), and now the internal organs like the kidneys and liver are becoming functionally impaired while the eyesight of the nation (CNBC, etc) has become blurred by diabetic retinopathy.
I have no problem with a modified bailout, and I do not think that the US/world economies are headed for the toilet. However, diet and exercise are indicated, not a pill(quick fix).
Enjoy the ride!

2008 Sep 30 10:00 PM