Defensive Positioning in the Bailout's Absence 33 comments
Martin Hutchinson
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Unless you’re the chairman of the George W. Bush Presidential Library hoping for one last truly memorable economic achievement that would guarantee some big donations – as well as eventual visitors – the failure of the $700 billion bailout yesterday (Monday) was no time to panic.
Of course, the stock market did panic, with the Dow Jones Industrial Average plunging more than 777 points in its worst-ever single-day point loss (although the 6.98% decline in percentage terms is much less severe than the 20% nosedives of 1987 and 1929). At this stage, however, it’s apparent that the U.S. stock market is actually catching up to a new – and more sobering – reality that’s been apparent ever since The Bear Stearns Cos. Inc. collapse back in March: For the U.S. economy as a whole, the failure is actually good news over the long haul; it paves the way for the re-emergence of American economic might on a basis that’s far sounder than has existed since the middle 1990s.
The outcome would almost certainly be a more or less total loss of the $700 billion by taxpayers, while the prices of certain assets on bank balance sheets would remain completely undetermined, since there would be no proper market for them, but only a bunch of politicians playing with funny money. That reality – plus the obligation to pay back the government’s outlay for a giant mess in five years’ time – would leave huge investing risks present in all banks up to, and including, JPMorgan Chase & Co. (JPM).
The bottom line is that the U.S. government would have controlled the entire U.S. financial sector.
Back in December 1929, then-U.S. Treasury Secretary Andrew W. Mellon – one of the greatest to serve in that role, and the only treasury secretary to serve under three U.S. presidents – announced that the problem of the Wall Street crash could be met by liquidation: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … purge the rottenness out of the system.”
The opposite path was taken by President Herbert Hoover with his Reconstruction Finance Corp. (RFC) – to a notably more unhappy result – just as the opposite path was chosen by Paulson and his acolytes. Borrowing $700 billion to invest in mortgage paper that has shown itself to be virtually worthless; it just reinforces failure and starves success of the capital it needs, which is the exact opposite of the recipe for success in a free market system. The great Austrian economist Joseph Schumpeter said that capitalism was a process of “creative destruction.” You cannot have the one without the other, so pouring money down a rat-hole to prevent further destruction will kill creativity and turn the economy into a Soviet-style mess.
As for the stock market, it is becoming increasingly clear that it has been suspended for the last decade at an artificially high level by the immense bubble of cheap money created by Federal Reserve chairmen Alan Greenspan and Bernanke since 1995. U.S. stocks, therefore, were poised for a drop, to an equilibrium level that could be as low as 7,500 on the Dow (I arrived at that potential nadir by measuring from early 1995, and calculating based upon a belief that stock prices should increase approximately in line with gross domestic product, or GDP), or even 5,000, should the market’s “animal spirits” find themselves to be exceptionally depressed.
Yesterday’s sharp drop could mark the beginnings of a realization by the market that the world has changed since 2006, that the subprime mortgages and securitized assets it thought so solid in 2006 were speculative toys, or outright junk, and that a world of lower asset prices can still be a world of increasing incomes and economic growth.
Once stock prices are so low that stocks yielding 6% can be found everywhere, the U.S. middle classes will once again begin saving and investing in stocks. Only then will the U.S. payments deficit disappear (because imports will no longer be artificially inflated) and the funding problems of government will become manageable.
This will bring about other benefits. New-growth businesses in the U.S. economy will find funding from domestic savings, something that’s non-existent right now. Emerging markets will have higher costs of capital than the United States, because of their smaller capital bases in a world of scarcer money, so that outsourcing jobs and investments to them will take place only when there is a true comparative advantage in the poorer country, including proper recognition of the higher costs of capital there.
As I discussed last week, the optimal current investment strategy is a defensive one, with inverse Treasury bond funds (such as the Rydex Juno Inverse Government Long Bond Fund [RYJCX]), some gold, and maybe some other carefully chosen counter-market plays. However, the failure of the bailout package, if it persists without a “rescue,” has made the moment when optimism returns considerably closer. For that we can be thankful.
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This article has 33 comments:
the problem is the government is like a computer with amazing abilities in the way of hundreds of programs... All of which launch when you hit the power button.
Now we have a virus somewhere in the computer, but no one knows the exact origin of the problem. Instead each 'expert' that opines vows that another 'program' is needed to eliminate the problem. But this new 'fix' or 'program' is not effective as it is competing with other 'programs' already on the desktop.
I HAVE A SOLUTION! Ctrl+Alt+Delete.
It is time we removed ALL programs from our crowded desktop and ONLY use what's necessary for our basic function.
At this point there are so many programs that it takes 23 seconds to add 2+2!
back to basics
It is almost impossible to determine what position to take in this environment. This animal has been, and will continue to be far into the future, an entirely different from past recessions, depressions and panics. Most people have forgotten, but everything FDR's programs attempted to do to improve the economy failed. If you look at the charts, the only real improvement came after the Lend-Lease program was implemented just prior to our entry into World War II. I don't think there will be a Lend-Lease program anywhere in our future...
It's always interesting to look at these complex problems and now that 50 years from now people will be looking back on what we did and what were are doing with the bail-out plan ans saying to themselves, how could they be so stupid?
This is hindsight... If we would have known what would happen would we have become involved in Vietnam? Invaded Iraq? Trained Bin Laden? Allowed margin buying in the 1920's?
My point is, we can't see what the problem is and we will not know or understand the problem until years from now. If the consequences were known and understood, we would not be where we are today. Unfortunately, today is just a bit too late to change the eventual outcomes on so major an error. If Congress passes this bill there will be nowhere ANY of them can run or hide if it doesn't work. I'm sure that's in the back of all of their minds. It will be far worse than the Great Depression... A broke populace and a bankrupt government...
Here... Look at this George Bush video made just TWO MONTHS AGO and provided to the BBC -- he didn't look to worried about the situation to me:
news.bbc.co.uk/1/hi/bu...
.
You know, I was talking to a friend about how things were when we grew up in the 80's. Most people didn't have credit cards, or if they did they didn't go into a constant state of debt. People would actually put things on layaway and pay for them over time before they got the goods.
We were pondering that concept and then started thinking... Society functioned pretty well then. People were happy, and didn't mind not being able to purchase $2k home entertainment systems on a whim.
House prices had ups and downs but were basically stable. People had savings accounts and actually planned how they would save. Life was lived, people were fed, things worked just fine.
So then we started wondering - what if this utter explosion of consumer debt and credit availability over the last 25 years was not a good thing at all? What if these massive asset bubbles and crashing deflations were very unhealthy for everyone except the banks at the top of the food chain?
Anyway what I see today is consumer negative savings rate, climbing credit card debt, spiraling government debt...
Kind of makes you wonder what exactly we are trying to build here - a day traders never-never land? Or a functioning country?
Economics and business are games that provide natural consequences for failure.
Obviously, hindsight is 20/20. But lets reduce debt. Bankers wouldn't be as rich, but society as a whole would be better off.
The way we are currently *choosing* to create money is through debt only. (Well and the FOMC.)
The constitution authorizes congress to issue debt free currency. We (America) have a record as the longest users of debt free currency in history. But we gave that up.
It's all about choices.
for two years, it will guarantee ALL deposits, the senior and subordinated debt of banks, and interbanking lending.
Seems appropriate and should maintain TRUST in the functioning of its major financial institutions without which any modern economy is doomed and this to the benefit of its people.
There is a proverb to the effect that he who wants revenge should dig two graves.
NOW I know what this crisis is all about...
The United State Government DEFAULTED on its loans to G-7 countries (and other). The DEAL was they passed the measure before Tuesday and it would be hush-hush. Now...
You have government leaders and ministers calling members of Congress and no doing it in the open with threats. It reminds me of those callers you hear about when you miss your credit card payment.
We've just joined the ranks of countries who have defaulted like Mexico...
The United States of America: Officially a pathetic country with pathetic leadership.
Why didn't Paulson and Push just come out and tell us the truth? We'd better pay up or they'll break our arms and legs?
The real answer: drastic cuts to the black hole known as the federal government budget, and drastic tax cuts across the board to every American and to business. Noone should be paying more than 15% total to the federal government. How did we ever get to the point where we thought that was just??? This government is sapping the economic strength of the people -- that's the REAL story here, and the real SOLUTION to this economic situation.
It's not time for a bank balance sheet reset. It's time for a severe overhaul of government and a reset of the economic basis for the people! When the government is cut to the core functions, and the people are given back what is THEIRS...both freedom and economic capacity will have been restored. People will again have their own money to pay a mortgage with, or do something entrepreneurial with. The yoke will be off.
We need to let our Congressmen and Senators hear this message!!
I hate to say it, but part three of this flick: zeitgeistmovie.com is coming to fruition.
Very happy I own gold (bullion) and live in Canada! (Uncle Sam can't get my stash up here) My home in BC has both a solar array and a wind tubine both regulated with a flow battery. I hope the time never comes where I stop getting paid for pumping the juice back into the grid (which would mean there is no grid!)
As the French on the other side of this country would say, "Bon chance mon amis."
The buyer ultimately determines worth as the buyer determines the opportunity cost required to obtain 'said' security.
Many of these holders of these securities have already marked down the previous misgiven value... problem is, the holder is tapped out of capital required to truly mark these securities to proper value WHILE keeping its doors open.
My issue with this problem is the government is going to pay what the current holder of these securities need to 'stay in business'... hence the proverbial 'bailout'
So the 'forgotten man' is to OVERPAY for these securities in interest of preventing a domino effect fallout of improperly positioned holders. and we are left holding the asset until they are 'worth' what we have paid for them.
Give me a say in what the amount given for these securities and I'll be open to it!
Text of the bailout plan (from the NY Times):
graphics8.nytimes.com/...
Sec 109c line 14 "principal write downs" of mortgages
Sec 110-2 Modifications (to mortgages)
(a) Reduction in interest rates
(b) Reduction in loan principal
Now think about this example:
There are two neighboring houses.
In the first house, Peter was prudent, saved his money, lived within his means, worked hard, and could afford his mortgage.
In the second house, Paul took on too much debt, lived beyond his means (possibly even taking out a HELOC or two to "live the good life"), worked just enough, and frankly cannot afford the mortgage he got himself into.
The aforementioned sections essentially say that the tax money that Peter has paid will go to help his neighbor Paul. Truly robbing Peter to pay Paul's mortgage!!
On top of that, everyone else who knew they couldn't afford a house and thus are renting... their tax money goes to help Paul too!!
That is f***ing ridiculous.
Sec 113a1. "Minimizing negative impact" -- This section is pure fluff but does clearly say there *will* be a negative impact, which they will attempt to minimize (ya right). None of "the gov't might actually make a profit" absurd punditry.
Here is a graphic showing who in the House voted for or against this absurd, Socialist bill:
www.nytimes.com/ref/wa...
I will vote for, and contribute to, the incumbent campaigns of those who voted against this bill.
I will vote against, and contribute to, the challenger campaigns of those who voted for this bill.
As a taxpayer, one who lives well below his means, and an American, I am utterly furious that House Speaker Nancy Pelosi, D-Calif., Senate Majority Leader Harry Reid, D-Nev., Paulson and House Republican Whip Ray Blunt, R-Mo could come up with this absolute garbage.
Moreover, the fact that Henry J Paulson originally asked for $700,000,000,000 without any oversight at all, just a "trust me, I'll spend it right" attitude, is completely un-American and goes against our democratic system of checks-and-balances. He is a snake, a complete failure at his duties, and should resign immediately.
I implore all of you:
PLEASE send emails, write letters and tell your Senator and Representatives that you-- as a financially responsible homeowner-- REFUSE to help pay the mortgages of your financially irresponsible neighbors. They don't need to be very long-- just a paragraph or two to get to the point.
Tell them you will send money to support the challengers to kick out the incumbents to voted for this bill.
And tell those Representatives who voted against this bill that you wholeheartedly support their vote, and will be contributing to their campaigns.
They need to know: Vote for this bill and they will be out of office.
Here is a text of the bailout:
graphics8.nytimes.com/...
Here are who voted for it and against it:
www.nytimes.com/ref/wa...
Can you imagine all the gov. giveaways under Obama and all Dem Washington.Every minority will be driving a cadillac and smoking a cigar..
But what about the Irish solution?
did you know that last week you loaned US automakers 25,000,000,000 to make cars????
Go buy a Toyota (also made in USA) and campaign for some new blood
welcome to the socialist states of amerika comrades.
save and grow slowly with capital(ism)
Years of bad decisions and stupid mistakes have created an economic nightmare in this country, but $700 billion in new debt is not the answer. As a tax-paying American citizen, I will not support any congressperson who votes to implement such a policy. Instead, I submit the following three steps:
Common Sense Plan.
I. INSURANCE
A. Insure the subprime bonds/mortgages with an underlying FHA-type insurance. Government-insured and backed loans would have an instant market all over the world, creating immediate and needed liquidity.
B. In order for a company to accept the government-backed insurance, they must do two things:
1. Rewrite any mortgage that is more than three months delinquent to a 6% fixed-rate mortgage.
a. Roll all back payments with no late fees or legal costs into the balance. This brings homeowners current and allows them a chance to keep their homes.
b. Cancel all prepayment penalties to encourage refinancing or the sale of the property to pay off the bad loan. In the event of foreclosure or short sale, the borrower will not be held liable for any deficit balance. FHA does this now, and that encourages mortgage companies to go the extra mile while
working with the borrower—again limiting foreclosures and ruined lives.
2. Cancel ALL golden parachutes of EXISTING and FUTURE CEOs and executive team members as long as the company holds these government-insured bonds/mortgages. This keeps underperforming executives from being paid when they don’t do their jobs.
C. This backstop will cost less than $50 billion—a small fraction of the current proposal.
II. MARK TO MARKET
A. Remove mark to market accounting rules for two years on only subprime Tier III bonds/mortgages. This keeps companies from being forced to artificially mark down bonds/mortgages below the value of the underlying mortgages and real estate.
B. This move creates patience in the market and has an immediate stabilizing effect on failing and ailing banks—and it costs the taxpayer nothing.
III. CAPITAL GAINS TAX
A. Remove the capital gains tax completely. Investors will flood the real estate and stock market in search of tax-free profits, creating tremendous—and immediate—liquidity in the markets. Again, this costs the taxpayer nothing.
B. This move will be seen as a lightning rod politically because many will say it is helping the rich. The truth is the rich will benefit, but it will be their money that stimulates the economy. This will enable all Americans to have more stable jobs and retirement investments that go up instead of down. This is not a time for envy, and it’s not a time for politics. It’s time for all of us, as Americans, to
stand up, speak out, and fix this mess.
the more the white house presses this issue, the more i believe there is a lot we don't know - and the more i move from being pro the bailout to against the bailout.
"Paulson and Bush threatened to veto the legislation if there was an explicit prohibition of transfers from foreign banks to an American subsidiary."
THE ASSETS DO NOT EVEN HAVE TO BE AMERICAN MORTGAGE ASSETS - THEY CAN BE AN OFFICE TOWER IN SHANGHAI!
YOU ARE GOING TO GET FLEECED FOR HUNDREDS OF BILLIONS OF DOLLARS IF THIS BILL PASSES - THAT MONEY IS GOING TO GO IMMEDIATELY OUT OF THE COUNTRY!
SEC. 112. COORDINATION WITH FOREIGN AUTHORITIES AND CENTRAL BANKS.
The Secretary shall coordinate, as appropriate, with foreign financial authorities and central banks to work toward the establishment of similar programs by such authorities and central banks. To the extent that such foreign financial authorities or banks hold troubled assets as a result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets qualify for purchase under section 101.
votenobailout.org/