Why the Financial Markets Haven't Responded

The stock market has experienced a serious decline since the passage of the Paulson Plan. The money and bond markets still seem to be frozen in spite of a coordinated cut in world central bank target rates. The only way that this behavior can be explained in my mind is that without strong leadership -- from the very top -- the financial markets will continue to be weak. Even though others -- Paulson and Bernanke -- have tried to provide some form of leadership, the leadership that must be exhibited from the very top continues to be missing. (See my post of September 25, The Absence of Leadership.)

Missing this leadership, members of the Bush 43 administration were hoping and praying that events would be relatively quiet until they were able to sneak out of Washington in January 2009 and let someone else handle the situation.
They didn’t make it.

And, like any other organization that does not have a leader, good people with good intentions when faced with calamities try to come up with some plan or some action that will plug the hole in the dike. The problem with this is that when they have to work around the leader, there is no unifying force present in such situations, no calm hand on the tiller listening to alternatives, asking questions, and guiding responses. And there is no one around to punish dissidents.

Up until a couple of weeks ago, Treasury Secretary Paulson and Fed Chairman Bernanke tried to band-aid the system, proposing temporary responses to the growing crises that would tide things over until the new government came into office to deal with the problems. It seemed as if Paulson and Bernanke had reached a game plan; a bailout took place for Fannie (FNM) and Freddie (FRE),  Lehman (LEH) was to fail with no help, and nothing would be done for [[]AIG].

Then, it appears by all reports, Bernanke reached a turning point.

Bernanke called Paulson and indicated that the financial markets were falling apart and that if nothing were done the economy might not be there the next Monday. The Congressional leadership had to be informed of this development and brought on board for a major flood of liquidity. In no instance could the financial system and the economy come up short of liquidity. Paulson set up the meeting with the Congressional leadership, and at that meeting Bernanke poured out his story of woe. According to some of the members of Congress that were there, Bernanke scared the life out of them!

One question needs to be asked at this point: Where was the “decider”?

The Treasury plan was assembled as quickly as possible for passage by Congress as quickly as possible -- no hearings, really, no questioning, things were so bad that there was no time for these niceties that could take place when things were not so dire.

And, then the financial markets froze!

Why not?

Here was the Chairman of the Board of Governors of the Federal Reserve System saying that the economy might not be there on Monday. What did he know that market participants didn’t? What was going on in Europe and elsewhere? Here was a major case of asymmetric information. And the people who were without information were the suppliers of funds.

Bear Stearns had failed. Merrill Lynch (MER) had failed. Fannie and Freddie had failed. Lehman had failed. Washington Mutual (WM) had failed. AIG had failed. Wachovia (WM) was failing. Who was going to be next? What did the Fed and the Treasury know that market participants didn’t know?

The initial effort to get “the bill” through Congress failed too. There was no one in a leadership position who could call the troops to order. (Even presidential candidate John McCain rode out at the head of his cavalry to lead the charge to get the bill passed, only no one followed him. Paulson could not do it, he was not the leader; there was no leader.

The “decider” was marched out -- but he  only mouthed the words that were given. Why should anyone have any confidence in what was being done?

So, is the bill passed last Friday any good? After what went on in the two previous weeks, the bill seems somewhat irrelevant-- a very costly irrelevance. There is still no vision going forward. There is no strategy. There is no structure. There is little or nothing. At best we are told that maybe in four weeks the “Paulson Plan” will be up and running.

That will be after the election and we will have a president-elect. But the president-elect will have to wait for over two months before he can do anything about the financial crisis.

Meanwhile the Fed floods world financial markets with liquidity.

Bernanke’s study of the Great Depression taught him that during such a crisis, the world cannot have too much liquidity. And so, “Helicopter Ben” is acting on that premise. Total reserves in the United States banking system, for the two weeks ending September 10, averaged about $44 billion on a non-seasonally adjusted basis. For the two weeks ending September 24, the total reserve figure was about $111 billion. Never has the United States banking system received so many reserves so rapidly. And look at the sources and uses statement of the Federal Reserve System (the H.4.1 release). In the last three weeks the sources of reserves in the banking system increased by more than 50%!!!!!

Never have we seen anything like this! Never!

This is what happens when there is no leadership. One cannot blame this situation on previous administrations or other conditions within the world. The current leader of the free world is MIA.

Unfortunately for the financial markets, for the economy, for workers, for families, for everyone else, there will not be a new president for several months yet. And, we still have to uncertainty with respect to what the newly elected president will do. Will he, when in office, be able to provide the leadership that is so badly needed?

So, there is still an enormous amount of uncertainty with respect to the future, and this enormous amount of uncertainty will reign in the markets until such leadership surfaces. Meanwhile, the financial markets will still remain tentative as they attempt to discern who will fail next…and then next after that…and then next after that…

Comments

[mbr]

Very interesting article. It begs this conclusion: in order to, as fast as possible, reduce the continuing uncertainty that is compounding the crisis and its consequences, should not the president of the US immediately tender his resignation?

2008 Oct 09 03:41 AM

[investor88]

A good way to look at the situation in the financial markets, ie lack of strong leadership.

2008 Oct 09 03:49 AM

[fatcat]

I don't think Presidential leadership has any bearing on this crisis...derivatives don't hear speeches....

2008 Oct 09 05:24 AM

[Benito Camela]

Clasical writer that gets scared because he probably has never lived through a crisis similar to this one.

The key here is that USD as a sign of confidence from foreign investors. Contrary to an emerging market crisis the dollar is going up for the most part telling us that money is coming to the U.S. The confidence for people to send money here will prove crucial to the healing.

On the contrary things are behaving rather well and three months from now we will view this is the greatest stock buying opportunity of the last few years.

I recommend that author to read about EM crisis in order to understand things a little better instead of running around like a headless chicken.

2008 Oct 09 06:31 AM

[Benito Camela]

Needless to say, but the run up in share prices I foresee is just in the short term -- Look to make about 10-12%.

Longer term, I guess it would take a while for things to heal and for the excesses to be corrected. We have lived on borrowing since the 1980's and that is coming to an end.

There could be an generational dissapointement with equities heres.

2008 Oct 09 06:50 AM

[Benito Camela]

Presidentianl elections and politics are not helping here

2008 Oct 09 06:52 AM

[I weep for this country.]

I can't believe all of this nonsense over AIG. IS EVERYONE STUPID! Obama made damaging reckless comments and didn't even look into the issue. The conference was set a year in advance and paid for by the marketing budget of the insurance companies which can not be tapped to pay back the loan from the FED and the FED loan money is not going into the insurance companies budget at all! Plus, the FED now owns AIG, even after AIG pays back the 100 plus billion dollar loan, the FED owns them. Why are we mad about a conference where 100 of their biggest clients were wined and dined by a 10 AIG employees that was paid for by the insurance companies? That is standard practice. The insurance company has a billion dollar marketing budget and needs now more than ever to keep their huge clients. The better AIG does the better tax payers will be when the FED sells the 79 percent interest later. Piling on against AIG is actually against every taxpayers best interest. We want them to thrive not go bankrupt you IDIOTS!

2008 Oct 09 07:19 AM

[whidbey]

As though a leader would know what to do. As Reed said "no one knows what to do". Of course it is a cover up by the political class which is never good at the details, or the broad plans either. One must suppose that this like much in nature will "fall out" of its tangle. Of course not all thing untangle and they stay knotted forever. The Gordian knot likely must be cut by one who will send purchasing power to the consumers directly. That takes not stimulus, but tax holidays for a spell. I shutter to think of the dollar or gold in that situation. Z

2008 Oct 09 07:21 AM

[john s. gordon]

the decider (the nonregulator) was out chopping brush in crawford TX leaving the SS titanic to wallow helplessly.

markets have not responded yet because the hedgie funds are still dumping their overleveraged positions, throwing babies out w/bathwater.
> jack

2008 Oct 09 07:57 AM

[Telling]

I rather agree with fat cat - to suggest that leadership - or statesmanship if you will, relative to a your perceived lack thereof has negatively impacted global stock markets because a bailout plan was not an overnight success is somewhat amateur. To suggest that past global regulatory and bsuiness development actions have no meaning on current developments is a bit political - the work out and unwinding of securitzed positions, both debt and investment - "ain't" going to happen in a day or two. Leaders and solutions will emerge in time. Have the courage to allow the process to work.

2008 Oct 09 08:15 AM

[User 143167]

The US needs socialism to work this thing out. Or even communism and Nasizm to make it more quickly. Starlin and Hilter's country did make some economic miracles in the last depression.

2008 Oct 09 08:24 AM

[tonny adamms]

I totally agree with John M. Mason on his analysis.Its for the ordinary American working class and the middle class to sort it out and pass the verdict.The current administration thought come November after the elections they could possibly sneak out unnoticed before this whole financial mess blew up in their faces!Leaving it all to the new administration to face the heat.But things didn't work out that way as anticipated.Lets face it.Greed and Irresponsibility starts from the Top then it tickles down to Wall Street and further down to Main Street.Irresponsible Leadership in Washington is what bred irresponsible greed in Wall street.Change IT or Face the dire consequences of further meltdown in the economy.McCain should read the writings on the wall!The Democrats are the Technicians to set it right into prosperity this time around!

2008 Oct 09 08:35 AM

[viva]

Read Marx again. Now that the credit system is owned by the government, you communists only need to grab control over the healthcare industry to achieve what he couldn't during his miserable lifetime. #9 domino down. #10 leaning. One presidential election to go. God forbid.

2008 Oct 09 08:38 AM

[Duude]

Mason doesn't seem to understand that politicians are way, way over their head. Politicians have very little grasp of the underpinnings of the financial system. At best they can digest small amounts of information about various parts. This economic crisis befuddles them. They can throw together plans but without acceptance of the Fed and Treasury, its doomed to failure, and should be. Bernanke and Paulsen are the only experts that can attempt to take control of this situation as it should be. Bush has no choice but to go with whatever they come up. At best, Bush can only serve as a surrogate messenger for what the finance team is proposing. There is no negotiation as time does not permit. Bush or Obama or McCain or any other politician have no choice but to go with what the experts are proposing. The few Republicans that attempted to block this plan had admirable intent but the realism had to set in, to gathering acceptance by the Fed and Treasury with little time left. We still don't know that they may have been on the right track all along.

2008 Oct 09 09:27 AM

[Robert Jung]

Grow up! We are all men and women responsible for ourselves. Do you need a leader to tell you to get up in the morning and brush your teeth.

Quite the politics; the market is not political. Investors looked at the underlying value of the asset of the differing investments and realized they were way overpriced. Real Estate has historically appreciated at about the same rate as inflation. But in 2000 real estate started to appreciate greater (2x to 3x) than inflation - simple because of EASY MONEY. Economics 101 - too many people with too much EASY $ chasing a limited resource = Higher prices. Then the bubble popped. What did you expect????? In 1999 the leaders did say we needed to pull things in on credit - did we listen??? Hell no, because we wanted our cake and to eat to.

2008 Oct 09 09:41 AM

[Mase]

In response to duude and others...in a corporation, a CEO may not and probably does not have the expertise needed to deal with specific situations that are not from their speciality. Still it is the responsibility of the CEO...the person leading the organization...to draw together the expertise needed to examine the situation and come up with a workable vision and plan to execute under the circumstances. This CEO...this leader...sets the tone of the culture, exhibits this culture in everything that he or she does, brings dissidents into line so that the culture prevails within the organization.
This is true for any form of organization, business, government, not-for-profit, sports team, religious, or academic.
Can you imagine a quarterback putting up with team mates that question the plays that are being called?
This leadership is not present in the current financial and economic situation! As a consequence, no one really knows what is being aimed for and how it will be achieved.
If the running back or the guard has to take charge of calling the plays because the quarterback is missing, how are the other players on the field to really know where they are to go?

2008 Oct 09 09:46 AM

[TBill]

I think you nailed it, Freddy Lou. These leftists are always looking for a strong leader [dictator] to tell them what to do. I dare say Bush has a better understanding of economics than either candidate. Fortunately, Mr. B does understand economics, and he is the man with the power.

2008 Oct 09 10:14 AM

[ain't no fortunate son]

Poor little dumbya looks like a lost little child... he's making fewer public appearances than Sarah the Silent... and they're about tied as far as expressing their total ignorance when they do make those isolated appearances.

I guess dumbya didn't like the poll numbers and this is his way of getting even.. he'll have his house and fat pension and medical insurance after this disaster, that's all that counts.

I'll finish with this quote from a great American writer... if you can guess his name you win the prize...

"The president we get is the country we get. With each president the nation is conformed spiritually. He is the artificer of our malleable national soul. He proposes not only the laws but the kinds of lawlessness that govern our lives and invoke our responses. The people he appoints are cast in his image. The trouble they get into and get us into, is his characteristic trouble.

Finally, the media amplify his character into our moral weather report. He becomes the face of our sky, the conditions that prevail. How can we sustain ourselves as the United States of America given the stupid and ineffective warmaking, the constitutionally insensitive lawgiving, and the monarchal economics of this president? He cannot mourn but is a figure of such moral vacancy as to make us mourn for ourselves."

Its time we mourn for ourselves people, for WE did not get here by accident.

2008 Oct 09 10:14 AM

[davesilb]

Mase,
Not a good comparision because a quarterback knows the game better then his teammates that is why he can lead. If he did not know the game he could not call the play and he would be better off letting some who knew the game call it!!! That is what happen in this bailout. I however do not agree with the play as I think the play caller and his former teammates (not present teammates),had too much to gain by the play he called.

2008 Oct 09 10:45 AM

[davesilb]

Mase,
Not a good comparision because a quarterback knows the game better then his teammates that is why he can lead. If he did not know the game he could not call the play and he would be better off letting some who knew the game call it!!! That is what happen in this bailout. I however do not agree with the play as I think the play caller and his former teammates (not present teammates),had too much to gain by the play he called.

2008 Oct 09 10:46 AM