Unintended Consequences of Four Government Policies

Includes: BAC, GS, MS, NUE, TLT, X, XLF
by: Jason Schwarz

Intelligent leadership is not determined by eloquence alone - instead it is measured by one’s ability to foresee unintended consequences and act accordingly. Many have remarked on the intelligence of President Obama, and early on he has been hailed as the perfect candidate to usher in a new era of change. It is encouraging to witness his ability to bring people together and his ability to inspire confidence but at the end of the day, he must enact policies that will solve the current crisis without creating new ones. Let’s take a closer look at some unintended consequences alive and well in today’s world:

1) The salary cap on executive pay. President Obama has decided that executives at banks who hold toxic assets and are in need of taxpayer assistance don’t deserve to be paid a customary salary. That sounds like good justice at work but might there be some unintended consequences looming around the corner? The performance of U.S. banking lies at the center of the global economy and it is important that we attract the best and brightest. Who is going to want to lead the mighty Bank of America (NYSE:BAC)/Merrill Lynch/Countrywide conglomerate that controls such a massive portion of our nation’s future? Like it or not, Bank of America has mega influence over our lives and I wonder who will want to run it for $500,000 when non-TARP can pay millions upon millions.

2) Buy American. The ‘buy American’ provisions proposed in the stimulus package only serve to infuriate global competition that has become such an essential part of the American lifestyle. Limiting competition unearths many unintended consequences such as mediocrity, limited trade, and artificial growth.

3) Mark to market accounting. This regulation was passed in the aftermath of the Enron scandal as a preventative measure against corporate deception. As an unintended consequence, this regulation has actually deceived the globe into thinking that a large chunk of our financial system is no longer solvent because of the short term devaluation of the mortgage backed securities that many of our banks carry on their balance sheets. Those who champion the principle of transparency aren’t intelligent enough to see the collateral damage and the true flaws in the timing of such marks. This valuation method caused Wall Street to get ahead of itself during its time of growth and it caused Wall Street to overreact and crumble during the housing correction. We need a more stable system.

4) Printing too much money. By going to such extremes in all things stimulus, interest rates, bad bank, etc... the government is printing a lot of new money that will be in the system once the economy turns. Inflationary plays could be a major investment thesis as these programs mature.

Now that the government is at the center of all economic recovery efforts, let's hope that solving one crisis doesn’t create another. The theme of unintended consequences is a big one for investors to grasp. Being able to identify such events can be very profitable. Right now it is looking like non TARP banks like Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) will attract all of the top talent and therefore lead going forward. It also looks like US Steel (NYSE:X) and Nucor (NYSE:NUE) will get a concentrated portion of the materials contracts for the roads, bridges, and tunnel projects built into the stimulus package, and it looks like short plays on bond funds like TLT might have nice returns if inflation creeps in and we continue to tick off the large international holders of such assets by only ‘buying American’.

Disclosure: Long LONG XLF.