Ramblings On The Treasury Bailout Plan And The Market
The government finally announced its plan for $250 bilion of the $700 billion bailout money yesterday morning. The money is to be invested in banks rather than used to buy toxic assets. I don't know if any attempt to buy toxic debt is officially dead, but it should be. My initial thoughts are that this is obviously much more palatable solution but I don't see any protection for the taxpayer. How is a 5% dividend going to benefit taxpayers when the interest rate the government had to pay to raise the money is about 5%? Is this money that will hypothetically flowing back into the government kept separate from the overall budget so it can be directly applied to this massive $700 billion loan? Or, will Congress spend it as part of general funds and we'll let someone else worry about the $700 billion in ten or twenty years?
While I support a plan to save the banking system, this is no doubt, first and foremost, a plan to save Wall Street - those that made the most foolish mistakes. A handful of banks that have achieved monopoly status in the markets get half of the $250 billion. There may be no other choice temporarily but the reality remains that these organizations represent systemic risk and the government should nationalize these firms and slowly remove them from the market place under a multi-year dismantling plan. That might be death or breaking them up. That still might happen at some point after this crisis has passed but I wouldn't hold my breath. A perspective that bigger is better is reinforced by the mindset that only size can compete globally. This is completely ludicrous. Additionally, on this note, there are over twenty thousand banks and credit institutions in the U.S. The government is endorsing favorites in the market place by giving a chosen few access to taxpayer funds. This approach will have an unintended consequence of weakening the strong banks that made every attempt to follow sound risk management practices unless every single bank in the U.S. receives comparably equal injections. And, how many of you believe that is going to happen under this crony plan?
Another glaring point to this plan that I find problematic is a guarantee of future debt issuance for a period of three years. I understand the reasoning. In fact, I was the only voice I am aware of that wrote long before this crisis developed that an environment could develop where banks wouldn't lend. This guarantee of future debt is simply to encourage banks to loan the money they now have instead of hoarding it as they have been. Of course, why lend or trade with other banks if you can go to the Fed? An unintended consequence of the Fed's significant credit facilities available to banks? Regardless, this incentive to lend government injected funds will also harm well managed banks - should it work. I'm dubious of such a plan having any impact. It's based on a faulty perspective of this economic environment. If it does work on some level, two additional issues jump out at me. One, these banks are global. Are we going to guarantee foreign loans or is this for domestic loans? If this is not mean as an infusion for the American economy, this will create even more problems down the road and do nothing to stimulate the economy. Of course, that is unless you believe it will stimulate global trade with the U.S. A position I find to be a fantasy. And secondly, is this truly for new loans or is it for new loans under existing covenants as well? The latter will produce significantly more future risk and will do significantly less to to stimulate the economy. Finally, there still has been nothing done to deal with the accountability of these corporate misfits. They appear to be getting bailed out with no stipulation. Are they to walk out of this scott free? Are they to receive taxpayer money and still recklessly manipulate compensation for their personal benefit? To continue the same ruse of governance that created this mess? It appears as though the current administration is committed to doing nothing. Personally, I believe the lack of accountability and government action in this arena will erode economics far more than any $700 billion bailout plan could ever offset. Another brick removed from the wall of confidence. Another reason why I believe Henry Paulson should recuse himself.
Finally, a remark about the stock market's blow upward on Monday. Were I to guess what happened, I would probably attempt to assign it to two points. One, the move was precipitated by a move of very poor breadth - focused in banking - this past Friday most likely because insiders knew the bailout plan was going to be announced this week. Actually, the plan was announced Monday but formalized on Tuesday. So, Wall Street insiders were surely informed of Monday's summons to the Treasury last week. What better opportunity to take advantage of information no one else has? So much for transparency. That coupled with the counter trend moves we have oft mentioned that occur during witching week, especially when markets have made major moves leading up to it, is also likely to have played a roll in Monday's rally. A runaway move to the downside has significant financial implications for many major market players. If this turns out to be the case, those fueling this rally have likely readjusted their positions and shorted the market. In other words, we would be going back down and likely very hard. This position makes some sense because Monday and Tuesday were futures driven while the cash market participation was nearly nonexistent.
In closing, I heard quite a few professionals talking about capitulation and selling exhaustion as the driver for this - so far - one day rally. That sellers had been washed out. This is complete nonsense. Anyone talking this game is talking trash. Much of the selling this cycle is forced selling. The concept of capitulation is that everyone who wants out, gets out. They reach a point of panic and dump everything they own because of overwhelming fear. How does that apply to a market where institutions and hedge funds are forced to sell even if they don't want to sell? These organizations aren't experiencing panic. They are forced to sell because of exogenous factors that can change at any point in time. (Re the prior posts on The Game.) Forget about this capitulation nonsense. People applying this notion of capitulation are the same ones calling bottom after bottom and losing more and more money. These seemingly exhaustive downside days used to happen once every year or decade or somewhere in between. In market dynamics of yore such a signal may have lent some type of anecdotal confirmation that a rally might develop for months or even years. Those days are long gone. In the last fourteen months we have had dozens of these capitulation-type days. What used to occur once every decade is now occurring up to five times a week. This is another prime example of fallacious logic. And there are some very smart people subscribing to it. It sure sounds plausible but it is more ignoratio elenchi.
While I support a plan to save the banking system, this is no doubt, first and foremost, a plan to save Wall Street - those that made the most foolish mistakes. A handful of banks that have achieved monopoly status in the markets get half of the $250 billion. There may be no other choice temporarily but the reality remains that these organizations represent systemic risk and the government should nationalize these firms and slowly remove them from the market place under a multi-year dismantling plan. That might be death or breaking them up. That still might happen at some point after this crisis has passed but I wouldn't hold my breath. A perspective that bigger is better is reinforced by the mindset that only size can compete globally. This is completely ludicrous. Additionally, on this note, there are over twenty thousand banks and credit institutions in the U.S. The government is endorsing favorites in the market place by giving a chosen few access to taxpayer funds. This approach will have an unintended consequence of weakening the strong banks that made every attempt to follow sound risk management practices unless every single bank in the U.S. receives comparably equal injections. And, how many of you believe that is going to happen under this crony plan?
Another glaring point to this plan that I find problematic is a guarantee of future debt issuance for a period of three years. I understand the reasoning. In fact, I was the only voice I am aware of that wrote long before this crisis developed that an environment could develop where banks wouldn't lend. This guarantee of future debt is simply to encourage banks to loan the money they now have instead of hoarding it as they have been. Of course, why lend or trade with other banks if you can go to the Fed? An unintended consequence of the Fed's significant credit facilities available to banks? Regardless, this incentive to lend government injected funds will also harm well managed banks - should it work. I'm dubious of such a plan having any impact. It's based on a faulty perspective of this economic environment. If it does work on some level, two additional issues jump out at me. One, these banks are global. Are we going to guarantee foreign loans or is this for domestic loans? If this is not mean as an infusion for the American economy, this will create even more problems down the road and do nothing to stimulate the economy. Of course, that is unless you believe it will stimulate global trade with the U.S. A position I find to be a fantasy. And secondly, is this truly for new loans or is it for new loans under existing covenants as well? The latter will produce significantly more future risk and will do significantly less to to stimulate the economy. Finally, there still has been nothing done to deal with the accountability of these corporate misfits. They appear to be getting bailed out with no stipulation. Are they to walk out of this scott free? Are they to receive taxpayer money and still recklessly manipulate compensation for their personal benefit? To continue the same ruse of governance that created this mess? It appears as though the current administration is committed to doing nothing. Personally, I believe the lack of accountability and government action in this arena will erode economics far more than any $700 billion bailout plan could ever offset. Another brick removed from the wall of confidence. Another reason why I believe Henry Paulson should recuse himself.
Finally, a remark about the stock market's blow upward on Monday. Were I to guess what happened, I would probably attempt to assign it to two points. One, the move was precipitated by a move of very poor breadth - focused in banking - this past Friday most likely because insiders knew the bailout plan was going to be announced this week. Actually, the plan was announced Monday but formalized on Tuesday. So, Wall Street insiders were surely informed of Monday's summons to the Treasury last week. What better opportunity to take advantage of information no one else has? So much for transparency. That coupled with the counter trend moves we have oft mentioned that occur during witching week, especially when markets have made major moves leading up to it, is also likely to have played a roll in Monday's rally. A runaway move to the downside has significant financial implications for many major market players. If this turns out to be the case, those fueling this rally have likely readjusted their positions and shorted the market. In other words, we would be going back down and likely very hard. This position makes some sense because Monday and Tuesday were futures driven while the cash market participation was nearly nonexistent.
In closing, I heard quite a few professionals talking about capitulation and selling exhaustion as the driver for this - so far - one day rally. That sellers had been washed out. This is complete nonsense. Anyone talking this game is talking trash. Much of the selling this cycle is forced selling. The concept of capitulation is that everyone who wants out, gets out. They reach a point of panic and dump everything they own because of overwhelming fear. How does that apply to a market where institutions and hedge funds are forced to sell even if they don't want to sell? These organizations aren't experiencing panic. They are forced to sell because of exogenous factors that can change at any point in time. (Re the prior posts on The Game.) Forget about this capitulation nonsense. People applying this notion of capitulation are the same ones calling bottom after bottom and losing more and more money. These seemingly exhaustive downside days used to happen once every year or decade or somewhere in between. In market dynamics of yore such a signal may have lent some type of anecdotal confirmation that a rally might develop for months or even years. Those days are long gone. In the last fourteen months we have had dozens of these capitulation-type days. What used to occur once every decade is now occurring up to five times a week. This is another prime example of fallacious logic. And there are some very smart people subscribing to it. It sure sounds plausible but it is more ignoratio elenchi.
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