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It's a Bull Market in Government Intervention

by: James Picerno September 20, 2008 | about stocks: DIA / QQQQ / SPY    
James Picerno

James Picerno

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First it was Bear Stearns. Then the government bailed out Fannie Mae (FNM) and Freddie Mac (FRE). Before the ink was dry on that deal, Uncle Sam loaned $85 billion to insurance giant AIG in exchange for an 80% stake in the company. Along the way, the Fed has been throwing money every which way, depending on the day.

But wait: there's more. In the last 24 hours, a new round of government bailout efforts are underway. Yesterday, Congressional, Federal Reserve and Treasury officials were talking of launching a massive government fund to buy up the toxic securities from investment banks and other institutions. Meanwhile, the SEC announced a ban on short selling on nearly 800 financial stocks. And the Treasury is now insuring money market funds to shore up sentiment in the wake of news that the Reserve Fund — a money market portfolio — broke the buck this week, i.e., its net asset value fell below $1. The drop stoked fears that even cash equivalents might not be safe.

The government, in other words, is throwing everything but the kitchen sink at the bear market. There's some logic to this, of course. Preventing bank runs and the like is just common sense. But how much is too much? Or too little? Alas, intervention is an art, not a science. Financial turmoil of the degree we've seen this week is rare, and so there's not a lot of precedent. The early 1930s are an obvious era for study, but the relevance is limited, since two or three have changed the days of FDR and "brother can you spare a dime."

Meanwhile, asset prices want to fall, and interest rates want to rise (i.e., those rates that involved private parties that can't print their own money). But the government is doing everything in its power to keep Mr. Market from having his way. This is reasonable, up to a point, although it's a safe bet that it'll take time before we know where reason ended and moral hazard began.

One can be forgiven for wondering if the latest batch of fixes will fare any better than the previous ones. Since the Bear Stearns bailout earlier this year, each new "solution" was initially greeted with cheers in the stock market only to be followed by more selling. Will the new fixes do any better?

Maybe. But it's debatable if government intervention, massive though it is in cumulative terms these past months, can engineer a bullish aura of any duration.

For the moment, however, hope springs eternal. Out of the gate this morning, stocks surged skyward. But after the warm glow of yet another of government intervention cools, how much bullish enthusiasm will remain? As troubling as all the toxic securities problem is, it's still a symptom of deeper problem, starting with the correcting real estate market. Meanwhile, there's the issue of consumer spending, which was already faltering before the latest ills went ballistic. It's hard to imagine that Joe Sixpack will take inspiration from all this news and run out and buy a new wide-screen TV.

The government can keep bailing out firms, buying up securities no one else wants, and guaranteeing money market funds. But the cycle will have its way eventually, in part because sentiment and psychology can't be denied.

It's worth repeating the reality that prices want to fall and interest rates want to rise. It's not clear that the government can change that reality. And while the government theoretically has access to unlimited amounts money to throw at problems, in practice there's a limit if only because the dollar is regularly valued vis a vis other currencies and gold. At some point, cranking up the printing presses to bail out Acme Finance is self-defeating because the marginal gains of injecting liquidity are more than offset by a slump in the purchasing power of the buck.

Of course, we're talking of medium- and long-term worries, and for the moment all the concern is about what happens in two hours. But at some point the fires will stop burning, the smoke will clear and the crowd will look out six months or a year and reassess prices and interest rates. This much is clear: fundamentals will regain their place as the dominant force in pricing. Exactly when that happens is unclear. Meantime, it's all noise.

Remember, too, that financial crises are nothing new, nor are interventions of one sort or another. In the panic of 1907, for instance, J.P. Morgan--the man--orchestrated a private-sector bailout of sorts. In some sense, we're not in uncharted territory in 2008. The future, on the other hand, is always unknown.

The details of the full government-sponsored bailouts will determine much of what happens in the markets and the economy in coming years. The challenge is that we don't yet know the details, and the future, well, it's still the future.

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This article has 71 comments:

  •  
    Sep 19 11:28 AM
    spot on.
    Reply
  •  
    Sep 19 11:48 AM
    yes...spot on.

    if this doesn't push interest rates substantially higher i don't know what will. the socialists got their bailout. i suspect their euphoria will be short lived.
    Reply
  •  
    Sep 19 12:17 PM
    Even if it works as planned, it fails to help consumers who need liquidity themselves. The banks may survive, but the customers may not be credit worthy, so it does not matter much. The fix is of no value to the consumers who are wallowing in debts and about to take gas. Same goes for small business who are suffering loss of demand. When the lay-offs get a head of steam it may occur to Hank that he fixed only part of the problem. The "hammer" just hammered us.
    Reply
  •  
    Sep 19 12:23 PM
    icandoitdon,

    It appears that national socialism has been established by those who told us the greatest threat was socialism, just like last time. Perhaps it always happens that way.

    BTW, did anybody realize that the govt. now owns a majority stake in their house, and that they pay the govt. to live in it. Creepy? Anyone?
    Reply
  •  
    Sep 19 02:26 PM
    First it was "save Bear Stearns and save the world" then it was "save Fannie and Freddie and save the world" now we seem to be at the point where it's "save the world and save the world".
    My question is who do we have to save next to save the world?
    Reply
  •  
    Sep 19 03:15 PM
    "My question is who do we have to save next to save the world? "

    The challenge as I see it is the government minions are blowing the wad trying to save Wall Street. Unfortunately, they are simply passing along the liability to taxpayers, kind of like what happened in Japan in the early 1990s after their meltdown (that is still underway).

    The problem is that as the recession worsens, Main Street will be next, consumer spending will fall as more get laid off and the economy weakens. Given that the Fed and government have now discouraged foreigners from investing in Treasuries see tradesystemguru.com/im... who will be left to bail out Main Street amid rising interest rates?
    Reply
  •  
    Sep 19 05:50 PM
    Remember when Paulson used the bazooka analogy to coax a blank check from the Congress to save Franny? At that time, the estimate the taxpayers might have to fork out if his plan did not stabilize the GSE was about 25 billion dollars. The tax payers are tapped for over 200 billion dollars MINIMUM for Franny so far.
    Now Paulson is asking a blank check from the Congress to the tune of over 800 billion dollars. Apparently he has moved up to using a nuclear bomb. And the true cost will be in trillions of dollars.
    Time and time again, Paulson has proved that his words are meaningless. Remember how he reassured us in 2007 by saying that the US and global economies were never better? If the Congress goes along with his proposal again, there is something seriously wrong with the workings of our "democracy." All the incumbent senators and congressmen should be thrown out with Paulson. More importantly, vote against the presidential candidate that sympathizes with Paulson's plan.
    Reply
  •  
    Sep 19 05:59 PM
    One more point. Paulson's trillion dollar plan to address the bad debts of financial institutions do not solve the real problem. Those debts are bad because housing price is falling and homeowners are defaulting. Paulson's plan will clearly help the bankers, but will do nothing about the rising defaults and falling housing price.
    Reply
  •  
    Sep 19 08:26 PM
    don't worry about the consumer who is underwater on his mortgage. there is a mortgage bailout plan afoot. when you've committed a trillion or two to help wall street) the only way to keep the natives quiet is to throw them a bone too. look for it.

    it's also interesting (and quite funny) to watch the greedy bankers scream like hell about the treasury's plan to insure money market funds. banks will lose billions in deposits if this happens unless they match money market rates. ordinarily it would be hilarious but it's hard to laugh at our country having become a bananna republic. there is more capitalism in china and russia than in the united socialist states of america.
    Reply
  •  
    Sep 20 02:33 AM
    Printing money with an already 10 trillion dollar debt is not sound economical advice.
    Reply
  •  
    Sep 20 03:49 AM
    Look it from the brighter side: if the government buys off all motrgages in trouble then the Fannie/Freddie bailout will come FREE to the taxpayer!
    Reply
  •  
    Sep 20 05:16 AM
    There is reason for skepticism, of course, but there is also reason that this intervention might actually do more than just give Wall Street a temporary boost. If the govt. can take the toxic funds off the banks' hands, they will be free to lend again without fear of nothing being capitalized. If those loans are made prudently, they will generate income and keep the economy going. The govt. meanwhile should be able to sell off the assets behind the bad loans over time without too much money being lost. It's win-win, if all goes well.
    Reply
  •  
    Sep 20 05:39 AM
    If the gov. buys the paper at 65% and restructures the loans at decent historical rates,say 7%,they could make it work..at least in theory..
    Reply
  •  
    Sep 20 06:48 AM
    Where's the outrage that we the ordinary taxpayers will end up paying the bill. Even if its only $1 vs. the $trillions that many fear, its not right. The folks that should be held accountable still have their $millions and will probably recieve even more $millions. As a starter, write your congressman "today" and demand that any bailout address eliminating exccessive compensation as a condition for receiving any bailout money. When I wrote, I even suggested that excessive compensation adjustment be 5 years retroactive. What we are whitnessing is not capitalism but simply rape and pillege of the average American taxpayer!
    Reply
  •  
    Sep 20 08:44 AM
    The Gov. has been making money at a rapid pace since 2001 when the World Trade Center were bombed. They have created debt of 1.3 trillion with the war, Fannie, Freddie, AIG and now another 500 billion or more!! It seems to me the Gov has created another 2 trillion on top of the 10 trillion owed in just a matter of a couple years. I did not notice but if anyone did, what did the dollar do in the wake of this announcement of mass gov. intervention? All my gold mining stockes have been soaring up almost 50% in last week with only a 10% move in gold bullion. It seems that maybe the big ,smart money in the system is fleeing for the safe haven of gold and precious metals. I also see oil rising in the face of a possible depression if this mass amount of liquidity does not work( oil has also been used this year as a hedge against deflation) This market rally was a rally in confidence that these financials that have been killed by short sellers can not be short sold anymore (till the ban is lifted) not because of better fundamentals!!! I still believe the demand for gold and other precious metals is the place to be for the long term during this deflationary time. Now that all this stimuluis is being injected into the economy will be seeing inflation of a magnitude much greater than that of the 70's. It almost has to happen, considering this problem is consideribly more dramatic than that of the 70's. Also what needs to be pointed out is that oil is hovering around 95 dollars a barrel and we certainly are in a recession. What do think the price of oil will be when our economy is back to 3% or 4% growth and we spark the BRIC countries by importing at our normal pace. I will tell you let's try 200 a barrel. Everyone has turned their head away from oil because of this financial turmoil. It is poised to soar again. What will the Gov. do stop commodity trading next. I don't think so. Well there is many other places to make money other than the broad market, but I truly believe we will see gold prices spike much higher that that of the seventies as people flee for a safe haven.
    Reply
  •  
    Sep 20 08:51 AM
    Spot on.
    In any case: some time ago a contributor to this introduced the book:
    Confessions of a subprime lender. An insider's tale of greed, fraud &
    ignorance ... by Richard Bitner / lendingsanity.com

    I found it very interesting, informative, useful. And it probably was
    useful for many others as well, those not taken by surprise.
    Reply
  •  
    Sep 20 09:05 AM
    Socialism,
    Banks may survive,
    Save the world,
    Buy my Junk,
    Sounds like a ViX Garage Sale
    that I don't wont to go too.
    Reply
  •  
    Sep 20 09:06 AM
    Socialism,
    Banks may survive,
    Save the world,
    Buy my Junk,
    Sounds like a ViX Garage Sale
    that I don't wont to go too.
    Reply
  •  
    Sep 20 09:47 AM
    What with the proposed "Resolution Trust" clone and money market fund backstopping ( not to mention the FNM and FRE rescues ), it now appears that the "bazooka" analogy has come up a bit light, in terms of "throw weight." In light of the estimated cost of "TARP" for the beleaguered taxpayer -- some half trillion dollars -- the Treasury has upgraded the deployed weapons system from the conventional bazooka to a squadron of LGM-30G Minuteman III's.

    $500 billion. Devastating throw weight indeed.
    Reply
  •  
    Sep 20 09:58 AM
    "And the Treasury is now insuring money market funds to shore up sentiment in the wake of news that the Reserve Fund — a money market portfolio — broke the buck this week, i.e., its net asset value fell below $1. The drop stoked fears that even cash equivalents might not be safe."

    "And while the government theoretically has access to unlimited amounts money to throw at problems, in practice there's a limit if only because the dollar is regularly valued vis a vis other currencies and gold. At some point, cranking up the printing presses to bail out Acme Finance is self-defeating because the marginal gains of injecting liquidity are more than offset by a slump in the purchasing power of the buck."

    Beware. The Govt. tells YOU not to panic, but panics itself.. They do not want a run on banks because they need our money in there to hold this stack of cards together.
    I have already made my run on my banks weeks ago in order to beat the inevitable crowds. I purchased the very thing that my Govt. does NOT want me to buy - Gold and Silver. They are trying to hold off the panic post election by applying bandaids to a gushing artery. Don't be fooled.
    If foreign countries bail on the dollar, by taking what they have and moving into gold, silver and oil, the dollar is dead. They hold billions of dollars of toxic debt...I imagine they might decide they would rather be holding a safer alternative.
    Doesn't it make sense to get in to Gold before your dollar won't buy any?

    Reply
  •  
    Sep 20 10:01 AM
    Icandoiton - Banks won't have to raise their rates...the money markets will lower theirs. The difference was a risk premium. That risk is now gone...therefore, the premium will be gone as well.
    Reply
  •  
    Sep 20 10:49 AM
    Here is a great NYT article on Russia (you may have to be registered to access... its dated 9/20... "Shaky Economy Suddenly Dims Russian Prospects") :

    www.nytimes.com/2008/0...

    One paragraph jumped off the page at me because of its incredible irony... it describes an almost 100% reversal in the economic ideology of the two great cold war superpowers.

    “Probably a period of struggle for existence and survival is coming,” said Dmitri Lutsenko, a member of the board of directors for Mr. Polonsky’s Mirax Group, which is building Europe’s tallest skyscraper beside the Moscow River. “The strong businesses will become stronger, and the weak ones will be wiped out of the market,” he said.

    Absolutely mind boggling.

    Mr. Lutensko speaks of the quintessential capitalist market theory, what I call financial darwinism, where the strong, growing, innovative shall attract the capital - and our Republikaan business and political leaders evoke the image of a socialist nightmare, where the weak and broken are temporarily propped up and force fed hundreds of billions of dollars of scarce capital that will now not be allocated to the growth of a strong economy. In America, the weak and dying are bailed out, and the strong are starved out.

    News just hit... Dumbya looking for $700 BILLION now for the bailout. Democrats and Repugnants alike should be ASHAMED at what they are creating, absolutely ASHAMED.
    Reply
  •  
    Sep 20 10:56 AM
    Here's the news... the bailout is now $700 Billion and that increases our national debt to threshold to $11.3 TRILLION

    news.yahoo.com/s/ap/20...
    Reply
  •  
    Sep 20 11:19 AM
    Bush Finally Admits To Taxes Increases!


    Americans, Get Ready for an Enormous Tax Bill
    Posted Sep 19, 2008 01:36pm EDT by Aaron Task in Investing, Newsmakers, Recession, Banking
    Related: JPM, AIG, XLF, ^DJI, ^GSPC, BAC, C
    "America's economy is facing unprecedented challenges. We're responding with unprecedented measures," President Bush declared in a press conference Friday.
    Bush, of course, was speaking of the government's coordinated efforts to tackle a financial crisis that has roiled global markets and brought down venerable financial institutions.
    "These measures will require us to put a significant amount of taxpayer dollars on the line," the President added.
    Ah, yes. There is no free lunch. Just how significant an amount of taxpayer dollars remains unknown, but it's going to be massive.
    Estimates of the proposal to let the government buy bad assets from banks range from $500 billion to $1 trillion -- and that's in addition to costs already incurred for various government actions this year, including, but not limited to:
    • $29 billion to fund JPMorgan's takeover of Bear Stearns
    • Up to $200 billion each for nationalization of Fannie Mae/Freddie Mac
    • Up to $85 billion for AIG
    • $50 billion to insure money market funds
    • Approximately $300 billion of Fed liquidity measures this week alone.
    "It's impossible to put any reasonable estimate on what it's going to cost us as taxpayers," says Tom Brown of Bankstocks.com and Second Curve Capital. "We know it's going to cost an awful lot [and] the more they borrow the more interest rates go up and the more taxes we'll have to pay."
    Reply
  •  
    Sep 20 11:29 AM
    Well there you go. Now can we just lose the political argument that we are taxed less under a Republican president? I think that this financial fiasco has shown everybody who has benefited and who got the shaft. Somehow, yet again, a few very rich and powerful evil-doers made off with the money and left the bill on the table for the rest of us.
    Just remember this on election day, and vote all the filth out regardless of party. Try and vote like you give a darn for your fellow man. Most of the greedy b**stards in power don't give a hoot about you or me or your aging parents...they vote knowing they can sleep peacefully in one of their 7 houses.
    Reply
  •  
    Sep 20 11:30 AM
    With the Administration using huge taxpayer money to bail out the big banks, did we just see the Repubs commit political suicide?

    They are a politically savvy bunch, so they must have seen something far worse just around the corner, something like a near 100% probability that there would be a run on the banks next week.

    Now that would have been just as, or more, expensive than the bailout, and even worse (much worse), the expense would be immediate and not spread out over several years.

    So in my mind the Bush bailout was inevitable, the lesser evil (but not by much) of two bad options. Therefore I'm not sure it signals a new American Socialism, just a continuation of business-as-usual.

    I'm not convinced of the 'short the dollar' theory, which presumes that foreign currencies are healthier than the $$ right now. I doubt it.
    Reply
  •  
    Sep 20 12:41 PM
    There may still be a run on banks next week... The sentiment of the average Joe will determine whether that happens or not. Basically, when you no longer have faith in your government you pull money out of the bank. They say our deposits are safe - which means that they will print the necessary currency to cover the deposits. That just means that the dollar is being devalued...you can buy less with that dollar.
    The alternative is to take your cash and buy Gold and Silver which is exactly what Washington doesn't want you to do... which is exactly why you should be doing it.
    Reply
  •  
    Sep 20 12:56 PM
    What if this weekend, the government cannot solve the unsolvable? What if they can only contain and limit the free-market effects of this deleveraging? While TV financial personalities tell people to "ride it out", "don't panic", "don't try to time the market" etc., what they really are telling people is to "not think". Why do officials keep telling everyone, "not to panic"? Do I look panicked? Should they not be saying, "prepare for a worse-case scenario"?

    Think about the people that re-entered their WTC building, not affected by the first plane, after exiting the building and being told by "authorities"... to go back inside.

    Think about the recent Hurricanes in the Gulf of Mexico. Did officials say, "don't panic and leave the area"? No, they said, "better safe than sorry, leave the area immediately".

    Why then are these same government officials and TV pundits telling me to not worry about it?

    Disclosure: Bought SDS on Friday's dip. Portfolio loaded with silver. Retirement in US Treasuries since last July. Currently constructing a bubble-wrap suit to place over my kevlar vest.
    Reply
  •  
    Sep 20 01:05 PM
    BTW, panic is not a system-preservation instinct. It's a self-preservation instinct. Let the talking heads on the Titanic rationalize. I'm already in the boat.
    Reply
  •  
    Sep 20 01:24 PM
    BxCapricorn,
    You got it. When every single person is telling you "don't panic" you better be in self-preservation mode. For months they have been telling investors not to sell their stocks and look how much people have lost! When they tell you something, do the opposite.
    Reply
  •  
    Sep 20 01:28 PM
    Kelly, I have a hard time recommending to anyone a large position in gold or silver when they are so close to their recent highs. Look at these charts:

    Gold: futures.tradingcharts....

    Silver: futures.tradingcharts....

    That would be reckless anytime, but esp. in the current marget. I think there are better short term investments in things that have real intrinsic value.

    I also think having some, maybe significant, cash reserve (not in a bank) is prudent. It was interesting to note that the money market funds now cannot maintain par ($1/share) value. I was wondering when they would release that bit of news.

    Looking at the 10-year IWM chart and current PEs, I believe stocks have further to fall.

    They are down for the week, and cash is still king.
    Reply
  •  
    Sep 20 01:28 PM
    Cool Heads will yet survive this crazy economy. Lets see..gold...silver...o... or what else. I'll tell you a scheme that worked like crazy during the last Depression and guaranteed to make you a future success for life. Grab all your assets and keep them liquid and GO TO SCHOOL and improve your professional abilities. When the economy comes back you will be in great shape to take advantage of the opportunities. Forget about everything but survival and schooling and you will be just fine. Remember the holy dollar was never worth anything anyway...ITS WHAT YOU GOT STORED IN YOUR HEAD THAT COUNTS. Marvin Friedman
    Reply
  •  
    Sep 20 01:42 PM
    GOLD and SILVER are going to new highs! This bull market has years to run. It has dwarfed the dow since 2001 and will continue to do so until gold and the dow have a one to one ratio...e.g. dow 5000 - gold 5000!
    Reply
  •  
    Sep 20 01:47 PM
    Then the answer is to buy education funds. EDU anyone?
    Reply
  •  
    Sep 20 02:15 PM
    Curious wording....

    "Sec. 6. Maximum Amount of Authorized Purchases.

    The Secretary's authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time"

    At one time....why is the media suggesting it's $700B, maximum, when the actual wording is thus? This leads us to my Potato Chip Theory....
    Reply
  •  
    Sep 20 02:18 PM
    BTW, this is a global economy now. Do you honestly believe that the rest-of-the-world isn't going to gravitate towards certain items that have had universal financial appeal, throughout world history? Yes. I'm talking about powdered wigs.
    Reply
  •  
    Sep 20 02:53 PM
    Act shall be limited to $700,000,000,000 outstanding at any one time"

    This is the way they will print the money. Once the bank gets rid of the toxic stuff it will again extend credit to anyone. This in turn will create more toxic crap that will move again to the tax payer repeat to infinity. I don't know about gold since I have the feeling that they will try to manipulate it. I think long oil and shorting US debt has a better chance on not being so easy to manipulate.
    Reply
  •  
    Sep 20 02:56 PM