Our government has changed the rules of the game. The result will be higher interest rates, higher inflation and higher taxes down the road. The de-leveraging process which began about a year ago has been preempted by one of the most aggressive legislative moves since the Great Depression. Our US Treasury Secretary, Hank Paulsen (former CEO of Goldman Sachs) is proposing to transfer billions in unrealized loan losses from the very institutions he use to serve (banks and brokers) onto the people he now serves, the US tax payer - Tax payers should revolt en masse!
In an instance last Friday morning, the US reverted to banana republic and socialist like tactics in order to address the credit crises. The problem is not liquidity. There is more than enough liquidity waiting on the sidelines to buy distressed assets. The problem is that the holders of these assets are unwilling to sell at prices that result in real losses. Perhaps now, these institutions (the ones which created the problem to begin with) will be able to sell their souring and ill-conceived loans to our US government at prices that do not reflect reality, thus greatly reducing their ultimate loss. When our government turns around to sell these loans to “real” free market buyers, the resulting losses will reside with you and me, the US tax payer. If, on the other hand, they end up holding these assets, they will have to finance them by selling treasury bonds. In either scenario, you will end up with higher taxes or higher interest rates or a combination of the two – both are bad for the US consumer and, like what happened in the great depression, both will likely exacerbate an already weakened economy.
In the near-term, the government’s plan will do nothing to spur lending or galvanize the now dead securitization market – the primary liquidity pump of the last twenty years. All it does is push out eventual losses and transfer such loss to the US consumer who is in enough trouble as it is.
How does this happen in a country which leads the world in promoting free enterprise and free markets? Our current administration will tell you that the alternative to doing nothing is far worse (ooh- scary!). I will tell you that the government did what they had to do (sans Fannie and Freddie Mac) which was to keep AIG from failing and to prevent a “run” on our money market system, the latter of which by the way has its own set of unintended consequences we will need to deal with soon (can you hear the “run” on FDIC insured bank deposits capped at $100k?). While our administration may have stemmed the outflow of money market funds, as we sit here today, our capital markets for commercial paper and other short-term lending facilities like LIBOR remain in disarray. Translation: money is still extremely tight. Global capital is being hoarded and just like price gougers who charge $10 for a gallon of water during a hurricane, global banks are doing the same with short-term money.
Also part of this plan is to temporarily ban short sales on 799 financial companies. Yes, this is our free market, free enterprise promoting government at work. As our articulate President said last Friday morning, he plans to “persecute” short sellers. While he meant to say “prosecute”, the reality is that they are doing both because, apparently, evil short-sellers started rumors that led to the eventual collapse and government bailout of AIG, Bear Stearns, and the GSEs Fannie and Freddie Mac. Must we remind our government that these institutions failed not because of rumor mongering or short selling stampedes? These institutions failed because they MADE BAD LOANS, INSURED BAD LOANS OR BOUGHT BAD LOANS! Rumors have now become facts. Moreover, the ban on shorting financial stocks will eventually lead to even lower stock prices in this sector than would normally be the case since the government just resected a critical component to our market’s liquidity: the short coverer, who buys back stocks when prices fall. Just as the current price of financial equities remains inflated as the result of this rule change, such prices will remain overly deflated when the reality of poor earnings and economic malaise re-enter investors’ mindsets, financial stocks drop and a group of very reliable buyers (short coverers) are no longer there.
As a corollary to today’s action, we wonder where the SEC was in 2000 when long buyers of stocks repeatedly started rumors about the next paradigm changing Internet company and drove stock prices to unthinkable levels? Would the markets have accepted an SEC ban on the purchase of technology stock back then? No chance. The irony is that these “rumors” about AIG and Lehman et al proved correct. The stories driving the stock market in 2000 largely proved worthless – but in either case, the government has no business meddling in free markets in order to restore order. The consequences of many of their actions today will likely result in more loss and disorder in the long-run. The SEC has compromised our free market trading system and it will come at a cost.
In an instance last Friday morning, the US reverted to banana republic and socialist like tactics in order to address the credit crises. The problem is not liquidity. There is more than enough liquidity waiting on the sidelines to buy distressed assets. The problem is that the holders of these assets are unwilling to sell at prices that result in real losses. Perhaps now, these institutions (the ones which created the problem to begin with) will be able to sell their souring and ill-conceived loans to our US government at prices that do not reflect reality, thus greatly reducing their ultimate loss. When our government turns around to sell these loans to “real” free market buyers, the resulting losses will reside with you and me, the US tax payer. If, on the other hand, they end up holding these assets, they will have to finance them by selling treasury bonds. In either scenario, you will end up with higher taxes or higher interest rates or a combination of the two – both are bad for the US consumer and, like what happened in the great depression, both will likely exacerbate an already weakened economy.
In the near-term, the government’s plan will do nothing to spur lending or galvanize the now dead securitization market – the primary liquidity pump of the last twenty years. All it does is push out eventual losses and transfer such loss to the US consumer who is in enough trouble as it is.
How does this happen in a country which leads the world in promoting free enterprise and free markets? Our current administration will tell you that the alternative to doing nothing is far worse (ooh- scary!). I will tell you that the government did what they had to do (sans Fannie and Freddie Mac) which was to keep AIG from failing and to prevent a “run” on our money market system, the latter of which by the way has its own set of unintended consequences we will need to deal with soon (can you hear the “run” on FDIC insured bank deposits capped at $100k?). While our administration may have stemmed the outflow of money market funds, as we sit here today, our capital markets for commercial paper and other short-term lending facilities like LIBOR remain in disarray. Translation: money is still extremely tight. Global capital is being hoarded and just like price gougers who charge $10 for a gallon of water during a hurricane, global banks are doing the same with short-term money.
Also part of this plan is to temporarily ban short sales on 799 financial companies. Yes, this is our free market, free enterprise promoting government at work. As our articulate President said last Friday morning, he plans to “persecute” short sellers. While he meant to say “prosecute”, the reality is that they are doing both because, apparently, evil short-sellers started rumors that led to the eventual collapse and government bailout of AIG, Bear Stearns, and the GSEs Fannie and Freddie Mac. Must we remind our government that these institutions failed not because of rumor mongering or short selling stampedes? These institutions failed because they MADE BAD LOANS, INSURED BAD LOANS OR BOUGHT BAD LOANS! Rumors have now become facts. Moreover, the ban on shorting financial stocks will eventually lead to even lower stock prices in this sector than would normally be the case since the government just resected a critical component to our market’s liquidity: the short coverer, who buys back stocks when prices fall. Just as the current price of financial equities remains inflated as the result of this rule change, such prices will remain overly deflated when the reality of poor earnings and economic malaise re-enter investors’ mindsets, financial stocks drop and a group of very reliable buyers (short coverers) are no longer there.
As a corollary to today’s action, we wonder where the SEC was in 2000 when long buyers of stocks repeatedly started rumors about the next paradigm changing Internet company and drove stock prices to unthinkable levels? Would the markets have accepted an SEC ban on the purchase of technology stock back then? No chance. The irony is that these “rumors” about AIG and Lehman et al proved correct. The stories driving the stock market in 2000 largely proved worthless – but in either case, the government has no business meddling in free markets in order to restore order. The consequences of many of their actions today will likely result in more loss and disorder in the long-run. The SEC has compromised our free market trading system and it will come at a cost.
Thank you Uncle Sam!
William J Roy, CFA
Director of Research
Jacobs Asset Management, LLC
Posts
1 comment:
Good thing the Randalls still plan on moving to Asia at some point..... :D Bren
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