Welcome to Socialism

For those of you who have not read my last blog, which was posted on September 11, 2008, please do so. Last Monday, September 29, 2008 a few brave congressman in the US House of Representatives voted against a $700 billion bailout package that was hastily put together by the US Treasury office and the Federal Reserve. In the days leading up to the vote, pressure was mounting on Congress from both sides of the debate. On the one hand, Congressional staffers were reporting that their phones were ringing off the hook from constituents telling them that if their elected officials voted for the bill, they would not vote for them and help mobilize a campaign against them the next time they would run for office. On the other hand, Congress had to keep in mind a rapidly declining stock market and financial executives and Wall Street telling them that if they did not vote for the bill, a financial meltdown of epic proportions would result. That morning, the market opened with a downward bias, and worsened as the day went on as the votes were starting to show that the bailout package would not be passed. The final tally against the measure was 228 to 225, with 133 Republicans turning against President Bush, the Treasury and Federal Reserve. By the end of the day, Dow Jones Industrial Average posted its largest point decline ever and the S and P 500 had its worst day since the 1987 crash. World stock markets quickly followed the US markets and by the end of the day, approximately $1.7 trillion was lost in markets around the globe. 

 

In the days following the vote, the Bush Administration vowed to put together and pass another form of a bailout package. Proponents of the bailout, including President Bush, Henry Paulson, and Ben Bernanke argued that without a bailout the US would face a “severe recession”. Leaders outside of the US were also quick to criticize Congress’ no vote on the bailout calling it “partisan and irresponsible”. The media, in usual fashion, sensationalized the volatility in the markets and instead of reporting the facts, began saying things like the US was headed for another Great Depression if a bailout wouldn’t get passed soon. Both the cable and network news channels were filled with guests proclaiming different versions of the doomsday scenario that would occur if the Congress would fail to approve the bailout. The public was lead to believe that if a bailout wasn’t passed, “farmers would not have access to capital, unemployment would immediately shoot up to 30%, and small business would not be able to make their payrolls”. The last statement in particular seemed especially puzzling to us as we began to wonder what kind of business needed to borrow money on a weekly or basis just to pay its employees?  Enter Arnold Schwarzenegger.  On Thursday, October 2^nd, the eve of the vote of the revised bailout plan, the Governator wrote in a letter that, “ California had been locked out of credit markets for the past 10 days”, and that “payments for teachers’ salaries, nursing homes, law enforcement and every other state- funded services would stop or be significantly delayed”. Certainly, with a dire warning coming from the Chief Executive of the worlds 5^th largest economy, the pressure was fully on Congress again to pass the new version of the bailout. On Friday, October 3^rd, 2008 Congress voted overwhelmingly by a 263-171 vote in favor of the bailout. 

 

When we first started this blog, we wanted to stay away from politics as much as possible and keep the focus on the markets. Obviously, with the events of last week this was not going to be possible. The ramifications of using taxpayer’s money to prop up failing companies will be felt for generations, and it is a foregone conclusion that there will more bailouts to come in the future. At last Thursday’s Vice Presidential Debate, Governor Palin was quick to deflect any remarks about her parties record over the last eight years by saying that voters are tired of looking backwards and want to start looking ahead as we tackle the challenges facing the country today. While we are in no way endorsing either candidate, because the truth is that both parties have failed the country miserably, the kind of thinking coming out from Ms. Palin is a big reason why we are in the horrible state we are in today. A quick look back at the last century of financial crisis’ shows that the path lawmakers have chosen to take to deal with this crisis is going to hurt more in the long run, with rising inflation and a debased currency, than the other alternative which would be to let the market clean the system out. $700 billion later, and in just three trading days after the revised bailout bill was passed, the S and P 500 has fallen over 10%. Although there is a possibility that the market will rally over the next weeks and months, the fundamental problem facing the markets, which is and has always been the decline in home values, has yet to be addressed by lawmakers. Like the good supply siders that they are, the Bush economic team and now Congress is putting the focus on the financial sectors ability to lend when in reality they should be focused on the consumers need to safely borrow. 

 

In a recent interview, Nouriel Roubini, an expert on financial crises suggested a few measures to restore confidence in the economy which include replacing Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke. Additionally, Mr. Roubini believes in starting a “$300 billion government works program focused on repairing and expanding our infrastructure”, or a “new, New Deal”. Lastly, Mr. Roubini thinks that the government should “provide blanket FDIC insurance on all deposits, without limitations, as there is still $2 trillion of uninsured assets in American banks and that money is moving to places like Ireland, which have granted blanket guarantees”. We are again in agreement with Mr. Roubini and are hopeful that the government begins to look at the demand side of the equation and the consumer. 

 

The ban on short selling in particular is a great example of just how government regulators and other “people in the know” are hastily trying to artificially support the market and causing more bad than good in the process. Thankfully this restriction is being lifted, but in the meantime, the move has caused hedge funds to liquidate positions, which has led to a cascade of selling and redemptions. Additionally, by banning short selling the government caused a vacuum to the downside in the equity market by not allowing profitable short positions to be bought back, which would have added liquidity and support to stocks. And in the “we’ll see how this works” category, today the Treasury announced yet another plan which would allow it to inject capital directly into banks instead of buying the banks illiquid assets. What a nice feeling it must be for a the management of a company to know that it can take as much risk as possible because if things don’t work out, the government will be there to support the company with endless taxpayer money.

 

While we are on the subject of policy, we found it very troubling that in the same week the US and most major western financial markets banned short selling for certain companies, Chinese regulators opened the door to short sellers in their own markets.  In addition, in the same week that the US passed the bailout package to prop up failing companies and assets, China put a man on the moon. It would be difficult to explain to someone just from these two examples alone which country promotes a free market economy, and which is Communist. Or which country inspires its citizens to think that anything is possible rather than one that uses excuses to help the privileged and wealthy members of its society in times of distress. 

           

In closing, we would like to put away the idea that the sky is falling and world is ending with a chart of the yield curve, (or the spread between long and short term interest rates).

 

Although we understand that the short end of the curve is being chased after at the moment by investors seeking safety, it seems that the bond market is much more optimistic about the future state of the economy than the media or bailout passing lawmakers and Wall Street would like us to believe.  Remembering that up until early 2007, the curve was inverted, which over the past 50 years has correctly forecasted 8 out of the last 10 recessions, and with this current recession should make it 9 out of the last 11. The current slope of the curve is normal, upward sloping, which most likely means that the enormous stimulus that the Fed has pumped into the system should be enough to at the very least stabilize the economy. What that translates for the stock market is anybody’s guess over the very short term, but in terms of the economy, the sky is definitely not falling. Any new attempts by bank executives (and ex bank executives who now work at Treasury) to secure new capital from taxpayer money for failed risk taking, should be viewed as self serving and untruthful. We have all had to deal with financial turmoil in our lives in some form or another. Unfortunately, most of us don’t have the direct phone numbers to the heads of Treasury and Federal Reserve and neither should bankers who should have known better than to take on the kinds of risks they did.

www.lawrencegoldfarb.com

 

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Comments

[Rod Divelbiss]

I agree. Now what we are looking at is a period of sustained inflation (6-7% is my prediction in the next 24 months and lasting for at least that long) and a debasement of the dollar.