Yesterday I said the Market would test the January lows. It was a pass-fail test–and we flunked. With stocks at a two year low, the Fed this morning announced a new infusion of $200 Billion and a loosening of the credit quality of the collateral it takes from the banks. I know old Helicopter Ben is scared, but should the American Taxpayers really be left holding all of this Toxic Waste that the banks are giving the Fed to get new capital?
Roubini, in full apocalyptic mode this morning says its only going to get worse.
So now the Fed has effectively entered into the business of propping up a market - and reckless investors - whose spreads are widening for good fundamental reasons (as such GSE are now experiencing mounting multi-billion dollar losses on their portfolios). No wonder that some observers are starting to talk about a covert partial nationalization of the US banking system. Then the explicit partial nationalization of this financial system may only become the next step of this financial meltdown.
This will define “Moral Hazard” for historians in the future.
update:The stock market ralled big time. The general public has no clue of what just happened in the last 48 hours. The U.S. Taxpayes just lent the Biggest Banks and Hedge Funds in New York $400 Billion in exchange for “mark to market valued” sub prime mortgage securities that are probably nearly worthless (being so far down on the claims chart in a bankruptcy). This is a “silent bailout” of the Republican’s biggest contributors that is going to be much more expensive than the S & L Rescue packageof the early 90’s. At least Bush Sr. proposed the S & L bailout in the sunlight. Bush Jr., Paulson and the Fed are doing the bailout without asking our permission. What does “pork barrel” John McCain think of this corporate welfare?
12 responses so far ↓
Morgan Warstler // March 11, 2008 at 6:35 am
“Fearing that weapons of mass financial destruction lie hidden inside Wall Street palaces, the United States is mobilizing the big guns: a fiscal stimulus, sharp interest rate cuts, the Fed’s promise Friday to pump money into the markets. Meanwhile, Old Europe sits on its hands: The European Central Bank has left interest rates unchanged since June and has lectured governments about budget deficits.”
http://www.washingtonpost.com/wp-dyn/content/article/2008/03/09/AR2008030901427.html?hpid=opinionsbox1
Here it comes.
Can you feel it?
“No Mr. President, there is NO way we can afford a single deficit dollar. YOU MUST balance the budget, YOU MUST sacrifice all your big spending ideas, YOU MUST end earmarks, or I will have to continue to rachet up rates - we CANNOT have inflation.”
Deficits trump Democracy everytime.
Cory Doctorow // March 11, 2008 at 6:47 am
Partial nationalization of the banks? When a sovereign wealth fund bails out Citi or another US bank, that’s nationalization — but it’s nationalization by another nation.
Jon Taplin // March 11, 2008 at 7:00 am
Cory-But when the Fed accepts as collateral worthless paper, they are in effect engaging in “covert nationalization” as well.
Morgan Warstler // March 11, 2008 at 7:02 am
Cory, I think you can better clasify it as:
Partial privatization of sovereign wealth. Remember, people are slaves to the things that they own, not the other way around.
Morgan Warstler // March 11, 2008 at 7:04 am
Jon, the Fed is only doing this until the election.
Jon Taplin // March 11, 2008 at 11:56 am
Morgan and Cory- See my update above.
John Hurt // March 11, 2008 at 12:00 pm
Communists socialize profit, capitalists socialize debt.
pancakecity // March 11, 2008 at 2:45 pm
I’m flabbergasted this story isn’t the headline on every major online newspaper. It’s a huge bailout, right? Am I missing something? Is there any chance all or most of this “loan” will be paid back?
Morgan Warstler // March 11, 2008 at 3:23 pm
Couldn’t this thing end Jon, with the US government owning a lot of homes?
Jan Sutherland // March 11, 2008 at 3:56 pm
Here, this might help. John Succo (Minyanville Professor and his mentor Mr. Practical always tell it like it is.) Here’s their take on one nice use of history as the teacher that I referred to in an earlier post. Helps explain better what really happened today:
A good example of a somewhat broad nationalization occurring in the U.S. was Texas, Arkansas, and Oklahoma in 1984 (another smaller, less clear one occurred in the savings and loan crisis).
Large regional banks like Interfirst (eighth largest in assets in 1982), Republic, and Texas Commerce were making many loans to oil and gas exploration companies, refiners, and energy production companies. The banks became extremely levered and were taking land, rigs, and oil production as collateral. All was chugging along until oil prices collapsed after the Iran oil embargo ended. What made business sense (positive cash flow and asset values supporting high leverage) with oil at $32 did not make any sense with oil at $14 a barrel. Cash flow dried up and asset values plunged.
The heavy leverage at the banks left them trying to collect collateral as all these companies stopped paying loans. But with no use for the collateral their value fell as well. The banks found out quickly they had no real capital and they all went bankrupt.
This process took about a year as they fought and fought. But eventually the government had to come in and nationalize: they essentially took over the banks and paid off all deposits with taxpayer money. Of course all equity value at the banks, and equity values for regional companies went basically to zero: A stock is an option on profits, not ownership in the assets of a company. When profits go to zero, stocks go to zero. The assets of what is left over is split up by bondholders. Learn that lesson well, for many people do not understand that dynamic.
What happened next is what will happen now except the much broader nature of this deflation will cause it to take much longer. Essentially everything just sat and sat. The economy slowly began to recover as oil prices recovered. But the important point is that it only recovered because debt was destroyed and the level of debt became supportable by the amount of economic activity basic to the region: economic activity produces income which services debt.
The U.S. economy will recover after a process of debt destruction where balance is restored and the level of income generated by economic activity can support that level of debt. Savings will grow and eventually supply the liquidity needed for new lending. We arrived at these imbalances after years of central bank fiddling where debt just grew way way too big. But the magnitude of this is hard to describe. Once Wall-Street realized the Fed was never going to let things slow down they invented all sorts of new ways to create debt. Securitization and derivatives now represents an astounding 80% of total global liquidity. Central banks can only affect a very small part of this liquidity pool.
That is why the Fed is so desperate as it illustrated today by taking on credit risk like never before. The amount of debt stuffed into areas they cannot control relative to the size of the U.S. economy will take years to unwind.
- Mr. P
http://www.minyanville.com/articles/
Fed-economy-debt-TEXAS/index/a/16238
Jon Taplin // March 11, 2008 at 5:06 pm
Jan- Thats really helpful stuff. The interesting thing is both crisises were brought about by the apostles of leverage. Mike Milken in the 80’s singlehandedly fueled the S & L acquisition spree.
And though Milken got busted, the guys who worked with him to invent the “High Yield Bond Business” (so renamed because “Junk Bonds” sounded so trashy) spread all over the finacial industry. They renamed the LBO business, with its stink of “Barbarians at the Gate”–the Private Equity business and immediatly started “levering up” again.
“De ja vu all over again”
Stilgherrian · The $400 Billion Gift // March 13, 2008 at 11:02 am
[...] up on news from earlier this week, I’m astounded to read the real reason the US stock market rallied: “The US Taxpayers just lent the Biggest Banks and Hedge Funds in [...]
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