Monday, September 29, 2008

Calm Before the Storm...

Updated: With the Dow down an incredible 777 points, the title may seem a little odd (in fact it was the title prior to the market open). However, as we'll detail later in this post, 777 points may just be the tip of an iceberg.

While the failed bailout package did remove some of the stigma associated with selling securities to the taxpayer (bailed out companies would still have a tough time hiring new talent after they use the bailout, but it encouraged current management to do so) AND I was wrong that prices paid by the taxpayer would be remotely near intrinsic valuations - click here for more details, it did mention helping homeowners and perhaps the most important change, it included a clause that allowed the Fed to pay interest on reserves (which should open up the floodgates for further Fed liquidity - for the why, go here).

However, it did have many additional holes (per Professor Roubini via Naked Capitalism):

  1. The plan is inefficient (i.e., it doesn't discriminate between who ought to be saved or not, and in fact rewards those who created dud assets)
  2. It runs counter to the best models of how to deal with this sort of problem
  3. It does not punish current shareholders or management
In other words, we have not learned from policy mistakes made in the past as this bailout seems to help out those that are in the worst shape, the most. Per the NY Times:
The Asian crisis teaches us that it is imperative that U.S. policy makers tell us which financial institutions will survive; and which not. This could possibly involve blanket government guarantees to unfreeze money markets. Until this uncertainty is resolved, financial institutions will be reluctant to deal with each other.
In other words, it probably wouldn't have worked... (per Financial Ninja):
Out of 42 systematic banking crises across 37 countries, despite the implementation of a wide range of policies, all resulted in the re-allocation of wealth AWAY from taxpayers and towards debtors (banks). None avoided recessions and all recessions were SEVERE.
Source: Table 3 IMF Report (Table 3)

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