23 September 2008 – The Aleph Blog

Our Manic Markets

Posted on 23 September 200823 September 2008 by David Merkel

The markets are manic.? It is rare that we have so many large moves in a short time.? Consider these graphs:

Gold is rising since the bailout announcement.

So are crude oil prices.

And the US Dollar falls.

Swap spreads rise.

And mortgage rates rise also.

Forces larger than the US government are acting on the world economy, leading to a partial repudiation of the US Dollar by some foreign entities.? This leads to higher implied volatility in the equity markets, and higher credit and swap spreads.? Commodity prices rise also. Would you want to own the securities of a country that overpromised what it would deliver in terms of debt repayment?

I think not, and the present economic environment is decidedly hostile to fixed US Dollar denominated assets.? Play in the US dollar with care… the short trade has much to commend it in the intermediate term, though the short term is cloudy.? Also, be careful on the long end of the US fixed income market… it could deliver some significant negative surprises.

We Need Oversight, and Compensation to the Taxpayers

Posted on 23 September 2008 by David Merkel

Here are the issues as I see them in the bailout:

The Treasury can’t do it as if they are autocrats.? The powers of the other branches of our government should not be curtailed here.? The Treasury should submit to oversight from Congress and be subject to the Judiciary.? Fortunately, it seems like that is happening.
Second, if you are going to bail out firms that are still alive, you must ask them for equity stakes that are somewhat punitive.? The Dodd bill does that, and though there are areas where I might disagree, it is a lot fairer to the American taxpayer than the original Treasury proposal.? Bailouts should always be painful, making the rescue a last resort.? (Note, in the Dodd plan, the key weakness is that the finances of the firm selling distressed assets to the government might will likely see its stock price weaken after the purchase, leaving not enough protection by the time of sale.? But it is better than the Treasury proposal.)
Third, the bailout still needs a way to deal with insolvent institutions.? The Resolution Trust Corporation was a way to deal with those problems.? It’s possible that a new entity could absorb the assets of failed financial institutions, but given the nature of regulated companies, deciding on the proper transfer price is difficult.

We are on slippery ground here, and I’m not sure that the market would react badly if no plan were put in place.? A bad plan is worse than no plan, and I believe the market fell on Monday because the original Treasury plan was horrid.? If something like Dodd’s plan were enacted, I think the market would rally, even with its deficiencies.? We need oversight, and compensation to the taxpayers.

To all my readers, I still say, contact your Congressmen and Senators, and tell them to stand up to the Treasury, and demand compensation for any bailout, and if no compensation, we only bail out insolvent firms.? Bailouts must hurt.

PS — For an entertaining view of one possible future as we socialize the financial system, read this piece from the ever-wise Caroline Baum.