The Bailout: How’s It Doing?

by: John Mason November 14, 2008    

John M. Mason

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Treasury Secretary Paulson held a press conference on Wednesday and indicated that things had changed. The focus of the bailout effort would not be on the purchase of ‘toxic assets’ but instead, would be aimed to assist the capital needs of financial institutions and consumer finance. The press has noted this ‘shift’ in focus.

Is the ‘bailout’ program having any success?

To answer this question, I am roughly in the same spot of someone I heard being interviewed on Marketplace on NPR radio: the ‘expert’ was asked the following question, “Has the efforts to add liquidity to financial markets and financial institutions shown any results to date?” His reply: “I think things are better than they would have been if the efforts had not been made.”

Does that give you a lot of confidence?

I just don’t think that at this time anyone can say more. We are in the middle of a situation that no one present has ever been through. Fed Chairman Ben Bernanke, an expert on the Great Depression, has seen to it that financial markets and financial institutions have been flooded with liquidity. From the banking week that ended September 10, 2008, Reserve Bank Credit has risen from about $890 billion to $2.1 trillion in the banking week ending November 5, 2008. This is roughly a 210% increase in a matter of eight weeks. (Dare I remind you that it took 94 years for the total of Reserve Bank Credit to reach just $890 billion, and only eight weeks to add $1,167 billion more!)

The $700 billion bailout bill is now turning into a provision of capital for financial institutions - a provision that the Treasury hopes will buy time for institutions to work out their bad asset problems. The unknown question here is whether or not $700 billion is enough to solve the crisis, or will Congress have to float more funds.

The underlying rationale for the provision of all this liquidity is that either (1) officials are going to be blamed for allowing another MAJOR economic bust to take place, or (2), these officials are going to have a problem cleaning up for all the liquidity that they have supplied to the financial markets on such short notice. Success, in the eyes of the officials means that they will have to clean up all the liquidity once the financial markets begin working again. Failure...”is not an option.”

At this time, no one knows what is going to happen. The idea is to keep tossing more and more liquidity into the pot until financial institutions feel that enough is enough! No one has been here before! This is all new!

Your guess is as good as mine is…

Then there is the need for fiscal stimulus. The Congress is going to consider a stimulus package, which seems to be similar to the first stimulus package they passed earlier this year. It will be aimed at consumers and, although it may not be any more effective than the first package, it can be done quickly, and it will show that the Congress IS doing something AND any little stimulus to the economy will be appreciated.

However, a second stimulus bill is being talked up. This one would be more capital intensive and aim at real projects like projects to rebuild the United States infrastructure. The idea here is that consumers are not going to start spending much until their job security is enhanced and they are sure that they will hold onto their homes. Businesses are going to have to restructure their balance sheets and have some confidence that consumers are going to start spending again before they loosen their purse strings and begin to invest in capital projects again. We seem to be a long way from either of these so the argument goes that the Government needs to engage in some real “Keynesian” pump priming. The problem with a Government expenditure program like this is that it takes time to prepare and then, once the bill is passed, it takes time for the projects to be implemented. So, help does not come quickly.

What about the stock markets? When are they going to come back? Well, we hear all the time that the price an investor is willing to pay for a stock is dependent upon future cash flows. Right now, market expectations concerning future cash flows are pretty depressed and uncertain. Investors must be able to sense a turnaround in future cash flows for them to develop any confidence to begin purchasing stocks, and investors don’t really know the value of the assets on the books of a large number of companies. To me, a good argument can still be made for more asset charge offs, more bankruptcies, and more depressed forecasts of future cash flows. In my mind, we are not near the bottom here, particularly given the situation described above.

What about uncertainty?

There is lots of it. Much of the uncertainty pertains to the programs that will be coming out of the new administration and the leadership that is put into place by that administration. It is still a long way until January 20, 2009. The current administration has been reluctant to do anything in the past until it became absolutely necessary to do something about the financial markets and the economy. They still want to pass on as much of the decision making as possible to the newly elected administration. So, we are still in a limbo as far as the national leadership is concerned.

What about the international situation and international leadership?

This is also an unknown. People are talking about a new Bretton Woods - the international financial structure set up after the Second World War:

  • That conference had two years of preparation and negotiation before the meeting was held. Basically, there has been little or no preparation for the meetings to take place this weekend.
  • The first Bretton Woods conference had seasoned world leadership behind it. That is not the case at the current time.
  • There is almost no intellectual consensus regarding the cause of the current situation and what should be done about it.
  • The world is still going through an economic downturn with more countries declaring every week that they are now in a recession.

International coordination and cooperation are going to have to be vital components of the world economic and financial markets in the future but for right now, I don’t think that we can expect much concrete to be forthcoming from the world community.

So, in my view, we will continue to see a downward drift to stock markets with a substantial amount of volatility. What else is new?

For bond markets, United States government securities are going to continue to be the pick for risk-averse investors and spreads will continue to rise between the least risky debt and that considered to be more risky. I saw that the spread between BAA corporate bonds and AAA corporate bonds exceeded 300 basis points last week. For even lesser credits, the spread has been increasing at an almost exponential rate. If there is any indication that the credit crisis is NOT over, it can be picked up from the market place.

The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!

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This article has 13 comments:

  •  
    Nov 14 07:50 AM
    with a different focus banks will depressed for lot longer time!
    Reply | Link to Comment
  •  
    Nov 14 11:40 AM
    Is the bailout working ? Depends on who you are. If you're one of Hank and Ben's buddies, it's doing great. Their year-end bonuses are being cut and the yacht is provisioned for yet another wonderful holiday cruise in the Caribbean.

    If you're a retiree living on portfolio dividends, it's very different. They are buying canned tuna rather than tuna fitets. And, since Hank and Ben started throwing money at the financial giants, a quarter million Americans no longer have jobs.

    So, if you are an average American, the results of the bailout so far are 100% negative. 100%.
    Reply | Link to Comment
  •  
    Nov 14 12:02 PM
    John Mason -

    Thanks for a thoughtful and thorough summary. The serious, subdued tone of the article was a fantastic prelude to the punchline:

    "The only thing that seems to be positive news at this time is that the Bush plan to get the price of oil below $60 a barrel has been tremendously successful so far!"
    Reply | Link to Comment
  •  
    Nov 14 12:03 PM
    With roughly $684 trillion in derivatives sitting out there (as of June 2008, BIS, 12x world's GDP) this is and is going to be a disaster. We need to wake up and elect Ron paul to the presidency. America needs to call for it and the electors can do it on December 15th.
    Reply | Link to Comment
  •  
    Nov 14 12:16 PM
    What bail out plan? There is no plan. King Paulsen changed the "Focus" from buying up bad debt which could have actually helped to buying preferred stock. Will he change the focus again to buy stakes in American express (AXP) or General motors (GM)? Where will the madness end? Dodd wants to eliminate dividends on bank stocks and Schumer wants to force banks to lend more money. Didn't we get into this mess by forcing or at least coercing banks to make "Risky" loans? So far I haven't heard one of these idiots including Bush propose that we stop lending money to people who have virtually no chance of paying it back. If we are going to start stiffer regulations let's start there. We should also reinstate the Glass/Steagul act and the uptick rule thereby providing some stability.
    Reply | Link to Comment
  •  
    Nov 14 12:47 PM
    RE: oil falling below $60. It is good that the oil companies are strong this time around or we would be in real trouble. In the 80's, the oil companies became involved in alternative energies (that still are not economically feasable). The government should probably use the same bailout for the banks as they used on the oil companies back then. Oil dropped to $10 and 300,000 people lost their job within 100 miles of where I lived. Over 400 of 675 homes in my subdivision were foreclosed on. The governments answer was to raise taxes on the oil companies and they reniged on their promises to back alternative energies (just like they will now). The oil companies had 25 really bad years and are still cutting jobs by 10% a year, but look at them now. While most companies are sending money overseas, ExxonMobil is paying more taxes in the US than they make. If you let the market alone and weed out the weak companies we will be better off.
    Reply | Link to Comment
  •  
    Nov 14 01:29 PM
    WayneS: Greetings. Your observation is spot on. While alternative energy sources are necessary they are not yet viable unless oil goes over $200 a barrel. In addition we should never consider any company or entity as to big to fail. Should General motors (GM) or Ford (F) go into bankruptcy the world would not come to an end. They would emerge from bankruptcy as more stream lined and competitive companies with better more economical product lines. The same goes for oil companies.
    Reply | Link to Comment
  •  
    Nov 14 02:16 PM
    The idea of a bailout is embarrassing. Welcome to the United Socialist States of America.
    Reply | Link to Comment
  •  
    Nov 14 02:46 PM
    An excellent article. But will some reader please help with my Eco 101?

    There is talk of deflation. With the government printing up a trillion dollars of paper to finance the many programs which we hope will kick-start the economy, doesn't this mean INFLATION?
    Reply | Link to Comment
  •  
    Nov 14 03:59 PM
    o/w/s: Greetings. Since we can't figure out how to tally inflation any more no one knows what the rate is. I've seen some economists using the pre Clinton method tallying current inflation at 8%.
    Reply | Link to Comment
  •  
    Nov 14 10:39 PM
    They shouldn't kept lowering the interest rates, If they'd hike them up a bit
    More banks would of been apt to loan out the money


    Nov 14,2008 9:38 PM
    Reply | Link to Comment
  •  
    Nov 14 11:27 PM
    o/w/s, if the government is successful in kick starting our economy inflation or hyperinflation will result. then the commodity prices will climb and the economy will recess (most likely depression this time) because the government must raise interest rates to kill the inflation.

    but i do not think it is likely the government within the next few years be able to revive the economy. this is good because the usa is very sick and needs time to heal. all these bubbles need time to unwind, and business needs time to get their balance sheets in order.

    in capitalism, it is usually better to do nothing and let the fundamentals of the market find their correct levels. the governments job now is to help the citizens (not the fat cats) who were run over.
    Reply | Link to Comment
  •  
    Nov 16 08:12 AM
    Good article of current reality. Many people think all these bailouts are good, will put Humpty Dumpty back on the wall. A close reading of this article will dis-abuse us of such optimism, we are in uncharted territory.
    Reply | Link to Comment
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