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Stock Ideas Investors Daily Edge The Government to the Rescue” Are Words You Never Want to Hear
Stock Ideas Investors Daily Edge The Government to the Rescue” Are Words You Never Want to Hear 
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| The Government to the Rescue” Are Words You Never Want to Hear |
| Friday, 12 September 2008 | ||||||||||
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I doubt that this was what Hank Paulson had in mind. I suspect he was hoping for a 1-2 month bounce. But Lehman jolted Wall Street back to the grim reality facing the financial sector before the party even got going. When the government “saved” the market in January with a three-quarters of a point cut in the Fed Funds rate, the subsequent rally ploughed over 1,000 points into the DOW in two weeks... Then in March the Fed helped smooth the way for a Bear Stearns takeover. The rally was bigger and lasted two months... Then in mid-July Hank declared that he wouldn’t let Freddie and Fannie fail and legislation was passed giving him the “bazooka” he never intended to use (that’s what he said anyhow). A nine-week rally again put over 1,000 points back into the Dow. You’d think with these 1,000-plus point rallies, the Dow would be moving up. But with each rally the Dow has moved to lower lows and/or lower highs. Every time the government puts its finger in a hole to stop a leak in the dike, it seems another even more damaging leak develops. How many more bailouts does the government have in its hip pocket? Not many. Perhaps not any. The U.S. government can’t protect Wall Street forever. It’s already damaged the preferred shares market. Whatever chance, for example, Lehman had of issuing preferred shares to raise fresh capital is now gone. In saving Freddie and Fannie, did the government kill Lehman? If not, it has certainly made Lehman’s survival more questionable. This is what happens whenever the government sticks its big nose into the private sector. Unintended consequences ensue. Nothing is fixed. And the next round of the crisis seems more serious.
You don’t have to believe me. Just look at how the market is behaving. So what is the next round? I can only hazard a guess. But I believe there will be a massive number of bankruptcies in the financial sector. Hundreds of banks could fall. Hundreds of hedge funds will fall. And some of these banks and hedge funds will be among the big boys. The subsequent unwinding of positions is going to cause a massive de-leveraging. Joel S. asks me how are we going to solve this financial mess. We all know what's going on by now. Let's have some ideas on how to best deal with it on a personal and a national level. Thanks. I enjoy your articles a great deal. The answer is this. On a national level, the government has to get out of the business of trying to save these funds and banks. Let the free market work it out. Certainly, picking winners and losers is not the proper province of the government. Bear Stearns is saved and Lehman goes under? Who decides? On what basis? Yet you get the feeling that the government isn’t rushing in on its white steed to save Lehman. Good. It’s a beginning. Bridget O. from Nigeria wonders, “how sustainable is the state of equilibrium in this "global economic food chain"? She’s referring to the willingness of cash-rich countries in Asia and the Middle East to lend us money so we can buy their goods and oil. This, Bridget, is the multi-trillion-dollar question. There are two things happening here. 1. As de-leveraging goes from being a U.S. to a global event, will these countries be able to afford to lend the U.S. the money it needs to pay off the interest in its debt? For example, China is growing slower and exporting less. The result is that its cash reserves are growing at a snail’s pace compared to before. It will be harder for it to buy on the scale of previous months – regardless of how badly the U.S. needs these loans. 2. On top of that, how many IOUs from the U.S. government is a country like China (along with others) willing to have? They’re safe. But so were the bonds of GSEs until recently. Then doubt crept in. and it grew larger before Treasury decided to support Freddie and Fannie’s bonds under their rescue plans. This Tuesday, the price of insurance (in the form of credit default swaps) on five-year U.S. government debt reached a record high – costing $18,000 a year to buy insurance on $10 million worth of U.S. government debt. Based on that price, the U.S. was more likely to default on its debt than Japan, Germany, France, the Netherlands and several Scandinavian countries. “Safe” when applied to U.S. government bonds has now become a relative term, and a huge psychological barrier has been broken. U.S. government bonds are no longer unassailable. U.S. bonds have been the ultimate flight to safety of global capital. Now, just as the financial crisis threatens to deepen and expand, that may no longer be the case. I leave the final word to Mr. John K. who has offered his insights on IDE articles before. He says that, “From a rank amateur's perspective, the economy is a confused geometric figure that requires support from every point to continue standing. If any section starts to weaken, especially a lower one, the entire structure becomes shaky. As the weakness spreads through the structure more and more areas fail.” I like the visual, John: The economy as a disfigured geometric shape requiring support from all directions is right on the money. But the “rank amateur” tag, I don’t know about that. Your comments usually hit the nail on the head – which is why I especially like your other comments: “the best move I have made in this venue was joining IDE then Wealth. I have never found your articles time wasting to get a nugget out. My Thanks and Compliments to Yourself and All at IDE.” On behalf of my colleagues, I thank you. We hope we’re not only giving you a “different” perspective, but that we’re giving you information to help you invest and make money. That is what it’s all about. And that’s why a financial system threatening to come apart wherever you are in the world leaves you with one sensible choice: Precious metals – especially gold. Gold loves a good crisis. And a good crisis is what we’re getting. Invest well, Andrew Gordon P.S. To let me know what you thought of today's article, send an e-mail to: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
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