The Bailout Nation has arrived and it is in full force. When problems arise, bad decisions are made, or Wall Streeters decide they want a financial mulligan, fear not because interventionist government stands ‘ready, aye ready’! In an article written by George Will shortly after the unlikely Fed orchestrated marriage of JP Morgan Chase and Bear Stearns, he commented on this topic by stating that “The description of the Fed as the ‘lender of last resort’ is accurate without being informative. Lender to whom? For what purposes? Last resort before what?”. Over the last year we have witnessed the most expansive examples of state control over private sector matters since the days of the ‘New Deal’ and the Great Depression.
To take this away from a political debate and turn it to an economic one, the entrance of government into the private sphere has many consequences for taxpayers and consumers alike. The conservatorship that Freddie Mac and Fannie Mae were placed into is not directly inflationary because the Federal Reserve is not monetizing the plan; however, this exercise will undoubtedly affect future fiscal policy decision because of the added obligation to the federal deficit, which could in turn be inflationary. Therefore any governmental intervention of this nature should be very short term or it risks restricting the options of both fiscal and monetary policy.
The troubles that Lehman Brothers is currently experiencing has people wondering if the government and/or Federal Reserve will step in to facilitate a rescue of the Wall Street firm. Unfortunately, it is because of two unlikely and utterly bizarre factors that the 150-year-old company is in the grips of utter catastrophe: Perpetual negativity and the FASB. It has become a self fulfilling prophesy through the fear of sellers perpetuated by media and credit rating agency negativity that Lehman Brothers’ stock has plummeted, thereby impairing the firm’s ability to operate normally as a going concern and raise capital in the open market. Rating agencies such as Standard & Poors and Moody’s played an important part in creating the current credit crunch through their lack of understanding of many structured financial products; now after the stock of Lehman falls into obscurity they decide to seal the firm’s fate by restricting the company’s access to capital markets because of their issuance of a negative downgrade on the firm. The judgment (or lack thereof) displayed by the rating agencies is despicable and must be recognized as playing a major role in the country’s current credit debacle. Additionally, the introduction of FASB 156 and 157 causes market participants to value assets based on current determinable fair value – a doctrine that is useless in a severely depressed, cyclical, and illiquid market. By improperly valuing these assets, financial ratios are skewed forcing unnecessary dilution of the company to satisfy liquidity and capital requirements.
There are many rumours floating around concerning the fate of Lehman Brothers, so I won’t waste time dissecting any possibilities. I will only end this topic by saying that I am partial to the creation of a so-called good bank-bad bank solution, similar to the outcome seen with Long Term Capital Management. The reason I would favour this idea is because the assets that cannot be properly valued, and are likely to have a relatively higher value at some future date, can be isolated from the bank’s other assets.
The current focus of policy makers should be towards that of credit stability and housing recovery, both of which are inseparable. The rescue of Freddie and Fannie in the short-term can be a net positive because of the shrinking effects on mortgage lending rates. The government guaranteeing to buy MBS through Freddie and Fannie removes default risk from these securities serving to tighten the spread over treasury paper. If banks have a secured buyer of repackaged mortgage debt, they should be more willing to lend to the public, which should serve to lower mortgage rates of all shapes and sizes: A huge positive for the consumer and the economy!
My advice is to take advantage of the market’s current distraction with bailouts and the like, because these events are unlikely to affect the profitability of the majority of publicly listed companies or the business cycle itself. The strengthening dollar, weakening commodity prices (inputs of production) and a soft labour market are all forces to be mindful of when making investment decisions. Potentially fading inflationary pressures means that the Fed’s bias should be toward neutrality; this is no time to sacrifice price stability for further monetary easing pushing rates deeper into negative territory. Remember that the market will bottom before the economy does and lower inflation, potential stability in credit and housing and a strengthening dollar are all signs to be optimistic about the future.
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