This was supposed to be a great week for Washington and Wall Street. The administration had leaked in advance that it was going to put a full-court press on for its stimulus and bailout programs. That led to intense anticipatory buying by the stock market bulls.
Monday night’s primetime news conference with President Barack Obama only heightened anticipation ahead of the main events on Tuesday: A big speech from Treasury Secretary Timothy Geithner and testimony before Congress by Federal Reserve Chairman Ben Bernanke.
Geithner's speech was full of grandiose talk and fluff.
Geithner’s speech was full of grandiose talk and fluff.
But shortly after Geithner opened his mouth, stocks began to fall. Then they fell further. By the end of the day, the Dow Jones Industrials had plunged 382 points, or almost 5%.
What the Heck Happened?
Why did the best laid plans of politicians and policymakers fail? What’s going to happen next? Those are questions every investor needs the answers to, and I’m going to provide them today.
Before I take the scalpel to Geithner’s gamble, let me explain exactly what the latest “plan” (and yes, I’m putting that in quotes for a reason) entails …
For starters, the Fed will be expanding its Term Asset-backed Securities Loan Facility, or TALF. This is a program whereby the Fed will lend money to investors who buy securities that fund various types of loans.
The facility was originally designed to help the student loan, credit card, and auto loan securitization markets. Now, it’s going to cover commercial mortgages and most likely residential mortgages outside the purview of Fannie Mae and Freddie Mac.
The Treasury will seed the TALF program with as much as $100 billion. The Fed can then provide additional leveraged funding, allowing for the purchase of as much as $1 trillion in assets.
Second, the Treasury is going to set up a public-private program to buy crummy assets from banks. Private investors would be offered loss caps and/or cheap financing to encourage them to participate. The idea is to avoid the excessively high cost of setting up a program completely funded by Uncle Sam. Early estimates of the size of the program run as high as $500 billion.
Third, there will be additional capital injections into U.S. financial institutions. Regulators will “stress test” bank portfolios, and inject capital into them if necessary through the purchase of convertible preferred securities.
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Finally, there was some fuzzier talk about foreclosure mitigation and prevention. The details weren’t entirely clear, but any program will probably build on existing loan modification programs under way at Fannie Mae, Freddie Mac, and private banks.
So what’s the problem? I hardly know where to start.
But Here Are the
Three Biggest Problems …
Problem #1:
The plan wasn’t ready
for prime time!
Heading into this week’s events, the stock market had rallied significantly. Certain options market indicators were reflecting high levels of complacency. Wall Street investors clearly were betting that this time, the government would spell out exactly how, when, and why it would save the day.
But while Geithner’s speech was full of grandiose talk and fluff — it was extremely light on details. A separate “fact sheet” on the bailout efforts wasn’t entirely clear on how things would work, either.
The message that came through to the markets, loud and clear: Policymakers don’t even have the specifics of their plan hammered out yet!
Why on earth would you make a big deal about a huge bailout plan, leak details to the press for days, and suggest everything was tied up with a ribbon, then essentially announce a “plan to come up with a plan?”
I have no idea …
But the market clearly felt that’s exactly what the administration did. So investors dumped their stocks.
Problem #2:
The “same old, same old” efforts
These programs appear to be nothing more than expanded versions of efforts that have already had either limited success, or failed entirely.
A public-private effort to buy up bad debts that are clogging the system?
Paulson’s attempt to buy up bad debts was a total flop.
Paulson’s attempt to buy up bad debts was a total flop.
Former Treasury Secretary Hank Paulson floated a plan similar to that called the “Super SIV” back in late 2007. It never really got off the ground and was a total flop.
Another Fed program designed to support the securitization market and jumpstart credit extension?
We’ve been seeing versions of these for more than a year. Remember the TAF, the TSLF, the PDCF, and all the rest of those acronyms? Those programs have kept many “zombie” financial institutions alive.
But the origination and securitization of all kinds of loans has continued to plunge — and credit standards have continued to get tighter.
Just one of many examples:
Commercial loan originations dropped 80% year-over-year in the fourth quarter. EIGHTY PERCENT! Just think of the impact that’s going to have on the commercial real estate business, which I warned you almost two years ago in my Money and Markets column was destined to collapse.
And how about the supposedly new effort to mitigate foreclosures or modify mortgage loans?
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Banks, loan servicers, and other interested parties are ALREADY trying to do that. Payment reductions, re-amortization of delinquent balances, interest rate cuts, and other “solutions” are ALREADY being used widely. Temporary foreclosure moratoriums have ALREADY been implemented in several states.
But they’re NOT stemming the tide of foreclosures — or keeping home prices from falling further. Indeed, many borrowers who’ve had their loans modified are just redefaulting anyway.
Don’t just take my word for it …
The Office of the Comptroller of the Currency, which regulates national banks, recently reported on the success rate of loans that were modified in the first quarter of last year. Some 36% had fallen behind on their payments again after just three months. After eight months, a whopping 58% were falling behind again!
Washington is talking a big game out of stemming foreclosures. But no interest rate or payment reduction can offset the complete loss of a borrower’s income.
Washington is talking a big game out of stemming foreclosures. But no interest rate or payment reduction can offset the complete loss of a borrower’s income.
Those findings jibe with private reports I have seen or read about. And that’s completely understandable: Some borrowers are so far underwater (they owe more than their homes are worth) that they see no reason to keep paying on their loans. Others are losing their jobs, and no interest rate or payment reduction can offset the complete loss of a borrower’s income.
So sure, Washington is talking a big game out of stemming foreclosures. But the numbers show the efforts aren’t really bearing fruit.
Problem #3:
Investors may finally be
starting to face reality
I think it’s finally dawning on investors that what Martin and I have been telling you all along is true. To reiterate from my January 30, Money and Markets column:
“This latest scheme to save the world will fail just like all the others. That is because nothing … NOTHING … can prevent a painful adjustment process.
“I wish that weren’t the case. But the time to prevent this painful correction and deleveraging process was a few years ago when the bubble was inflating.
“If regulators, policymakers, borrowers, and lenders hadn’t acted so stupidly then, we wouldn’t be in this mess now. But they did, we are, and no amount of Washington happy talk can change that fact.”
Personally, I believe we need to stop shoveling hundreds of billions of dollars more down the financial sector rat hole and get busy eliminating the dead weight.
* That means we should start nationalizing and carving up crummy banks that are just walking zombies anyway — instead of propping them up.
* That means we should also stop pretending the problem is that bad assets can’t be priced. Or that we need to eliminate mark-to-market accounting. Or that we should use taxpayer money to buy assets at inflated values.
Instead, we should acknowledge that the REAL problem is sellers are living in denial. Vulture investors are willing to bid for bad assets. But the banks don’t want to accept those bids because doing so might push them into insolvency.
So we end up with a paralyzed market.
That is EXACTLY what happened in the early stages of the downturn in the underlying housing market. The official gauges of house prices didn’t fall even as volume all but dried up. The dynamic: Buyers were dropping their bids … but sellers weren’t willing to accept them … and the result was paralysis.
But pretending that prices weren’t really falling didn’t help those sellers one bit. By hanging on and hoping for improvement, rather than just selling and getting it over with, they ended up losing even more money because the “real” market kept deteriorating. The same thing is going to happen with the banking industry if policymakers and executives keep sticking their heads in the sand.
For investors like you, the bottom line is clear: You can buy into the hype coming out of Washington and Wall Street. You can believe that there’s some magic bullet solution out there for all that ails us. Or you can acknowledge reality and take steps to prepare your portfolio for a very tough slog.
I trust you know which is truly the best course of action.
Until next time,
Mike
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