By William Patalon III
Executive Editor
Money Morning/The Money Map Report
Look, up in the sky…it’s a bird; it’s a plane; it’s SUPER PREZ!!!
Or is it?
With his second term nearing an end, U.S. President George W. Bush is searching for a lasting legacy [in case “peace in the Middle East” doesn’t work out] and has set his sights on the spiraling U.S. credit crisis. Of course, being the [compassionate] conservative, free-market, “less-government” capitalist that he is, Bush is quick to point out that his plan will not include any federal bailout and involves only private-sector assistance. With U.S. Treasury Secretary Henry M. “Hank” Paulson Jr., as his point person to iron out the more-technical financial details [although President Bush does have a Harvard MBA], the plan calls for a five-year rate freeze on certain subprime mortgage loans [The plan covers homeowners only: Real estate speculators, investors, and flippers need not apply].
Apparently the subprime debacle and ongoing housing “challenges” have prompted the need for a “Bat Signal” to summon in the big guns [no offense, Dr. Bernanke].
Make no mistake: This so-called “bailout” isn’t going to turn Super Prez into the certified Super Hero that his father was – although it is interesting that current President George W. Bush and his father, former President George H.W. Bush, were both immortalized as action figures.
The senior President Bush was the pilot of a Grumman Avenger torpedo bomber that was shot down on a dangerous mission and was fished out of the Pacific Ocean by a U.S. submarine. He was decorated for having flown 58 missions and was the youngest commissioned U.S. Navy pilot in World War II. His son, the current President Bush, was replicated as an action figure after he hitched a ride on a U.S. Navy S-3B “Viking” jet that landed on the deck of the U.S. aircraft carrier U.S.S. Abraham Lincoln (CVN-72) back in early May 2003. If it weren’t for those few exciting seconds, it’s doubtful there would be an action figure of the current president. One thing’s for certain, Mattel wouldn’t be rushing out to create a President Bush action figure based solely on this subprime bailout deal.
Although the president’s plan has yet to be fully defined, it’s clearly packed with problems. The key problems are simple to explain: By freezing rates, it keeps the “free market” from operating in an unfettered fashion, which can only delay the full resolution of the crisis. And by creating this artificial backdrop, it may allow financial institutions to delay the full recognition of their losses.
And that was an issue even before the Bush Administration plan was rolled out late last week. Deutsche Bank AG Chief Executive Officer Josef Ackermann said as much in a speech he gave at the University of Zurich last Wednesday. In a telling commentary, Ackermann said the credit crisis wasn’t over yet: Banks have yet to fully report their losses from risky credit investments, meaning additional write-downs can be expected as the already troubled credit markets turn even more illiquid as the year draws to a close, he said.
That can’t help but push the end of the crisis well out into the future.
With any kind of a speculative frenzy, or period of financial excess, the best and quickest way to return to normal is to allow market forces to “clean out” the system, and in a much-quicker fashion than any manufactured bailout.
If you want proof, consider Japan’s “Lost Decade,” the 10 years or so that followed that country’s speculative mania from stock and real estate. Japan “protected” its financial system, and didn’t force its financial institutions and keiretsu-linked corporations to recognize the massive devaluations in the assets (stock and real estate) they carried on their books. Couple that with key fiscal and monetary policy missteps the central government and central bank repeatedly made, and you can see why their malaise traversed the entire decade of the 1990s and lasted into the 2000s.
Contrast what happened in Japan with the quick resolution the United States engineered for the savings-and-loan crisis in the 1980s. The government created the Resolution Trust Corp. and forced insolvent banks to close. As a result, the S&L crisis cleanup was finished years ahead of schedule and for billions less than was originally projected.
The Bush Administration mortgage deal followed a few ratings cuts that were announced last week. Moody’s Investors Services (MCO) reduced the credit ratings on more than $100 billion of structured debt securities [Many sponsored by Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM)], and downgraded virtually every financial firm [besides itself]: Goldman Sachs Group Inc. (GS), Lehman Brothers Holdings Inc. (LEH), Merrill Lynch & Co. Inc. (MER) and Morgan Stanley (MS). Amid the high fives and back-slapping that seemed to follow the announcement of the Bush plan, the Mortgage Bankers Association announced that residential foreclosures soared to a record high in the third quarter [and the worst may be yet to come…then again, that was before the “non-bailout” bailout].
Believing – perhaps too optimistically – that the mortgage mess was now “clearly” on the road to recovery, investors next turned to the other high-profile issues du jour: holiday retail sales and energy prices.
Analysts were busy evaluating Black Friday, Cyber Monday and beyond to get a better feel for the potential success for the holiday season. Unfortunately, the same store-sales results for November were mixed, at best. Discounters Wal-Mart Stores Inc. (WMT) and Costco Wholesale Corp. (COST) proved that their constant promotions seemed to be working, though many traditional mall retailers like Limited Brands Inc. (LTD) posted less-than-satisfactory sales numbers. Department stores like Nordstrom Inc. (JWN) and Macy’s Inc. (M) benefited from the extra [post-Thanksgiving] week in November, though analysts fear that those decent results will be reversed this month. Only 18 more shopping days to analyze and over-analyze [But don’t forget that so many of those popular gift cards won’t be redeemed until January or February].
Oil took its cues this week from the decision by OPEC to not raise production levels at the present time, though it did agree to monitor the situation in the months to come. Apparently, oil at $90 a barrel and more seems quite appropriate to the ministers, despite the fact that prices have surged more than $40 since the start of the year. Investors reacted favorably to the Bush “bailout” plan and seem convinced that the central bank’s Federal Open Market Committee will do its part to help with another rate cut this week [It will probably be a quarter-point cut, but some observers still wonder whether 50 basis points remains possible]. The rally in stocks continued for a second straight week last week as investors reversed some previous “flight-to-quality” trades and moved out of safe-haven Treasuries. The yield of the benchmark 10-year pushed back above 4%. For the time being, confident investors clearly believe that “there is no need to fear…‘W’ is here.”
Unfortunately – at least from the standpoint of the subprime bailout plan – time could well prove those investors wrong.
Economically Speaking…
* Reflects changes in interest rates over various time frames.
Weekly Economic Calendar
In the worldwide central banks club, the game of “follow the leader” continues. Last week, the central banks of Canada and England each lowered short-term rates in lockstep with the recent moves of the U.S. Federal Reserve. Now the question remains…will Federal Reserve Chairman Ben S. Bernanke do them one better with another rate cut? Most economists believe that a 25 basis point move is in the cards, though investors are still holding out hope that the Fed will lower the funds rate by half a percentage point.
Does the recent economic data justify such a move?
While both the manufacturing and services sectors continue to experience growth [as depicted by the ISM indexes], the paces have slowed over the past few months. The Bush mortgage plan has offered renewed hope that housing will begin to rebound at some point in the future, though mid- to late-2008 seems the most optimistic time projection. The same-store-sales results spawned more confusion about the holiday season and the buying activities of the almighty consumer. The labor market continues to be the U.S. economy’s one saving grace. With the solid addition of just under 100,000 new nonfarm-payroll jobs in November, the unemployment rate held steady at a near historic low of 4.7%. Additionally, a separate ADP Employer Services survey (ADP) also revealed strong job growth last month.
Now it’s back to the U.S. Fed to “follow [be] the leader,” and slash rates once again. Ready to grab the limelight back from that Harvard MBA, Dr. B?
News and Related Story Links:
- OPEC.org:
The Organization of the Petroleum Exporting Countries. - Money Morning:
Bush Announces Rate Freeze for Subprime Borrowers. - Wikipedia:
Henry M. Paulson Jr. - Reuters:
Deutsche Bank CEO Says Credit Crisis Not Over Yet. - Amazon.com:
Flight of the Avenger: George Bush at War. - Amazon.com:
Flyboys: A True Story of Courage. - Official Site:
U.S.S. Abraham Lincoln (CVN-72). - International Monetary Fund:
Japan’s Lost Decade. - Minneapolis Fed:
The 1990s in Japan: A Lost Decade. - Wikipedia:
Keiretsu.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.