Wracked by Problems, the U.S. Economy Keeps Digging Its Way Out

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

Where to start?  Market volatility is sure to continue for the indefinite future as investors, economists, analysts and politicos debate the merits of the federal government’s ongoing move – and try to make heads or tails out of the new financial landscape.

Mega-financials that offer everything (deposits, lending, brokerage services, deal underwriting, wealth management, mergers & acquisitions deals) appear to be the wave of the future (is beleaguered Citigroup Inc. (C) suddenly ahead of its time?).

Comparisons to past crises are emerging: The Great Depression, the savings & loan crisis, the junk bond collapse, Japan’s stock-and-real-estate implosion, and even Tulip Mania).

Many investors have thrown in the towel (capitulation) and unloaded any and all financials (not to mention autos, airlines, and even technology stocks…anyone catch the 25,000 jobs lost at Hewlett-Packard Co. (HPQ) or the negative Dell Inc. (DELL) comments?).

To some, this environment represents a great time to buy and seek out bargains.  To others, today’s markets have become sheer speculation and investors who wish to participate in the growth potential of their favorite corporations are instead subject to daily gyrations, often without much rhyme or reason.  Housing and gross domestic product (GDP) data will be given cursory analyses in the upcoming week, but the biggest story will be how the markets perform, and on the changing role of the government. Still want to be president, Sen. Obama or Sen. McCain?

Market Matters

When Henry M. Paulson Jr. left his “cush” job in the Goldman Sachs Group Inc. (GS) executive suite to serve as U.S. treasury secretary, who knew he was becoming the head of the world’s largest private equity capital firm?  (At least, his new boss had a Harvard MBA.) 

Fresh off of the nationalization deals of Freddie Mac (FRE)/Fannie Mae (FNM) the week before, Paulson and his friends at the U.S. Federal Reserve orchestrated another government buyout (bailout has such a negative connotation) of a global institution, American International Group Inc. (AIG), the nation’s largest insurer.  While analysts claim that its core insurance business remains sound, bad bets (to put it mildly) on mortgage derivatives brought about AIG’s rapid demise and no “White Knight” emerged to keep the financial markets from further unraveling.  Hopefully, Paulson’s investment banking background and financial savvy will propel the $85 billion investment into a tidy profit for the taxpayer  (One can dream, can’t they?) 

For good measure, he passed on a national investment in Lehman Brothers Holdings Inc. (OTC: LEHMQ), a move that forced the 158-year old investment giant into bankruptcy.  A day later, Barclays PLC (ADR: BCS) bought many of the failed firm’s banking assets for a bargain basement price of $1.75 billion. 

Fearful for its own future, Merrill Lynch & Co. Inc. (MER) sold itself to Bank of America Corp. (BAC) (of recent Countrywide Financial Corp. fame) for $50 billion to create a mega-financial institution (that may one day also be considered “too-big-too-fail”).

Almost lost in the shuffle, Morgan Stanley (MS) and Washington Mutual Inc. (WM) sought some form of private relief/bailout of their own.  A large money market from the Reserve “broke the buck” (fell below $1 NAV) as its plunging Lehman holdings prompted mass redemptions and sent shockwaves through the markets.

Suddenly, the most riskless of investments proved super risky. And, thus, the nation’s (make that the world’s) financial landscape had changed forever.  Unbelievably, in one day, Merrill and Lehman virtually ceased to exist (“Bank of America is Bullish on America” just doesn’t have the same ring) and the government is involved in areas many believe are well beyond its true role.  McCain swooped in to demand U.S. Securities and Exchange Commission (SEC) Chair Cox’s firing.  Meanwhile Obama (as expected) called for “change.”  In reality, there is plenty of blame to go around and identifying the major culprits and victims will take years.

Hurricane Ike has long been forgotten (except by those directly affected). Houston felt the devastation and its “reasonably” healthy energy-driven economy was threatened as businesses assess damage.  Despite production disruptions, oil traders initially disregarded the Ike news and prices plummeted well below $100 per barrel for the first time since March.  However, as the week progressed, prices rebounded as investors moved back into commodities (like gold and oil), perhaps because they simply did not know where else to go. 

Global equities plunged early and often on the never-ending financial negativity, and a measure of market volatility known in some circles as “the fear index” surged to its highest level in six years.  Fortunately, bottom-fishers emerged in a big way as Paulson and the SEC proposed additional relief and the markets reversed an earlier mass sell-off. 

Uncertainty remained the universal theme, though eternal optimists began to believe the initial panic selling was overblown.  Has equity investing become sheer speculation?  How does one justify 200-, 300-, 400-, 500-point moves (up, down, or both) each day?  Here’s to hoping Henry Paulson will make a heck of a private equity fund manager.  
                       

Economically Speaking

"The American people can be sure we will continue to act to strengthen and stabilize our financial markets and improve investor confidence." 

Somehow, those soothing words from renowned economist, Harvard MBA and (lame duck) President George W. Bush provided little comfort.  Many politicos questioned the authority granted Paulson and U.S. Federal Reserve Chairman Ben S. Bernanke to “bail out” those global financial failures (let the grandstanding begin), though few (none) offered any real solutions of their own.

Meanwhile, the Fed chose to leave rates unchanged at the past week’s policy meeting, and instead worked with other global central bankers to apply much-needed band-aids on the global financial system through some significant injections of short-term liquidity ($180 billion on Thursday alone).

For now, the talks about upcoming interest rate hikes have all but ended, and analysts are projecting Federal Funds Rate cuts prior to the end of the year.  Additionally, late in the week, the government proposed the creation of a Resolution Trust Corp.-like entity to manage (and ultimately sell off in an orderly manner) much of the remaining underwater assets on these financials’ balance sheets. 

The economic data of the week took a back seat to the other more pressing news of bailouts, bankruptcies, and buyouts.  In fact, nothing earth-shadowing was announced that prompted any real change in most economists’ overall (pessimistic) views. Housing remained weak as new construction experienced its slowest pace since early 1991.

Industrial production dropped by more than 1% in August as automakers continued to struggle.  The consumer price index (CPI) fell for the first time in almost two years as the recent dramatic decline in energy prices and other commodities eased some of the prior inflationary fears (for the time being).  Even the core numbers (which excludes volatile food-and-energy prices) rose by a mere 0.2%, a welcome sign in light of the other depressing reports.

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