In less than a week, we've gone from U.S. Treasury Secretary Paulson being "adamant" that no government money be used to bail out Lehman to an $85 billion bailout of AIG to a rumored $800 billion bailout of the financial industry and a new guaranty program for U.S. money-market funds. On top of that, the SEC is banning the shorting of 799 financial stocks.
All I'm reading is praise for these moves from all corners. Has everyone gone mad? This is a sad day in this country. Taxpayer money on a huge scale will once again be used to rescue failed private businesses, the bar for "too big to fail" is being significantly lowered, and moral hazard is again being trampled on. The "communist" Chinese must be doubled over laughing at us "capitalist" Americans.
I'll save my capitalism and regulation rants for other posts. For now, let's focus on this new government plan to buy distressed securities from financial institutions. First, we need to ask why the banks aren't selling these assets to raise capital. Paulson contends that they want to sell them but can't because there aren't any buyers. That's why the government "needs" to step in as the buyer of last resort. Well, Merrill Lynch was able to offload $31 billion of these securities at what really worked out to about 5 1/2 cents on the dollar. We also know that a number of funds have raised a significant amount of money to invest in distressed debt.
So, is the issue really that the banks can't sell the securities? Perhaps it's more intellectually honest to say that the banks could sell the securities, but if they sold them at a true market price, they would end up taking huge write-offs and would be technically insolvent. If this is the case, the only way the government will be able to help these financial institutions is by buying the securities from them at significantly above market value prices. Great deal for management and the shareholders. Not such a great deal for the U.S. taxpayer.
By the way, who is going to value the securities? The Wall Street financial whiz kids don't know what they're worth. Are we seriously supposed to believe that some government bureaucrats have the answer? I imagine they'll hire some Wall Street firms to tell them how much to offer for the toxic securities owned by the Wall Street firms!
I'm sure we'll hear how the taxpayers could actually make money on this deal, and that's certainly possible if the markets settle down, housing rebounds, employment rises, foreclosures stop, wages increase, and we're able to find some greater fool of a government to sell the securities to. Unfortunately, there isn't likely to be much upside for the taxpayer. If the government offers to buy these securities at true market prices, then very few banks will likely participate, and the bailout is irrelevant. On the other hand, if the government offers to buy the securities at above market prices there will likely be many takers, with the risk being transferred to the U.S. taxpayer who will be starting out this investment already under water (think load mutual fund).
So, the markets are rallying again on news of yet another government bailout. Everyone feels good. Just remember, if you're trying to figure out who the patsy is, and you still don't know after a few minutes, then you (Mr. Taxpayer) are the patsy.
We were fortunate to have reduced a good portion of our short position earlier this week following Wednesday's decline. We're once again gradually adding to our shorts on this rally.
The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.
