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Relief Rally Likely in Wake of Bailout Legislation

by: J.D. Steinhilber September 29, 2008 | about stocks: DIA / QQQQ / SPY    
J.D. Steinhilber

J.D. Steinhilber

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It appears that Congress grasped the urgency of the financial crisis, and worked through the weekend to reach a compromise bailout package, which will in all likelihood be signed into law early this week.   Few people familiar with the issues deny that government action is needed to stabilize the financial markets.  In recent weeks, the financial crisis evolved from event-driven to systemic.  A crisis of confidence caused credit markets to freeze, which is an untenable situation in a credit dependent economy such as ours.  As debt markets have plunged into a state of disarray, short-term money markets, which are fundamental to the day-to day operation of our economy, have ceased to function. Naturally, a taxpayer-funded bailout of the banking system is objectionable and regrettable, but with the financial system teetering on the brink of collapse, the alternative is worse. The greatest danger right now, and the reason that government action is required, is not "toxic" mortgage debt, but the loss of confidence, growing fear, and panic in our financial system. 

Assuming the bailout legislation is passed by Congress and signed into law by the President, it remains to be seen how well it is implemented, and how much of the cost of cleaning up the bad debts is born by taxpayers versus the firms currently holding the assets.  The critical variables will be how much the government pays for the assets and what the assets are ultimately worth.  A number of analysts have suggested that the government may actually make money on this bailout, by buying assets cheaply and buying them at the bottom of the cycle.  We find that suggestion to be ludicrous.  Hundreds of billion of dollars of additional bad debt needs to be written off.  Hopefully, the government can administer this bailout in such a way that as much of this cost burden as possible will be absorbed by the stock and bondholders of the financial firms holding the bad debts rather than the U.S. taxpayers. 

This is an exceedingly confusing and challenging period for investors.  The extreme pessimism and fear we have seen in the markets in the past two weeks suggest that the stock market has made a short to intermediate term bottom, and that once the bailout is signed into law, stability will return to credit markets and stock markets will embark on a relief rally, which could persist into the fourth quarter after the election uncertainties have passed. 

It is also possible that we are making an important longer-term bottom in the stock market. Market history teaches us that financial crises, because of the fear-driven market evacuations they cause, produce excellent longer-term buying opportunities, and perhaps we will look back on this as one of those times.  However, we are going to need many more convincing signs of a lasting market bottom to conclude that we are at the end of this bear market. 

The economy and our financial system are undergoing a wrenching transformation and deleveraging period, and it remains to be seen how painful and long lasting this adjustment will be.  Government intervention will in all likelihood stabilize markets in the short run, but will delay the corrective processes in the longer term. Given the upheaval in the banking system (which will lead to tighter credit), the continuing imbalances in the housing market (i.e. excess supply and overvaluations relative to incomes and rents), and the need for consumers to de-lever their balance sheets and rebuild savings, we would not expect a strong economic or stock market recovery out of this.  

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This article has 11 comments:

  •  
    Sep 29 10:16 AM
    You are so wrong. This bailout can work only if it could pass all the bad assets onto taxpayers without recoupment, AND the auction has to be non-transparent. With this rediculous revised plan, it is pretty much useless to the banks and confidence in the credit markets.
    It shocks how few people really know about the banking and credit markets.
    One more thing, you can not put a floor on the house prices without subprime. You have to issue more subprome to get over it. Regulate the banking system and mortgage practice could only make things worse. Wake up! This economy boom over last 5 years is based on evilness and lies. Without more evilness and lies, depression is inevitable.
    Reply
  •  
    Sep 29 10:19 AM
    Looks like the markets are going to make sure the bill gets passed. Leave it up to Congress to debate while Rome burns. This deal really needed to be done prior to WB blowing up. Now confidence may be lost. We'll see.
    Reply
  •  
    Sep 29 10:49 AM
    It needs to pass by Tuesday (end of quarter) so that the mark-2-market rule can be waived so banks don't need the level of writedowns in the 3rd quarter. The bill allows m2m to be postponed. A silver bullet.
    Reply
  •  
    Sep 29 12:13 PM
    LEAVE PARTISANSHIP BEHIND! VOTE THE INCUMBENTS OUT !....

    The ridiculous argument that congress is making boils down to one basic premise: that these 2 ordinary guys (one who never lead anything other than a classroom and the other who made his fortune gambling on Wall Street) can all of a sudden predict with certainty the economic future of this country. If these 2 guys were so smart why weren’t the ringing the alarm bill months ago?

    The fortune tellers however do deserve credit for accurately predicting that top congressional leaders were so beholden to Wall Street for years of financial support that they would work weekends in backrooms to get the big fix in. However it still begs the question that: if this really is a national economic crisis then why are our legislatures negotiating the details of the solution in secret behind closed doors instead of on the floor of the houses.

    You would think that given that the cost of this bailout is almost $10,000 per household that congress would hold lots of hearings with expert economists and scholars far and wide to seek some kind of consensus or assurance that this $10,000 for tax bill every American household would solve the problem.

    According to these two fortune tellers (the gambler and the professor) the bailout purpose is to buy stuff no capitalist will touch in an effort to free up money. Well from my experience there nothing like a bargain to get people to buy and put money to work. Why don’t we pass legislation that forces the banks to sell either write down or sell the assets. If the bank fails we let the FDIC step in and protect the taxpayer. After all it is their job.

    These two fortune tellers (the gambler and the professor) also said it is import that we free up money so that the banks can lend to businesses for investments and to consumers for purchases using credit cards and other loans. They say that absent this bailout companies would have no money to expand or, in some cases, to make payroll. Seems like if companies can’t meet payroll without a loan they are already too far gone. Credit tightening for consumers sound reasonable given that the problem is a result of consumer credit being too freely available. Experts agree that regardless of what happens, good people with good credit who are not overleveraged will still be able to get a loan


    PIGS GET FAT and HOGS GET SLAUGHTERED
    The gambler and the professor bet correctly that the upcoming recess and Jewish holiday would allow them to rush the bailout through. The Congressional leadership did their part by telling their party members that they can sidestep repercussions of voting for the bailout with the same ease as they did for the voting for going to war. They think that if you claim that everyone is suffering and that they believed that they acted selfishly to try and prevent a the deep and prolonged recession that it will give them the political cover they need.

    The American people will not be so easily fooled.
    Despite all the hype and hysteria from the fortune tellers (the gambler and the professor) congress might come to its senses. It might realize that even if the markets do decline that it is not going to be the end of the world despite what those two fortune tellers think. Because if the bailout is the right answer it will be able to rescue and resuscitate the markets from the worst case scenario whether it be 3 days, or 3 weeks or 3 months from now.

    It is time for the American People to wake up and take this country back from the special interests. Tell everyone you know that we all need to send a message to Washington that the voice of the American people stills counts by voting out each and every incumbent who votes for the bailout without an open debate.
    Reply
  •  
    Sep 29 12:33 PM
    Dow is down over 300 - really good relief rally. Can you give me your NFL picks too so I can take the other team?
    Reply
  •  
    Sep 29 04:20 PM
    All the bad things you listed in the first paragraph just got worse. Too many just "assumed" the bailout would pass. We may have a relief rally again some day, but I think it is some time off in the future.
    Reply
  •  
    Sep 29 08:06 PM
    $1.1 Trillion in lost market cap today .. so the arguing over a $700 billion package /loan cost the country an extra $400 billion on top of the $700 billion we needed .

    haha .. now that is funny .. I am calling today the Pelosi Crash ..
    She had to open her piehole 10 minutes before the vote on the bill .. blasting Republicans !
    well the Republican's bit back and decided not to be the "bailout goats" ..on this day !
    If Pelosi wanted the bill passed .. she has the majority and they could have done it !!She has the majority of votes in the HOUSE !!!! so the blame the Republicans ain't flyin on me !
    I think Pelosi has cost Obama the election !
    Now we have a meltdown and I hope it spills over to the Main Street naysayers on the relief package , you bunch of dopes .. Hope you can't get a loan to run your meaningless shops full of trinkets .. go F yourselves ! I ain't shopping this year .. or next either .. dumbos .. suffer like me !
    Reply
  •  
    Sep 29 08:44 PM
    "$1.1 Trillion in lost market cap today .. so the arguing over a $700 billion package /loan cost the country an extra $400 billion on top of the $700 billion we needed . "

    What a bullshit argument.

    So if the market climbs back up 8% next week did the 1.1T$ "reappear" out of thin air? And the next week it goes down, it's gone again? And so forth? Look at how well the SEC added trillions to our nation's "wealth" when it banned the shorts - does that count too?

    Anyone basing daily market gyrations has arguments for the bailout is a moron. If the bailout package is signed this is 4000$ REAL MONEY, taxed now or in the future. Not some bullshit spinning of electronic stock tickers based on skittish traders throwing their fists on the eject button.
    Reply
  •  
    Sep 29 08:45 PM
    N.B. I meant 4000$ per citizen.
    Reply
  •  
    Sep 30 01:06 AM
    Muzie's post is a classic. Nice work!
    Reply
  •  
    Oct 01 05:59 PM
    Zero content.
    Reply
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