Sep

20

V NI wonder naively, with the news of the bailout: will there not be clamors with the $1 trillion of assets that are being bought by the government at above market values, to extract some bits of flesh from those who are bailed out? Peter Public is being robbed to pay Paul Financial Firm, so to speak. But will Peter not complain and get his ounces of flesh? And will that not tarnish the luster of the gains in financial institutions in due course?

This is a speculation about which I have no expertise and no recommendation over and above saying, as I have for 30 years, that when you get out of the market because it's a "bear market," you have to get back in some time to reap the drift, and I don't know anyone astute enough to overcome that drift while he's out.

Alex Forshaw adds:

It reminds me of the October 15, 2007 announcement, except that this time the "Super Siv" (or MLEC) is $1 trillion-plus in size (instead of $75-100bn), the regulations are all the more drastic, the government has thrown $1 trillion away to save Wall Street's richest socialists, and… yeah, that's pretty much it.

If one had actually stuck to one's capitalist convictions throughout all this, one might actually not even be very surprised at the enormity of Bernanke's and Paulson's failure.

Alan Millhone worries:

I wonder if that 'long spoon' cradles castor oil? You hear the term hard to swallow. To me this applies to the bailout as the Bureau of the Treasury is running the presses 24/7 with someone holding the oiling can to keep down the sparks from the printing presses and all that paper may over time become nothing more than shin plasters!

Nigel Davies writes:

GM NigelOn the long term drift: Can someone please show me the data for all these centuries in which stocks went up 1 million percent, or are we talking about just one, the 20th? The last 24 hours have admittedly seen some of the most desperate short covering from a heavily leaning market, but I don't think one should extrapolate too much from this.

About the bailout: Maybe these measures will "save the system," but there's a huge cost involved for Mr Taxpayer. And as Mr Taxpayer is also Mr Voter I wouldn't want to bet against his supporting some heavy handed regulation by those seeking office. Not to mention the fact that he's being hit real hard in the wallet region by this mess.

James Sogi comments:

J SogiThe problem with the rescue plan and the upcoming regulation is that the creators of the plan are filled with hubris. Why should these few men with limited experience and knowledge compared to the smartest people of the entire financial world be able to solve the problems that the entire financial world was unable to? Like central planners around the world, they will just create new problems and backlogs and inefficiencies that were so prevalent in the authoritarian and socialist countries.

The country is sliding into socialism, which is the extension of the moral hazard. Where there is no more risk, there will be little reward. On the television, the prevailing meme seems to be the bailout is for the benefit of the greedy Wall street moguls and is paid for by Joe Sixpack. In any case, it will create new opportunities as cycles change yet again. Today's S&P high from yesterday's low was the greatest up move. This is a signal of new cycles, just as much as February 28, 2007 was a signal to move into a high vol cycle. The definition of cycles resists quantitative testing, so the qualitative will have to suffice.

Alex Castaldo takes a turn to the left:

Why should these few men with limited experience and knowledge compared to the smartest people of the entire financial world be able to solve the problems that the entire financial world was unable to? — James Sogi.

Yes, but don't we also need to revise downward our estimate of how smart the so-called smartest people were? When the Warren Spector's, the Dick Fuld's, etc. etc. issue so much mortgage debt to people who now can't pay, that the entire financial system is put at risk, can we really continue to call them the smartest people?

Irrespective of that (…maybe I would have made the same error…), doesn't it make sense at this point to have the "smartest people" take a time out while the second-rate people in government (and I fully agree that they are second rate) try to patch up the problem so the game can resume again? Or do we just let the system blow up because the mistakes were made in good faith by the smartest people available at the time?

Don't tell me that markets are better than Soviet style central planning, Mr. Sogi, I already know that. Tell me what is to be done under these circumstances.

Someone told me today that the nationalisation of AIG is just like what happens in France and Argentina. I am sorry but again I have to disagree. The French government ran Air France for 40 years. The AIG measure is temporary; rather than a nationalisation in the Argentinian sense I would call it a controlled liquidation of AIG. Rather than be liquidated immediately (as was about to happen) they will do so gradually over two years; rather than receive subsidies from the Argentinian government they will have to pay LIBOR plus 8%, a punitive rate, etc. The differences are major. Let's not put all government interventions on the same plane.

Back to the "smartest people" issue. The analogy I see is the following: you have been operated on by the best available surgeon; unfortunately he made a mistake and left a clamp in your abdomen before sewing you up. It is midnight on a Saturday and the only available surgeon is a semi-retired practitioner of average skills. Would you agree to have him operate on you to save your life? It may well be that you would have not agreed to be operated on by this guy in the first place. But what do you do now?

[Disclosure: Alex is a depositor of Washington Mutual and owns Morgan Stanley stock].

James Sogi replies:

J SogiIt is the spoiled child syndrome. Each time the spoiled child is saved from his mistakes, errors, rudeness, tantrums – he is inadvertently being trained to make these mistakes again. Better to mete out a measured negative punishment, time out, a reprimand, or suffering the consequences of bad behavior. Soon the child learns. There are behavioral cycles, adaptive mechanisms inherent in nature and free markets. By tampering with these, we end up with worse and worse swings as the adjusters over-adjust. Better to let Dick Fuld, and the overborrowers, take the hit. The entire financial system will not fail. It will start up again the next day no matter what happens. It may look different. There may be different players, but it will be there.

Remember the bitter pills Volcker dealt out in the 1980s with 24% mortgage rates, 14- 17% bonds. I saw many people take the hit. But inflation was crushed, and we enjoyed 20 years of moderation and prosperity. That was worth the price. Those who make bad choices should not be bailed out. It will encourage wild swings. It's the Greenspan Put all over again. If people know there's no second chance, they won't take the risks. If they do, they should be entitled to their profit or the pain of failure. When you do it your way, there is no cleansing cycles, and the toxin remains. Like Japan. It's just hiding the problems and they'll resurface somewhere else. Better to kill it now.

Let the big banks, big brokerages go down. New ones will take their place, smaller, faster moving. The market will find a way.


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