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10/1/2008

Moral Hazard, The Great Experiment in American Capitalism WAS On, Catharsis, Tainted News

6:30AM New York time. If there was ever a day/time to bend the rules and let myself go for multiple titles, it was today. It’s not every day you get to watch history get made.

First off… let me make a couple of observations. If you watch the financial news, you would get the impression that without the Paulson Plan, (of whoever’s name is on it now) the entire financial system will come crashing down. If you watch the network nightly news, the Financial Crisis of 2008 is just another news item. When I first saw the original hearings and House members didn’t sound sold, the people I talked to in the markets told me I was wrong… this is just for show to the voters back home… I was told. Passage is a done deal. Then the bill failed. Wall Street was shocked and mortified at the initial defeat. And now they are now saying yesterday’s rally was on news of the resurrection of the Plan in some other form. If you ask me, equity prices were already recovering BEFORE House members tried to resurrect the “Plan”. Maybe there was some talk going around on Monday night to try again, but from what I saw, Asian and then European markets were stable to higher well before there was serious talk that the Plan could still be passed. Besides, if the rally were really based on a resurrection of the plan… why was the dollar up so sharply with gold lower in the aftermath of the defeat? My conclusion; we are dealing with heavily tainted news and analysis from Wall Street. They are fighting for their professional lives and will work to sell this plan and the doomsday scenario for the economy in its absence, no matter how much they need to bend the truth or skew perception. Other than for a quick check of prices, I am no longer watching CNBC at home, nor listening to Bloomberg Radio while on the road. I had thought the bounce yesterday (especially early) would have nailed the coffin shut on the plan, but the financial press quickly seized on expectations of a resurrection as the reason for the bounce. I wasn’t watching, but a market friend said CNBC commentators were blasting Wells Fargo for walking away form Wachovia on Monday, saying Wells has the cleanest balance sheet around, why wouldn’t they do it? WHY DO YOU THINK WELLS HAS A CLEAN BALNCE SHEET?!! It was and continues to be willing to walk away from what it sees as imprudent risk.

By the way… for the record… at this very moment… as resurrection of the plan comes closer to reality, what are US stocks doing? They are in fact lower. The Dollar rally has stalled and gold is higher. Personally, I think the markets are telling us the direction they want things to go.

When I first heard news of the defeat I was actually excited. Since I, (along with everyone else in the financial industry) thought the Plan was going to pass, I thought the alternative was not worth considering. But once it became a possibility… I found it exhilarating. I have been living through change in a world of counterintuitive result for the past 8 years in oyster land. It has forced me to be more of an observer of events rather than a predictor of events. I gleefully proclaim how little I know. It’s like wanting Barak Obama as president. The single biggest draw for me is that electing him would not only make history, but it would shake up the system, make the world scratch its collective head at how fast things can turn around in this country. It’s the same for the Paulson Plan. The unexpected outcome was defeat, and the unexpected result would have been the sky not falling, stocks recovering faster than expected, and the whole system hanging together and doing surprisingly well thank you. Not only would we have closure, but we would have avoided serious moral hazard. We would have actually held to our principals, principles that say, if you take risk in a capitalist system, you have to own those risks. When I put a trade on, it’s my ass on the line. If I lose, my broker doesn’t console me and put the money back in the account. Losing is in fact how I learn to become a better trader. I found myself thrilled that the Government would not be taking on that huge slug of debt. Yes some institutions would fail, some companies would not be able to get credit, but in the end I felt strongly that the system, our American Capitalist System, would survive, recover, and in time, thrive again. The great experiment was on! I saw the news as a positive for the Dollar. Now the federal government would have plenty of money where it was needed, the FDIC, to protect the true innocent third parties, the depositors.

Just two days later we are back in limbo, and the road we embark on is still undecided. In the beginning, I wasn’t sure how I wanted things to go. Now I think we have been given a sneak peek at one of the potential outcomes, and aside from one climactic day, that outcome didn’t look so bad. I think the other road, the road we continue to force and be force-fed will be far worse.

I’ll allow myself this one prediction. If the plan passes, stocks rally briefly and then sell off again, probably making news lows before year-end. The Dollar rally ends and it rolls over, gold goes on to big new highs. If the Bill fails, stocks hold the lows, the Dollar holds its gains, and gold consolidates around current levels. If the bill fails, the sky doesn’t fall, banks don’t fail en masse, and life goes on. Recession is a foregone conclusion in either case, but hey… we haven’t had one in a while and they are part of the cleansing process. The worst-case scenario in my book is passage of the plan, which ultimately proves insufficient; Treasury and the Fed have to go back to Congress in early 09. There is no resolution, no closure… the problem just drags on and on… a bottomless pit of funding that digs the US deeper and deeper into debt.

Steve Plant

FXA

Please email Steve Plant with any questions or comments

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