Agora Financial’s Rude Awakening

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Laguna Beach, California

·      Throwing the TARP over the corpses of America’s worst performers,
·      A closer look at Wall Street’s “cash-hemorrhaging” finance companies
·      A graphical display of the grotesque bear market anatomy and more…

Eric Fry, reporting from Laguna Beach, California…

Treasury Secretary Henry Paulson appeared before the House Financial Services Committee Tuesday to provide an update on the Treasury’s spiffy, new $700 billion Troubled Asset Relief Program (T.A.R.P).

Secretary Paulson repeatedly reminded the Committee members that the TARP’s initial mandate was to re-liquify the banking sector so that banks might resume “normal” lending activities. But some members of the Committee repeatedly suggested that the TARP might do even more…like re-liquify the auto sector…or re-liquify the growing community of mortgage-defaulters.

Your editors here at the Rude Awakening have been entertaining a related thought, “Why not re-liquify the stock market?” Is there any troubled asset that needs relief more urgently than the stock market?

This deeply troubled asset tumbled another 427 points yesterday, bringing it to fresh 5-year lows. It’s clear the stock market could use some federal assistance.

During the last several months, many investors have declared “the bottom” of the bear market. So far, many investors have been wrong. The bottom may be drawing near, but it hasn’t arrived just yet. The chart below depicts the hypothetical outcome of buying an S&P 500 Index fund on each of the last eight Friday’s.
Notice a pattern? Every single purchase would have produced a loss. Not ONE would have produced a gain.

This chart tells us absolutely nothing about the future, but it shows us very clearly just how painful – and treacherous – the recent past has been. The chart also shows us very clearly that the Treasury’s bailout efforts to date have failed to produce any measurable benefit for the stock market. The economy isn’t looking too spry either.

The TARP, which is the most celebrated of all the Treasury’s newly minted bailout acronyms, made a splashy debut by “investing” $25 billion apiece in nine of America’s largest finance companies. These unprecedented handouts, Fed Chairman Ben Bernanke explained Tuesday, “[were] critical for restoring confidence and promoting the return of credit markets to more normal functioning.”

Maybe so, but signs of “normal functioning” in the credit markets remain more hope than substance. Meanwhile, signs of the normal dis-functioning on Capital Hill remain all too real. Back on September 29, the House of Representatives defeated the initial version of the TARP because it would have cost too much.
Just a few weeks later, however, a kind of bailout mania has gripped the nation, and almost no one bothers to ask how much the bailouts will cost, or where the money will come from.

We’ve simply stopped counting. But on some level, somewhere deep down, every American knows that the bailouts aren’t free. Every American knows that we’ve borrowed a heck of a lot more money than we could ever actually repay. But are we worried? Not really. Lenders worry more than borrowers.

And so we continue to borrow money and continue to avoid uncomfortable questions about repayment schedules and continue to toss around billions of dollars of bailout funds as if we just won them at a roulette table. Nevertheless, the nation’s financial sector continues to implode, little by little, day by day.

Perhaps the banking sector, and the nation at large, would have been even worse off without all the federal bailout programs. But as the Treasury adds zeros and digits to its various “lending facilities,” the financial sector adds zeros and digits to its quarterly losses.

In other words, this bailout stuff isn’t going so well…which suggests at least two courses of action: 1) Investors should still steer clear of the finance sector and 2) Investors should not yet abandon all hope for gold; inflation might surprise on the upside.

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Bailout Fatigue Syndrome
By Eric J. Fry

When the Treasury finally abandons its bailout programs and/or the executives at the cash-hemorrhaging finance companies finally exhibit more humility than chutzpah, the economy and the stock market will have reached the bottom.

But it doesn’t feel like we’re there just yet…

So far, the Treasury Department, Federal Reserve and FDIC have cobbled together about $2 trillion worth of bailout programs, along with an unknown-trillion-dollars worth of implied and actual guarantees. What do we have to show for all of this financial firepower? Nothing more than a smoldering pile market capitalization and implausible declarations of victory.

Bailouts aren’t all bad, they’re just mostly bad. They’re bad because they tend to subsidize failure, rather than to underwrite future success. Failure consumes capital investment, success multiplies it. Like UN food programs, bailouts tend to land in the hands of crafty despots, rather than needy orphans. In other words, bailouts tend to produce exactly the sort of capital misallocation that prolongs economic stasis and impedes recovery.

When the TARP tosses billions of dollars at a hodgepodge of finance companies, for example, does it actually save anything of long-term economic value or does it merely preserve museum pieces?

The Treasury has funneled $150 billion into the AIG cesspool, but the beleaguered insurance company continues to stink up the place. The company just posted a fresh $25 billion loss in the third quarter, and is probably amassing another multi-billion-dollar losses for next quarter. And yet, somehow, in the tortured logic of the powers that be, it’s okay to waste $150 billion on AIG, but not to waste $25 billion on GM, Chrysler and Ford.

The logic, if you can follow this, is that AIG’s failure would be a “systemic risk,” GM’s failure would merely be a catastrophic. To be clear, GM doesn’t deserve a bailout any more than AIG does…or any less. AIG miscalculated in such a spectacular fashion that it will receive six times the money that GM will NOT receive. Does that make sense?

In some ways, yes. No one wants a systemic risk walking around on the streets. But at the same time, what do we gain over the long term by resuscitating a model of incompetence like AIG, when we could be investing billions in lots of competent enterprises.

If the brain trust at AIG did not realize that policy-holders sometimes file a claim, too bad for AIG. It should go bankrupt. A blind monkey could write an insurance policy without considering the risk of a claim. A blind monkey could also figure out that if you write lots of policies on the identical risk – or family of related risks – you can kiss your actuarial assumptions goodbye. But blind monkeys almost never rise to the top ranks of a major insurance company.

We’ve got nothing against blind monkeys, but we don’t believe they should receive multi-billion bailouts from the Federal Government. Because, you see, when blind monkeys fail, sighted mammals can take their place, and usually operate a business more successfully. That’s called, “Economic Darwinism”…and we could probably use a little more of that about now.

If we’re going to waste $700 billion…or $2 trillion…let’s waste it on the folks who are building successful businesses…not on the folks who have demonstrated a penchant for colossal failure. Alternatively, let’s waste it on the folks who are trying to save their homes. In other words, let’s waste it on the effort to restructure existing mortgages. As a last resort, we could waste $2 trillion subsidizing journalists who write daily financial columns containing the words, “Rude Awakening.” But this would truly be a last resort.

If the government really wanted to INVEST the TARP funds, rather than squander them, it would buy a $25 billion interest in America’s nine BEST companies (whatever those might be). But that’s not the TARP’s mission. The TARP’s mission is to throw good money after bad, with the hope that the bad money becomes good again.

Good luck.

The TARP, itself, is a troubled asset. In fact, this particular tarp is beginning to look an awful lot like a shroud – an ornately embroidered gossamer that the Treasury Department is wrapping around the lifeless remains of the financial sector. The Treasury Department continues to insist that this shroud…er, tarp…will restore the financial sector to new life and vitality. We don’t believe it.

The financial sector is more King Tut than Lazarus. It will not come back to life, at least not in anything resembling its current form; it is dead already. The pyramids and the gold and the perfumes did not make King Tut any less dead. His 5-star Egyptian mummification/spa treatment did not bring him back to life. Likewise, dressing the ashen frame of brain-dead finance companies in $700 billion worth of bailout baubles will serve only one purpose – to send $700 billion into the afterlife as well.

Don’t send your money there too. Beware the financial sector…still.

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[Rude Endnote: Only time will tell whether the bear market pattern outlined in the above chart will continue to spill red across traders’ screens. That said, early indicators don’t bode well for a refreshingly green day in the markets today.

Asian stocks took yesterday’s U.S. selloff as their cue to shed a few more billion in shareholder wealth. The stronger Yen hampered Japan’s export sector, which slumped 7.7% in October compared to the same period last year. By the day’s close the Nikkei had slouched 6.9%.

Hong Kong’s Hang Seng and the Aussie All Ordinaries index fell 4.2% and 4.3% respectively while South Korea’s Kospi ended down 6.7%, posting its eight consecutive loss.

European investors are still digesting the barrage of bad news emanating from all corners of the globe. As we write to you this morning, London’s FTSE is about 2.25% in the red while Gremany’s DAX and France’s CAC are down 2.8% and 3.2% respectively.

A barrel of oil goes for about $52.30 while gold, with a rare splash of green on our screen, is up just over eight bucks at $744 an ounce.

On another note, thanks to all the readers who wrote in with suggestions for your wandering editor on his upcoming tour through India and South East Asia. We’ll be meeting up with local investment experts from Mumbai all the way through to Cambodia and will be sure to bring you the boots-on-ground news.

In case you need to contact us along the way, whether to offer travel or investment tips or any other Rude suggestion, we can be reached at the address below.

Until next time…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com