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MAKING CENTS OUT OF THE NEWS
Blog #11
(September 23rd, 2008)
IT'S THE LIQUIDITY, STUPID!
By Tom McAllister, CFP™
Chaos? Yes. Economic crisis? No. Is the $700 billion government emergency proposal really a "bailout"? Not really.
First of all, as I point out in the Fall 2008 issue of One Man's Opinion (posted on tom.mcallister.com), despite the liquidity crisis in our financial markets, the U.S. economy remains strong. And, while failure to address liquidity issues could, in fact, trigger an economic crisis, liquidity issues are being addressed forcefully, if belatedly, so that at this time no economic crisis exists.
In Blog #10, Rules Gone Wrong, I pointed out two triggers that I believe are responsible for at least a portion of the liquidity problem: a) the new accounting standards requiring financial institutions to "mark assets to the market" on a quarterly basis and b) the elimination of the "up-tick" rule for short sales (which unleashed a torrent of hedge fund selling of financial stocks they did not own.
The failure of our regulatory agencies to track asset pools and dampen volatility has created our present liquidity problems, worst in the U.S. since the Great Depression. There's more than enough blame to go around, that's for sure. The Securities and Exchange Commission failed to foresee the problems. The Federal Reserve allowed the U.S. dollar to depreciate versus the European currencies. Lastly (probably carrying a major part of the blame), Congress tolerated these dollar devaluations, failed to develop a sensible energy program, and allowed deficit spending to spiral out of control, often operating in a partisan gridlock throughout the current administration.
Details of the "The Bailout" are still being worked out. But, what I want to emphasize here is that what is really going to happen is a "buyout" more than a "bailout". The Treasury has asked for $700 billion dollars, yes, but not for giving away! The money is to be used, over the next two years, to purchase troubled assets from financial institutions. (The mechanism will be a sort of "reverse auction" in which the commercial bank or other lender will have to agree to take the lowest amount bid for the package of assets.)
In trying to grasp the concept of this buyout, we must remember that 91% of all mortgages are not in arrears (although some may have had missed payments or are due for an adjustable rate reset that could present a foreclosure risk). In other words, our government will be buying assets. And while the value of those assets is down from their face value, the assets in the aggregate are far from worthless. The government will be buying at sale prices, with a very real possibility that a portion, possibly a very substantial portion, of their "investment" will be recovered in future years.
The whole idea is to provide a "breather" for financial institutions from further markdowns, collection activities, and managing foreclosed property, allowing those institutions to resume normal lending operations. That, in turn, should provide a boost to the economy.
Yes, it's all about liquidiity, and the situation is serious as all get-out. But, speaking of liquidity, I prefer to see this buyout proposal as a glass that is half-full rather than half-empty. Bringing order out of chaos demands levelheaded approaches and levelheaded words. The press seems determined, as per usual, to use the vocabulary of panic. I prefer to share with my clients and blog readers a more measured perspective. From the vantage point of four and half decades serving my financial planning clients and studying the markets, my goal is to help make sense - and cents - out of the news!
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