Friday September 19, 2008 1:37 p.m. (with additional material on Sunday afternoon)
The American Government has wisely announced that it will with the approval of Congress create an agency to relieve the beleagured financial sector of its bad mortgages in order to remove the toxic influence of these products and prevent them from further poisoning the economic system. The full details are not yet available but it is likely that these bad debts will be bought up for a fraction of their value , mothballed and then over time resold as Brady style assets at a discount below their original value but possibly at prices above those that the Government acquires them at. In return for this there will be a complete overhaul of the regulations governing Wall street and the plethora of financial derivatives that have caused the current damage.The Fed has also taken steps to restore confidence to the mutual market funds by providing additional credit facilities through its discount window up to the value to $230 billion. The S.E.C. has also announced that it has banished the short selling of stocks for some 700 plus financial corporations. These are all good measures.
All the details must still be revealed but the news of this massive bailout which will run into the 100s of billions,[the rumour is 700 billion] according to Secretary of the Treasury Paulson, has led to a steep rise in stock prices with the index in New York now up over 330 points. So this week so far we have seen the index drop 800 points in two days of panic selling and in the past two days so far rise almost all the way back.
However , if we examine the trajectory of stock prices since August of last year and compare it with the path of the S and P index from 1929 to 1930 there are some eerie parallels. The 1929 to 1933 chart is available in Friedman and Schwartz 's classic work A Monetary History of the United States 1867-1960, Chart 29, p.304 and the Wall Street Journal, the New York Times and other sources provide us with the contemporary situation.
It is not a cheery picture and not for the faint of heart.
With respect to the bailout the Democrats are demanding that homeowners in trouble with their mortgages also be helped and that a new infrastructure oriented stimulus package be added to the proposal. This is also a good idea so long as it does not lead to wrangling that prevents the bill from being passed.
To limit the damage to ordinary taxpayers it is essential that the new agency not pay top dollar for toxic assets but does buy them for a not life threatening discount off the nominal values to the institution selling them. In addition the government should consider receiving stock warranties from the firms involved.Eventually because these debts are linked to real real estate assets they will be worth something significant and can be sold off to recoup some if not all of the taxpayers' money.
The grotesquely overpaid executives who are responsible for the mess should also be called to account.This is something that has the support of both Senator McCain and Senator Obama and most of the American people.
Given the size of the bailout the treasury and its agent the Fed will be selling bonds. The appetite for these bonds as safe investments will be enormous guaranteeing low rates. Institutions and people will be restocking their portfolios with these debt instruments. In addition the government is seeking approval to expand its debt to over 11 trillion dollars or about 82 % of the GDP. A good portion of the newly issued government debt will be purchased by government pension plans, internal agencies and some also by the Fed itself.
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