Newsletters 2008 Newsletters The Calgary is Here (10/08)
Tuesday, 04 October 2011 10:47
The markets have been thrown into a state of chaos during the past 30 days, in large part due to the uncertainty surrounding the differing, reactive measures used to abate each crisis as it arose and the “whose next” mentality that occurred as a result. When Bear Stearns was delivered into the arms of J.P. Morgan a seeming eternity ago, the Fed offered J.P. Morgan a $30 billion guarantee to J.P. Morgan and introduced a certain expectation (“moral hazard”) of how future potential episodes might be handled.
Yet with each episode that followed Bear Stearns, the government reacted in “band-aid” manner and surprisingly handled each crisis in very different ways. Fannie Mae and Freddie Mac have been nationalized with the equity holders now virtually wiped out and the debt holders receiving the full faith and credit of the United States. Lehman Brothers was allowed to fail, so equity holders lost their entire investment and bondholders will have to muddle through bankruptcy proceedings. AIG was provided an $85 billion loan in exchange for 79.9% of AIG equity, essentially a conservatorship. Bank of America paid $50 billion for Merrill Lynch, liabilities and all. The FDIC engineered the rescue of Washington Mutual by handing all the deposits, assets and branches to J.P. Morgan, leaving the bond owners holding the bag. And finally Wachovia was forced into the arms of Citigroup who was to assume all assets and liabilities, that is until Well Fargo emerged with a bid of its own for all of Wachovia.
In many ways, the fear currently witnessed in today’s markets is an aftershock of all the above that has already passed and is already known. While the market certainly fears the unknown economic consequences for what has transpired, the cavalry has finally arrived and the Paulson Plan (enacted as the Troubled Asset Relief Program or TARP) is the first attempt at a systemic rather than piecemeal solution.
The TARP plan gives Treasury a $750 billion authority to acquire mortgage securities from troubled banks, removing the toxic assets that have forced banks to hoard capital and hampered their ability to lend. The Treasury possesses the only balance sheet large enough to own these troubled assets and hold them to maturity. It is widely expected, confirmed by the likes of Bill Gross and Warren Buffet, that taxpayers will eventually be made whole in this rescue plan and may even make money.
In addition, TARP raises FDIC insurance limits on bank deposits from $100,000 to $250,000, eases the alternative minimum tax burden, increases important research and development tax credits and reaffirms the SEC’s existing authority to suspend “mark-to-market” accounting. In addition to TARP, monetary authorities worldwide joined together for an unprecedented synchronized rate cut. The Federal Reserve, Bank of England, European Central Bank, Sveriges Riksbank of Sweden, the Banks of Canada and Swiss National Bank all lowered interest rates by 50 basis points. The Reserve Bank of Australia cut rates by a full percentage point. And Asian central banks followed with 25 basis point cuts in South Korea, Hong Kong and Taiwan and a 27 basis point cut in China. Perhaps the most unique nature of the current crisis is its global scope, which necessarily requires a global solution. It is widely expected that further cuts are in the pipeline.
Other important policy initiatives include the Fed providing an unlimited backstop for the commercial paper market, a 12-month guarantee for funds in money markets held prior to September 19th for subscribing fund companies, an Internal Revenue Service tax law modification that allows acquiring banks to recognize tax benefits on loan write-downs at target banks immediately rather than over many years and the ability for U.S. companies to repatriate foreign domiciled funds without tax penalty.
Taken together, we are confident that these measures will eventually thaw out the credit markets, put a floor beneath the housing market and get the economy back on track. The recovery will take time, but the global firepower unleashed (and that still yet to come) to combat today’s market ills is truly unprecedented.
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