Dow Syndrome

I’m back again for a pre-Thanksgiving dose of vitriole.  

Is it possible, I wonder, for anybody who doesn’t know anything about business or economics to shut the fuck up for the remainder of the financial crisis?

I am just so totally sick to death of turning on the TV and seeing these half-smart half-wits coughing-up furballs over their half-understanding of what’s going on. The greatest indicator of ignorance is when the commentator makes reference to what the Dow did during the course of the day as though that were some sort of final verdict on the effectiveness of the action taken that day.

There are so many reasons that that is not true. Here are a few:

1) A simple market dictum: “buy the rumor, sell the fact”. When people think good news is coming, they tend to bid-up the stock market. When it comes, it’s almost never as good as they hoped (the very act of bidding things up induces a frothiness that inflates expectations even further than the initial cause for optimism) and so they sell into strength. We saw this a lot during the early stages of the “bailout” discussions - markets rallied on the rumor that there would be a big bailout, then dipped a bit when it was announced. They dropped a lot when the bailout collapsed but rebounded when it was announced that the congress was going to vote on it again. When it finally passed, the market barely moved. The movements of the Dow are totally out of synch with the day’s headlines, if you are taking only a simpleton’s view of cause and effect. Stop it.

2) The bailout package is “evolving”.

I’m not a big fan of the way Paulson has handled some aspects of the bailout. Some of the decisions he made are clear only to have been mistakes in retrospect. My biggest complaint with Paulson is the arrogant Goldman Sachs approach he and his cronies have taken at every step here, from the 3 page bailout bill which insisted on no oversight, to the initial refusal to accept provisions that punished Wall Street bankers or gave taxpayers a chance of getting their money back or gave any relief to home owners, through to his appointment of Neil “the chump” Kashkari. It’s over-confident Dicks like Kashkari that (partially) got us into this mess, and the idea of bailing out people like him that infuriates taxpayers.

But one thing I can’t really fault him for is the way the bailout package, or packages, have changed from week-to-week.

Nobody knew how big the problem was, or where the bodies were buried, and nobody really knows what it will take to get money flowing again. Perhaps he could have made this more clear at the beginning, instead of suggesting that the three page $700 billion (a number we now know was pulled from thin air, or somewhere more suspect) was the final answer. He also could have been stricter about closing loopholes and preventing abuse. There is no good reason to allow GMAC to become a “bank holding company” to get part of the bailout money, or to allow banks to pay big “retention” bonuses to top executives, none of whom have the immediate prospect of another job.

Given the changing environment, the rapidly developing news and the lack of any useful blueprint on how to deal with this kind of situation, he has had to improvise and experiment as he went. I would like to have seen the experiments structured a little better (again, this is clearer in hindsight). For instance, the initial infusion of cash into the banking system should have a) been a little smaller and b) come with a provision that said that if the money wasn’t put to work in the form of loans to businesses and restructuring of home loans, it would be taken back within 45 days. Instead, the banks are sitting on whatever cash they have been given to bolster their own stability, while the rest of the economy is being squeezed.

My guess is, the people who are adding up the totals of each version of the plan that comes out as though each one is additive will prove to be way off in terms of the total cost of the bailout. Some of this is because a lot of the money being pumped in to various institutions is in the form of loans, or equity stakes, or buying troubled assets. All of these stand a good chance of recouping most of the cash outlay. Some of the money is in the form of guarantees - for example the government has “only” parted with $20 billion in cash to Citigroup, with the $306 billion number being for guarantees; the theory being that if the government guarantees the debts, the creditors won’t panic and call it - that money will probably never get spent. Also, some of the money is being re-purposed. The initial TARP program (the “$700 billion bailout”) wasn’t working, but most of that money had not been spent. So, what hadn’t been spent is being spent on TARP II, the Citi bailout etc

When you just read the headlines and add-up the numbers, the totals seem enormous, but between the overlaps, the guarantees that wont get called and the “investments” that should pay back, my guess is the total cost of this bailout will, over five years, be much smaller than it appears now

3) There were two things inflating the Dow in the last few years: one was unsustainable amounts of debt flowing through all sectors of the economy (LBOs, home mortgages, credit cards, leveraged stock investing) and the other was unrealistic expectations about the economy. The former has been sucked out of the stock market’s value with alarming rapidity - that’s why the Dow is down around 40% for the year. But the market is only just beginning to impound the reality of the underlying economy: rising unemployment, declining real household incomes etc etc. Good news - however temporary - like the price of oil coming down, is conflicting with bad news - which may be more lasting - as the effects of both the real economy (people with fewer jobs and less money) meet up with the effects of the financial crisis (less credit available for everything).

On any given day, changes in the Dow reflect an attempt by the market to accurately reflect hundreds of pieces of news about individual companies and the economy as a hole. Given how unprecedented some of the news is and how difficult to judge some of the rest of it is, I wouldn’t be surprised to see the Dow experiencing a lot of volatility in the next few months, with an overall downward trend (though who knows how much further down).

So, on any given day, don’t confuse what is happening with the Dow with any kind of instant market reaction to the headlines of the day. Leave that to the dickheads on CNBC.