Fed's Latest $800B Plan: Will it Work?
Wednesday, November 26, 2008 | Teeka TiwariRating:
[Editor's Note: All of us in the Tycoon family are taking some time off for the Thanksgiving holiday. We'll be back on Monday, December 1. Happy Thanksgiving, Tycoon readers!]
Ah it’s good to be the king! When you can make money appear out of thin air, have little to no oversight and can make decisions that affect the lives of billions of people, how can you not feel like a king? Hank Paulson and Fed Chairman Ben Bernanke now have more power over the global economy than any ancient ruler of old.
I’m not suggesting that these fellows are doing anything untoward, but it is a little unnerving how much power these guys have. What happens if either one has a heart attack or slips in the tub? Will the rest of the financial system slip away with them? Does anybody in the government even know how to handle our current economic situation? It sure looks like they are making it up as they go along.
The latest scheme hatched by the brilliant minds at the Fed involves another $800 billion being pumped into the finance system.
Here’s the problem, the Fed and the Treasury have been pumping billions of pesos err … I mean dollars into the banking system in an attempt to shore up their balance sheets and spur lending, but the banks are refusing to lend. The consumer finance market in particular has collapsed, I mean seriously disappeared. We went from doing $50 billion in consumer finance backed bonds back in October 2007 (which was already a slow month) to a measly $500 million in October 2008.
That’s terrifying for the Fed because it means that we are looking at a complete shutdown of consumer-driven purchases. Consumer credit is the grease of consumer spending. Without it, the whole machine seizes up. It’s not all the banks' fault either. Fear of impending job losses is causing many Americans to ratchet back their lifestyle in a big way. Even if consumer credit were readily available, I don’t know that we’d see a stampede of people taking advantage of it.
The Fed is proposing making $200 billion available through what they call a “term asset-backed securities loan facility” or TALF. It’s essentially going to be used to support bonds that are backed by consumer and small business debt like credit cards, student loans, and auto loans. In the past the providers of consumer credit would simply package their loan portfolios into bonds, sell them off, and originate more loans.
What’s happening now is that no one is buying these bonds so the loan originators don’t have the liquidity they need to make more loans. Let’s look at this logically; can we really blame the marketplace for not wanting to buy great big slugs of American credit card and auto loan debt right now???
Will a government guarantee even matter? Fannie's and Freddie's bonds are government guaranteed, but they are still trading like they have the black plague. This recent initiative just doesn’t look like enough to get liquidity back into the consumer debt market.
From a macro point of view, the consumer still has a ways to go before bottoming out. Consumer spending hasn’t bottomed yet, consumer credit defaults haven’t bottomed yet, and most importantly unemployment hasn’t bottomed yet. Until that actually occurs or there is a market perception of that occurring at a specific time in the future, then the consumer credit market will remain on lockdown.
Put yourself in the shoes of an institutional risk manager. As a professional, you want to be expanding credit into an economic up cycle and contracting credit during an economic down cycle. Why would you accelerate your lending going into a down cycle? It makes no sense for the Fed to try and incentivize lending going into a down cycle. It’s actually irresponsible. Try as he might, Ben Bernanke and the U.S. economy are not above the inexorable power of the business cycle, nobody is.
So what turns this around?
The number 1 issue plaguing both debt and equity markets right now is lack of earnings and business conditions visibility. Until that visibility returns, we will be mired in the to-and-fro of a manic depressive, sentiment-driven stock market. As soon as the smart money can get a clear bead on when business conditions and corporate earnings have bottomed, we will see this market have an explosive and prolonged move to the upside.
We as investors want to keep our eyes out for some of the tell-tale signs. They include stabilizing housing prices, stabilizing building permits, declining foreclosures, upside earnings surprises, and consumer and business credit expansion.
Think about this, when housing does finally stabilize, it will set the stage for a torrent of new bank lending which will reignite both consumers and corporations. Every month that housing prices go down, the banks have to keep marking down their vast real estate portfolios. When the bottom finally hits in housing, the banks will be in a position where their net capital will actually be increasing each quarter, not declining. They will be able to lend against a growing equity base rather than a shrinking one. In short, they will have the confidence to lend again that comes with asset value visibility.
So my recommendation is to look at housing. It’s the banks' biggest asset, as soon as housing prices stop going down, the banks will start lending again and it will be the beginning of a brand, new up cycle.
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“Let the Game Come to You.”
Teeka Tiwari
Chief Investment Officer
Point & Profit
