The Fed’s ‘Bad Bank’ could make the financial crisis worse
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Associate Editor
David Stevenson Sep 19, 2008
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Take advantage of the bounce to dump financial stocks
Turn on this morning’s business programmes, and what do you see?
In the middle of the worst financial crisis since 1974 - or is it 1929? -and share prices are soaring all round the world. As I write, the FTSE 100 is up 8%!
Why? Seems the so-called financial ‘authorities’ have had enough. Despite bigger and bigger bailouts, the nationalisation of large chunks of the US financial system – and part of the UK’s too – and pumping more cash into the money markets than Croesus could count, they hadn’t been able to stem the tide.
So the latest effort contains yet more stellar wheezes.
“Let’s set up a new firm to take over all that dud debt at the root of the problem. And while we’re at it, let’s stop people ‘shorting’ – i.e. selling shares they don’t own in the hope of buying them back later at a lower price – all those bank stocks whose prices have been plunging.” (That temporary shorting ban, by the way, includes 29 UK financial firms and 799 in the US. And the Fed will be acting as backer to money market funds, too).
This must do the trick, mustn’t it? Surely everything’s going to be all right now?
Well, no actually, it won’t. Here’s why.
On shorting, inevitably we’ve seen plenty of drivel about ‘spivs’ from politicians wanting their media moment. But as my colleague John Stepek points out today, shorting isn’t the problem. Brutal it may be, yet it’s just a symptom of a much deeper malaise.
And banning it merely adds to the sense of things being out of control. Short-selling “undoubtedly speeds up a share price in decline”, says Damien Reece in The Telegraph, but “these kind of panic measures after the event reduce, not increase, confidence”.
Then there’s the dud debt fund, or ‘Bad Bank’ as several pundits have described it. The proposal set to go before US Congress involves “moving troubled assets from the balance sheets of American financial companies onto a new institution”, says Bloomberg.
“I think the market’s just so relieved to see somebody doing something,” said Pavlic Investment Advisors’ portfolio manager Terence Pavlic, referring to the bounce.
We can understand the relief. But sadly, that’s all there is to this rally. Because all those dodgy loans won’t disappear overnight. They’ll just be shovelled onto the poor old American taxpayer, already lumbered with a massive possible $900bn (£496bn) bill for pledges on the bailouts so far.
Nor will property prices benefit. In fact, “we may just be prolonging the housing slump”, says Republican Congressman Scott Garrett. “We should let the markets work”. Peter Boockvar at Miller Tabak agrees that unless the Fed stops interfering, Wall Street's problems will continue. “The market can get to the right price on its own. Anything that prevents it from happening is just prolonging the inevitable”.
And with lots more defaults in the pipeline, this new deal might be the last straw. “A giant dumpster for illiquid assets brings up the troubling question of whether the US government is big enough to take on the whole problem”, says Mirko Mikelic at Fifth Third Asset Management.
“Random bailouts confuse markets”, says Professor Joseph Mason of Louisiana State University. “Such a policy will certainly draw out the economic effects of the crisis for far longer than would otherwise be the case.” And as Peter Schiff of Euro Pacific Capital puts it, “every time the authorities intervene, they do more harm than good.”
So it’s only a matter of time before that share price rally goes the way of the last one, i.e. disappears into thin air. But at least it’s a chance to dump any remaining financial stocks you have left – provided, of course, that you don’t sell them short.
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