Flawed $700 Billion Bailout Plan

By: Money_Morning

William Patalon III writes: Even with a congressional compromise having been reached, the $700 billion credit-crisis bailout plan will remain the headline story this week as analysts monitor whether the deal is viewed as a good one, or is ultimately regarded as a flawed deal that can only do damage to the U.S. economy over the long haul.

Indeed, those analysts will watch to see how the stock-and-bond markets open this morning (Monday) as investors "vote" on whether the deal is a good one or not. A lot will depend upon what the so-called "experts" have to say about the long-term prospects of any deal (or non-deal) - and what strategies those experts tell investors to adopt:

Should they avoid "risky" equities at all costs and look to the "safe-haven" of commodities?  And can you label the commodities sector as "safe" during a market in which oil can shoot up $25 a barrel in a single day? And what about money markets, which most investors view as the safest of investment plays: Are more money-market funds close to "breaking the buck," a trend that threatens the most conservative of investors?

Congress seems more concerned about affixing blame than fixing the problem, so it's little wonder that while there was a lot of finger pointing, few of our elected officials were analyzing their own roles in - and responsibilities for - this mess. There were no admissions of that one of the root causes was the lack of legislative oversight. Surely, the next Congress will seek to prevent similar calamities in the future and will rush to enact new (though not necessarily better) laws and regulations.

While everyone already realizes the economy is sluggish, this week will bring further confirmation through reports on labor (unemployment rate, non-farm payroll), manufacturing (ISM index, factory orders), and the U.S. consumer (income/spending, confidence).  Some positive surprises sure would be nice.

Market Matters

Ah, the theater of politics…let the grandstanding begin.  Apparently, when a U.S. treasury secretary, Federal Reserve chairman or even a president speaks, House Republicans (and a presidential candidate) don't listen (especially in an election year).  Throughout the week, Congress grilled the powers-that-be about the specifics of the $700 billion government bailout plan; at one point, they appeared to have reached an agreement by adding provisions on executive compensation and equity interest in those participating firms.  But before the "I's" were dotted and "T's" crossed, disgruntled House of Representative members offered their own "insurance-based" plan (that, of course, included tax breaks), which U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. and many banking experts called "unworkable." U.S. Sen. John McCain, R-Ariz., (apparently now a renowned economist) appeared to have sided with this vocal minority, ceased campaigning, and even tried to reschedule the first presidential debate to focus on these matters (and to further pander to certain constituencies), while Sen. Barack Obama, D-Ill., preached "change").

Meanwhile, U.S. Federal Reserve Chairman Ben S. Bernanke warned that inaction could lead to " recession, higher unemployment, and increased foreclosures ." Even global investing icon Warren Buffett, whose Berkshire Hathaway Corp. ( BRK.A , BRK.B ) just made a confidence-building, $5 billion investment in Goldman Sachs Group Inc. ( GS ) , urged Congress to act now and said " he could understand the anger… but action was needed ."

 While most people would agree that the bailout is far from an optimal solution, inaction could lead to the worst economic times since the Great Depression .  Despite the politicizing, some form of a deal most likely will be passed (and just in time for Congress to hit the campaign trail).  But it will take years to evaluate the plan's effectiveness.

While much of the country focused on the bailout, the negative ramifications of the financial meltdown continued.  Washington Mutual Inc. ( WM ) was taken over by the Federal Deposit Insurance Corp. (FDIC) and became the largest bank failure in history.  WaMu's assets were promptly sold to JP Morgan Chase & Co. ( JPM ) , which jumped into first place in terms of domestic banking deposits. 

Meanwhile, Goldman Sachs and Morgan Stanley ( MS ) moved beyond the old investment-banking model to become bank holding companies with the hope that their newfound abilities to accept deposits will improve both their liquidity and their overall operations (even with the increased regulatory oversight). Morgan Stanley also bolstered its balance sheet by selling a 20% interest to Japan's Mitsubishi UFJ Financial Group Inc. (ADR: MTU ), while its country counterpart, Nomura Holdings Inc. (ADR: NMR ) , bought the Asian operations of Lehman Brothers Holdings Inc.'s (OTC: LEHMQ ) for $225 million.

General Electric Co. ( GE ) reduced its earnings expectations , ended its stock repurchase program, and hold its dividend steady through 2009, thus becoming another victim of the financial crisis. This will be the first time in 32 years that it won't boost its dividend .

Commodities remained highly volatile as investors scrambled to make heads or tails out of the bailout deal, and seem to have no idea where to invest their dollars. Oil even soared $25 a barrel in one day, before profit taking ensued and prices eased a bit.

Supply issues in the aftermath of hurricanes Gustav and Ike contributed to the energy uncertainties . Stocks initially took a beating on congressional inaction, rose on prospects for a deal, and fell again once the plan fell apart.

As last week wound down, investors were clearly holding out hope that a deal would be reached by today, with naysayers underscoring that the time for political theater is over - the stakes are simply too high.  

Economically Speaking

While Congress debated the merits of the bailout and the prospects for further fallout, numerous sectors of the economy continue to suffer.  Analysts once considered the U.S. healthcare sector to be immune from a slowdown, though recent data showed that fewer prescriptions were filled in the first half of the year than during that time frame in 2007, a phenomenon that hasn't occurred in more than a decade.

Additionally, an insurance commissioners' survey reported that consumers are visiting their physicians less frequently.  Retailers are declaring "gloom and doom" for the holidays as the National Retail Federation predicted that sales activity will increase by only 2.2%, far less than the 4.4% average growth rate of the prior 10 years (at least it's still a positive number).  On the non-profit front, donations are down all across the country, especially in New York, where organizations rely on the philanthropy of Wall Street.  Finally, a poll conducted by AARP (formerly the American Association of Retired Persons ) found that 27% of employees over age 45 claim they will postpone their plans for retirement because of the uncertain times. 

And the news did not get any better from last week's economic reports.  Housing continued to struggle in August, as existing home sales declined by 2.2%, and new-home sales dropped to their slowest pace in 17 years.  Durable goods orders dropped by 4.5% as the manufacturing sector remained weak, thanks to transportation.  The domestic growth rate, as depicted by 2nd quarter gross domestic product (GDP) was revised down to 2.8% from the 3.3% reported last month, a sign that the prior stimulus package was not nearly as effective as was once believed. 

Weekly Economic Calendar

News and Related Story Links:

• Money Morning News Analysis: Republican Opposition to Paulson's Bailout Plan Stalls Talks .
• Money Morning News Analysis: Buffett's Goldman Deal Has Big Benefits, but What Else is Berkshire Up To?
• Wikipedia: The Great Depression .
• Money Morning News Analysis: JPMorgan Chase Biggest U.S. Bank With Its Purchase of Failed WaMu .
• Money Morning News Analysis: Japan's Nomura Broadens Horizons With Purchase of Bankrupt Lehman Assets .
• Wikipedia: National Retail Federation .
• Money Morning News Analysis: Goldman Sachs, Morgan Stanley Seek Fresh Start as Holding Companies .
• Money Morning News Analysis: GE Cuts Earnings Forecasts Amid U.S. Credit Turmoil, Shifts Focus to Industrial Businesses in China .
• The Financial Times: GE issues second profit warning of the year .
• Money Morning Market Analysis: Hurricane Ike is the Latest Wild Card in the "Guess the Gasoline Price Game."

By William Patalon III
Executive Editor

Money Morning/The Money Map Report

©2008 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.