First it was Bear Stearns. Then the government bailed out Fannie Mae and Freddie Mac. Before the ink was dry on that deal, Uncle Sam loaned $85 billion to insurance giant AIG in exchange for an 80% stake in the company. Along the way, the Fed has been throwing money every which way, depending on the day.
But wait: there’s more. In the last 24 hours, a new round of government bailout efforts are underway. Yesterday, Congressional, Federal Reserve and Treasury officials were talking of launching a massive government fund to buy up the toxic securities from investment banks and other institutions. Meanwhile, the SEC announced a ban on short selling on nearly 800 financial stocks. And the Treasury is now insuring money market funds to shore up sentiment in the wake of news that the Reserve Fund—a money market portfolio—broke the buck this week, i.e., its net asset value fell below $1. The drop stoked fears that even cash equivalents might not be safe.
The government, in other words, is throwing everything but the kitchen sink at the bear market. There’s some logic to this, of course. Preventing bank runs and the like is just common sense. But how much is too much? Or too little? Alas, intervention is an art, not a science. Financial turmoil of the degree we’ve seen this week is rare, and so there’s not a lot of precedent. The early 1930s are an obvious era for study, but the relevance is limited, since two or three things have changed the days of FDR and “brother can you spare a dime.”
Meanwhile, asset prices want to fall, and interest rates want to rise (i.e., those rates that involve private parties that can’t print their own money). But the government is doing everything in its power to keep Mr. Market from having his way. This is reasonable, up to a point, although it’s a safe bet that it’ll take time before we know where reason ended and moral hazard began.
One can be forgiven for wondering if the latest batch of fixes will fare any better than the previous ones. Since the Bear Stearns bailout earlier this year, each new “solution” was initially greeted with cheers in the stock market only to be followed by more selling. Will the new efforts hit pay dirt?
Maybe. But it’s debatable if government intervention, massive though it is in cumulative terms these past months, can engineer a bullish aura of any duration.
For the moment, however, hope springs eternal. Out of the gate this morning, stocks surged skyward. But after the warm glow of yet another government intervention cools, how much bullish enthusiasm will remain? As troubling as the toxic securities problem is, it’s still a symptom of deeper problems, starting with the correcting real estate market. Meanwhile, there’s the issue of consumer spending, which was already faltering before the latest ills went ballistic. It’s hard to imagine that Joe Sixpack will take inspiration from all the news and run out and buy a new wide-screen TV.
The government can keep bailing out firms, buying up securities no one else wants, and guaranteeing money market funds. But the cycle will have its way eventually, in part because sentiment and psychology can’t be denied.
It’s worth repeating the reality that prices want to fall and interest rates want to rise. It’s not clear that the government can change that reality. And while the government theoretically has access to unlimited amounts money to throw at problems, in practice there’s a limit if only because the dollar is regularly valued vis a vis other currencies and gold. At some point, cranking up the printing presses to bail out Acme Finance is self-defeating because the marginal gains of injecting liquidity are more than offset by a slump in the purchasing power of the buck.
Of course, we’re talking of medium- and long-term worries, and for the moment all the concern is about what happens in two hours. But at some point the fires will stop burning, the smoke will clear and the crowd will look out six months or a year and reassess prices and interest rates. This much is clear: fundamentals will regain their place as the dominant force in pricing. Exactly when that happens is unclear. Meantime, it’s all noise.
Remember, too, that financial crises are nothing new, nor are interventions of one sort or another. In the panic of 1907, for instance, J.P. Morgan–the man–orchestrated a private-sector-based bailout. In one sense, we’re not in uncharted territory in 2008. The future, on the other hand, is always unknown.
The details of the full government-sponsored bailouts will determine much of what happens in the markets and the economy in coming years. The challenge is that we don’t yet know the details, and the future, well, is still the future. But make no mistake: the price tag will be big, very big. But that’s tomorrow’s worry.