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Tags: bailouts

Bailout Band-Aids Will Break Us

Wednesday, 17 September 2008 04:52 PM

Agencies of the U.S. government have implemented numerous actions over the past 14 months to try to prevent the United States from entering a recession and to stabilize equity prices. Yet the economy has continued to struggle, and stock prices have fallen sharply since the government first intervened in the markets last August.

In addition to lowering the target federal funds rate seven times and dramatically increasing the money supply since September 2007, the Federal Reserve has interceded an amazing 34 times in the financial markets over the past 14 months, primarily by providing liquid U.S. Treasury securities to investment-banking firms in exchange for those companies’ holdings of illiquid mortgage-backed securities.

In other words, the Fed has essentially bailed out private business enterprises that pay their employees exorbitant salaries while lowering the value of assets held by ordinary people (via higher inflation) and potentially increasing the taxes that Americans will need to pay during the years ahead to compensate for the worthless mortgage-backed assets now held by the Fed.

On March 14, 2008, the Fed orchestrated the JPMorgan acquisition of Bear Stearns & Co., which was on the verge of going bankrupt due to the falling value of the firm’s holdings of mortgage-backed securities.

More specifically, the Fed indirectly provided a 28-day emergency loan to Bear Stearns (via an agreement with JPMorgan) to prevent an expected stock market crash in the event that Bear Stearns became insolvent.

Yesterday morning, the Fed decided to lend $85 billion to American International Group (AIG), the nation’s largest insurer, in an attempt to prevent that company from going bankrupt. Although spokespersons for AIG claim that the company is solvent, AIG is unable to pay all of its monthly bills because it is now required to provide additional collateral to creditors after the company’s credit ratings were reduced.

In addition to the Fed’s numerous interventions, the U.S. Treasury Department announced on Sept. 7 that it was in the process of taking over Fannie Mae and Freddie Mac because those publicly-traded companies had become insolvent.

In other words, our so-called government representatives at the Treasury Department decided that every American taxpayer should bail out two poorly-run business enterprises that previously paid regular cash dividends to their investors and paid their top executives enormous sums of money.

For example, Fannie Mae’s previous CEO was paid a $987,000 salary in 2007, a $2.3 million bonus, and a total compensation (including stock) of $11.6 million.

Not to be outdone, Congress decided on July 31 (via a new housing bill) to provide financial relief to hundreds of thousands of persons who signed mortgage agreements to live in homes that they can’t afford. The bill raised the national debt ceiling by $800 billion (to $10.6 trillion) and created risks for taxpayers that are virtually impossible to calculate.

Now, presidential candidate Barack Obama wants to get in on the action by proposing that the U.S. government — that is, the taxpayers — spend $130 billion a year in new government programs over the next 10 years. Obama essentially believes that the government can solve the nation’s economic problems.

Meanwhile, John McCain wants to create a 9/11-type commission to figure out the cause of the ongoing financial fiasco.

Pretty sad, isn’t it? Obama apparently thinks that money grows on trees, and McCain still doesn’t know the causes behind the nation’s credit crunch.

What should investors do?

Although I disagree vehemently with the type of socialistic actions proposed, I do believe in the old adage that “If you can’t beat them, join them!” Not by asking for my own share of government handouts —in effect, by stealing from other Americans — but by studying the likely effects of those actions and proposals and then investing in securities that will likely benefit from actions.

For instance, my research suggests that commercial banks will significantly benefit from the government’s financial bailouts over the next 18 months. I’m therefore closely monitoring a few exchange-traded funds (ETFs) that hold a diversified portfolio of bank stocks.

Meanwhile, subscribers to my investment newsletter, The ETF Strategist, are actually making money from the recent decline in equity prices via an inverse-index fund that I recently recommended to them.

Click here if you’d like to be kept informed of my findings by trying a free trial subscription to The ETF Strategist.

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Agencies of the U.S. government have implemented numerous actions over the past 14 months to try to prevent the United States from entering a recession and to stabilize equity prices. Yet the economy has continued to struggle, and stock prices have fallen sharply since the...
Wednesday, 17 September 2008 04:52 PM
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