Behind the Scenes at the Credit Crisis
By: Dr. Charles Lieberman
Date: 9/29/2008
The public discussion includes so much nonsense, politics, and statements from vested interests that the public is very confused over the nature of the current crisis. So it is not at all surprising that professionals and investors are spending lots of time trying to figure out both what is happening and the implications of any new structures that might be approved. I think thats the reason it appears that many people reject any agreement of a "bailout". So, I will try to clarify the issues.
First and foremost, the purpose of the package is to improve liquidity in the credit markets to rejuvenate mortgage and other forms of lending. Without credit availability, consumers will experience even greater credit scarcity. If they are unable to obtain a mortgage, then sellers cannot sell, so both parties are damaged. Moreover, consumers may also be unable to borrow to finance college tuition, auto purchases, or other durables. Thus, a lack of credit availability is an enormous problem for Main Street. If demand weakens because consumers are unable to obtain credit, then manufacturing firms will cut back productions, laying off workers, further impairing the overall economy. Thus, the credit crisis will directly damage Main Street, even if the operations of Wall Street are curtailed most directly. Contrary to popular belief, this is not just a Wall Street problem.
Second, it is inappropriate and misleading to describe this as a bailout package and, most certainly, it is not a bailout of Wall Street. That it is billed as a bailout is pure mislabeling, misunderstanding or politics. The program would purchase investment assets in the market at market prices. Sellers are not being forced to sell. Nor, will sellers be paid more than the assets are worth. Thus, it makes no sense to impose severe penalties on sellers for their willingness to participate in the program by selling some of their loans or securities because the government is bailing them out. Thus, proposals to demand warrants, shares, pay limits, and such on any firm that participates in the program are either designed to destroy the value of the program, or to pander to the public sentiment on a purely political basis. With such penalties, sellers may prefer to sell directly in the market, even if they are forced to take a lower price. But more likely, they will not sell at all, keeping credit very tight.
Why is the public so opposed to a deal? I think the public fails to appreciate the severity of the problem, partly because it is mislabeled as a bailout and, partly, because most Americans do not understand the nature of the underlying problems. Many of the problems originated in the securities markets, because credit was badly underwritten in the sub-prime mortgage market, but this ultimately undercut confidence in the credit system and clogged up credit flows between firms. These problems arose because numerous other parts of our system failed to function properly or normally, including government oversight, regulatory, and accounting. Few of these system failures affect consumers directly, making it possible for the average consumer to think these problems will not affect them, and allowing people to think politicians should not bail out Wall Street. That judgment is incorrect. Unfortunately, if these systems fail to function, it is just a matter of time, likely a short period of time, before the adverse effects afflict consumers from conducting every day business as usual.
What is the role of politics in this negotiation? Politics would be a key element in any such negotiation under the best of circumstances, but with just weeks before a Presidential election, the politics of this debate are even more intense than usual. Subtle and not-so-subtle efforts to blame the other side, politically charged provisions proposed as part of the deal, and public posturing before the cameras is very intense and hinders any kind of timely compromise. Both sides are playing chicken, risking a market meltdown as they jockey for position.
What will be the ultimate outcome? I think it likely that some sort of compromise will be reached, but not without going right up against any deadline, and quite possibly, beyond any deadline. First, any deadline is purely artificial, so it is not really binding. That encourages the two sides to keep playing chicken to try to extract better terms. The only real deadline is the markets tolerance of the negotiations before investors become totally disgusted and sell off securities sharply and indiscriminately. That, of course, would force the negotiators back to the table to work out a deal. The role of politics is deadly in this process. Neither side can tolerate being blamed for failing to reach an agreement. Neither side will be able to take the fallout on the broad economy that the politicians know will occur. So, neither side can walk away from the bargaining table.
So, where how do things unfold from here? It is hard to be confident about the precise details of any compromise. I expect a deal to include a significant authority that allows the U.S. Treasury to purchase a sizeable dollar value of securities in the market. Beyond that, everything is up for negotiation. We will try to provide an analysis as soon as the details emerge. Download this article in PDF Format
About Advisors Capital Management, LLC
Advisors Capital Management, LLC (ACM) is a provider of managed portfolios and financial services for industry professionals and their clients. As investment strategist, Dr. Lieberman oversees the company's "Portfolio Partners" investment program. Additionally, he provides guidance to the ACM Wealth Coordinators who integrate the work of financial advisors, financial planning, tax, estate and portfolio management professionals to build, protect, and maintain clients' wealth. Although the information included in this report has been obtained from sources Advisors Capital Management, LLC believes to be reliable; we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
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