The Pundits Strike Out
Here at "A Dash" we try to focus on the implications of public policy for investors. We have opinions about the best policies. We also try to distinguish between the citizen role and the analyst role.
Most of the punditry has been unrelentingly bearish for months. Nothing was working. Nothing would work. All solutions would fail.
Meanwhile, there is a key question: What will get the economy back on track?
Everyone agrees that 30-1 leverage at investment banks and the unregulated CDS market were mistakes. From this, some conclude that all mortgage investments are "toxic" and that we must return to some historic debt/GDP ratio of olden days.
Perhaps that will happen, but it need not happen at WARP speed. The combination of FAS157 and the interminable delay of the Presidential transition and the development of the Obama Administration plan created a sense of doom — a self-fulfilling prophecy.
A weak economy means lost jobs, little housing demand, more foreclosures, lower home prices, declining asset values, and no incentive for lending.
A solution to economic problems needs to break this cycle. Anything that restores normal and sensible lending will help the economy. Business activity depends upon a normal commercial paper market. It also means that qualified borrowers can get loans for homes, cars, and education.
The so-called "toxic assets" are central to this problem. The mission for Obama and Geithner was to address the issue in a way that restored normal and sensible lending.
The Plan is in Place
There is a simple strength to the plans now proposed: Flexibility. The Administration does not pretend that there is a single solution. There is no presumption about the value of assets now on the books of financial institutions. There is the ability for some institutions to hold assets, probably with mark-to-market relief. Other institutions may choose to sell assets to the new public private investment partnership (PPIP). No one knows how many banks will choose one method over the other, but both will help.
The outlines of the plan have been known for weeks. The federal government is providing non-recourse loans to investors, allowing a high degree of leverage for those bidding on distressed assets. This removes the illiquidity stigma and provides an imbedded "put option" for new investors, as John Hussman notes here, and as we have predicted would occur.
Is This a Good Policy?
The true answer is that no one really knows. It depends upon whether it works. If it succeeds in stabilizing the economy and restoring normal and sensible lending, the government guarantees will not come into play. Investors and the government will profit. If it does not work, the government will experience losses.
Whether this is good policy depends upon the risk of the guarantees compared to the near certainty of further economic declines in the absence of action.
In typically excellent fashion, Abnormal Returns noted yesterday that "the Treasury’s new plan for toxic assets is hopelessly complex and overly generous. Check out the many links in the post. Following up today, Abnormal Returns observed that "the stock market loves the toxic asset plan. Every one else pretty much hates it. Who's correct?" Once again there are many pundit links.
The Pundit Error
The problem for investors is that pundits often stray into long-term opinons about public policy. They often begin with an idea of what assets are worth. They speculate about who will participate, generating over-simplified stereotypes about how financial institutions will react. They look far into the future about possible inflation (not the current issue) and confuse normal lending with excessive leverage.
Briefly put, everyone has been writing bearish posts to be in line with the market and to get visibility. It seems wise.
Only a few observers, like Doug Kass, who called a "generational market bottom" were willing to look ahead at the possible impact of the collection of proposals and the likely impact.
The problem is that the policy implications are difficult to forecast. When you are swinging out of your "happy zone" you are likely to have a lower batting average. Hat tip to Ted Williams.
A Flexible Solution
Regardless of our opinion of the specific solutions, the key question is whether they will work. We like the flexibility of the plans. Some will work better than others, but the collection offers promise.
Our TCA-ETF model picked up the growing market support for these initiatives last week, helping us to a good position for today's market action. The market reaction includes many voting with dollars rather than writing articles. It is meaningful.
We repeat our frequent message: Investors should put aside policy opinions and focus on the immediate effects.