The recently approved bailout is yet another attempt to prop up the markets with an election around that corner that will only delay and worsen the inevitable pain ahead…
There is definitely a lack of trust and confidence in the markets, but it is due to the blatant lies and unethical representations. How many times have we heard an NAR (National Association of Realtors) economist call the bottom in housing? How many times have we heard the reporters on CNBC call a bottom in the equity markets? How many times have we heard phrases like “subprime is contained,” “we’re comfortable with our capital position,” “we have adequate liquidity,” and “the economy is fundamentally sound?”
The benefits of this package are being oversold to Main Street. And many don’t realize that a large part of this funding will be channeled to foreign banks through our domestic institutions. Furthermore, distribution of funds will not be exclusively through reverse auction; therefore preferential distribution—both in funds provided and responsibilities assigned to select agents—is a negative consequence. It is a disaster in the making and we will be left with a really bad hangover in a few months once we realize what happened.
During the early phases of this crisis, capital providers were buying these representations and investing billions of dollars of fresh capital in troubled financial institutions only to find out that portfolio values were not as represented. After sustaining large losses and with the inability to adequately assess risk due to lack of transparency and misrepresentation, capital providers, for the most part, have decided to sit on the sidelines with trillions in capital.
What we really needed was a market solution. I would rather have seen these institutions be forced to mark their portfolios (and their level 3 assets and off-balance sheet assets) to fair value and then raise private capital to fund any solvency gaps. Only when this happens can we truly assess the risks and raise the appropriate capital. Adding capital to these financial institutions may shore up solvency, but we’re still in a recession and lending always tightens when that is the case.
Unfortunately, we are headed for a nasty recession and the bailout will not stem the tides. In my opinion, it’s about time. Economic recessions are the natural cleansing process of an economic cycle and come as a result of excesses that have been built in periods prior. The longer we delay, the worse it will be.
John K. Paglia, PhD, MBA, is an Associate Professor of Finance of the Graziadio School of Business and Management of Pepperdine University.
Related in the GBR
Using Asset Allocation Strategies to Recover from a Bear Hug by John K. Paglia, PhD, FRM, CFM and Ivan C. Roten, PhD
Has the Dow Really Escaped the Bear? by John K. Paglia, PhD,