Bailout People not Banks

Looks like someone thought the Bailout was a good idea (the whole damn market). The market lost over $1.4 trillion in market capitalization today after the failed bailout. I'm tired of hearing about the "constituents" that are contacting their representatives to hold up the bailout plan. This is not a time to ignore the doctor's orders and subscribe to some herbal remedy. We have elected these representatives not to control their every vote, but for their principles and ability to make the right decisions for our country's future. The loud obnoxious populist minority "constituents" need to pipe down and let our representatives listen to some truly credible advisers.

Crystal Ball

Looks like some people do have crystal balls. Check out this article from 1999.

http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260&sec=&spon=&pagewanted=1

Monetary Phenomenons

I recently attended an industry conference for equity funds where the relationship of rate of return to risk, and supply and demand was brought into question. Funds were primarily attributing their increased offered rate of return to the decline in investor demand for their product. Some Funds were however suggesting that a higher rate of return may imply higher overall risk.

Rate of return for investments typically correlates positively to the underlying risk of the investment. While this premise seems accurate, it should only be applied under constant circumstances. At any given time it would be fair to evaluate different investments’ risk based on their return as long as external monetary factors are held constant. Investors try to measure this risk by using a risk premium, the additional return they require over risk-free investments.

If outside monetary factors such as the supply of money are changing, risk premiums under one set of circumstances are not comparable to those of another monetary situation. When the supply of money is reduced as it has been during the current credit contraction, returns will be greater for that reason alone regardless of investment risk. This is a relationship that was developed by Milton Freedman in his book Capitalism and Freedom where he explains why inflation is purely a monetary phenomenon.

Unfair value accounting

Fair value accounting has been discussed widely recently and deserves comment from a free market advocate. First off, having confidence in free markets is not the same as thinking market values represent useful information. Useful and transparent information is the purpose of attempting to implement fair value accounting. Seems reasonable, however there are several inherent flaws.

Unfortunately markets are not efficient in the short term i.e. the measurement date used for financial reporting. These short term inefficiencies when interpreted as fair value can cause unnecessary volatility in firm’s balance sheets and reek havoc with the slightest amount of leverage. Warren Buffet uses the analogy that if you buy a farm, you don’t hire an appraiser to come out every day an tell you what it’s worth. Just because the market produces a price on a measurement date does not mean they are producing a reasonable value. By definition, a market is only capturing data from a few of the parties involved in a particular asset. The transaction is taking place between two parties who believe they are benefiting from a favorable price, that’s why they are making the transaction to begin with. What the market price does not consider is all of the parties that are not able to come to an agreement, because their perceptions of value are too far apart for the particular asset. Fair value accounting is in essence forcing these two holdout parties to accept the price set by the transactions and reflect that on their balance sheet.

What is the value of an asset that currently has a market price $70 and a 5% dividend? Under traditional valuation methods, this assets value would be some discounted factor of the future dividend income and a projected sale price. Using fair value accounting, the asset would be valued at the market price. The market has valued the following assets at $70 or more in the past year: Bear Sterns, Fannie Mae, Freddie Mac, Lehman Brothers, Ambac, AIG, etc… Fact is the market was dead wrong on every one of these firms and was extremely inefficient in the short term.

Bailout - Yeeeeaaaaaaaahhhh

Can't let $700 Billion go by with out a little critique. First off, I don't really think it's all that much; it's only about $2,300 per capita. Next if people way smarter than the average person are the ones proposing this maybe we should listen. Henry Paulson did manage to run the most successful investment bank for quite some time (one that is still around).

The politics of the plan are at best despicable. First the blame game, then they play savior of the Free World (Nancy Pilosi & Barney Frank should kiss off, they've had plenty of chances to regulate and both were around during the Clinton administration when many regulations were lifted). This is also not the time to implement every populist regulation legislators can think up either, put those in on their own merit later.

Who knows what the economics of the plan are, no government has ever spent $700 Billion in a week. Proponents claim financial disaster if we don't act and detractors claim skyrocketing inflation and an untamable deficit. It's unlikely either is completely correct in their views, although I would error on the side of some of the smartest bankers in the World. Finally, the gov't is not really spending $700 Billion, they are buying these "worthless" securities and are going resell them at a later date. Once a market returns for the securities whatever the price, they will be sold back possibly at a loss or potentially at a gain.

The bailout could be too small - If the $700 Billion is not enough to provide a sufficient market in these securities, competition in the auctions will be too much and they will still sell at a depressed value. Once these auctions begin they will also serve as a "market price" for similar securities that some banks may not want to sell or be able to sell due to the size of the bailout. Similar securities may then have to be marked down further due to these auctions.