Bailouts
Sept. 22, 2008
Since I work in the trading industry, I got to see first-hand the market reaction to the recent economic crisis. It has been complete chaos. One of my more cherished beliefs about the free market is that prices in the market are dictated by the unseen forces of supply and demand. Individual decisions of value come together in the market place to set the price of everything, from physical commodities like oil and corn to more abstract notions such as interest rates and risk.
The hidden assumption is that everyone is playing the same game and that the rules won't change in the middle. For the last two weeks this hasn't been true at all. The government, in the form of Treasury Sec. Paulson, has been a much larger influence on the US markets than anything else for the last two weeks. I've watched gigantic market swings every day that would have been unthinkable a month ago. Oil moved up $25 today when the previous record one-day move was $12. The stock market has had some of its largest single day moves ever in the last week, and it seems every day is as volatile as the last. Even the interest rate spreads that I trade, usually rock-stable, have been flying all over the place. It is as if no one can predict the time value of money any more.
To make things worse, the SEC chairman decided to ban short-selling of financial stocks on Friday. Short-selling is the act of selling a stock you don't own because you think the market is going down. A short-seller arranges to borrow the stock from someone who doesn't plan on selling any time soon and pays a small fee to borrow it. Later, if the seller was correct and the market has gone down, they can buy it back at a lower price and profit. This is simply the inverse market operation of buying a stock and selling it at a higher price later for a profit. In my universe (since I trade primarily in futures), selling and buying are equal, symmetrical operations. If I couldn't sell short as easily as I could buy, then I know exactly what would happen - the market would go skyrocketing up. It is as if you turned gravity off temporarily. This is exactly what happened on Friday. The stock market took off, led by the financial stocks which were being protected by the SEC. To see the effect I'm talking about, GE was added to the protected list in the middle of the day and took off, pushing the Dow 50 points higher in a matter of minutes. It was insane.
That was just one part of the chaos. The other is the new plan proposed by Sec. Paulson to buy up all the bad mortgage backed securities with as much as $700 billion. That's about 7% of our entire GDP and more money than we've spent in Iraq so far, so of course that's going to have an effect on the market. The only way the government is going to be able to get that kind of cash is to borrow more money, devaluing our currency even more. Basically we're going to be paying for it in terms of higher taxes as well as increased inflation. Since real wages of the poorest Americans have decreased the last 8 years, this is going to squeeze them even tighter through increased energy and food prices. It is really depressing.
I'm never seen a political ideology fail so hard and so fast as the Bush administration's. To me it seems like we either need to keep banks from getting so large that we need to bail them out, or large banks need to submit to intense regulations and also be banned from lobbying Congress to decrease those regulations. When the players of the game get to write their own rules, they are of course going to write them in a way they can exploit. Our only hope is that these mortgages securities go up in value after the Treasury buys them so that the US makes a profit on this deal. I'm just disgusted that we've gotten into such a mess that the US is required to make a huge bet with the taxpayer's money.