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Five Things You Need to Know: Will the Bailout Succeed?


Although unprecedented in magnitude, the solution proposed by the Treasury is hardly unique.


It's just past midday on the first Monday after the "Troubled Asset Relief Program" (TARP) proposal. The market is down 2.5% and things feel tense and weird, as if we are teetering close to the edge of something dangerous and unpredictable. That combination is usually all it takes to encourage the lurid thrill seekers while raising the hackles of the authorities. And indeed, that's precisely where we find ourselves, that strange place between aggressive fun and oppressive violence.

Much of this weird tension today stems directly from Treasury Secretary Hank Paulson's rounds yesterday on the Sunday morning news shows. His behavior was jarringly disturbing and erratic. On "This Week" with George Stephanopolous, Paulson could barely answer a single question without glancing nervously over his shoulder like a man who had just escaped from a medical detention center hurriedly explaining his side of the story to a passing motorist.

And what was his side of the story? Well, that is the awful crux of it. There was no side; there was simply "The Abyss." We have "narrowly avoided it," according to some. We have "stared into it and stepped back," according to others. Some say we have "faced it." Still others, that we "came within hair of plunging into it." But no one anywhere will say with any definitive completeness what, exactly, "The Abyss" is.

Shortly after Paulson disintegrated into a sweaty, jabbering mess under the TV lights on "This Week,' Senator Christopher Dodd (D-CT) and Representative John Boehner (R-OH) appeared.

"What is it will happen if we don't have this legislation?" Stephanopolous asked. It's a reasonable question. In fact, it's the only reasonable question.

The answer from Dodd and Boehner? Silence. Pressed, Boehner said, "You can't describe on Sunday morning how ugly this picture would look if we don't act."

"Why not?"

No answer.

Ok, we'll skip that part for now. How about this, will it work? Although unprecedented in magnitude, the solution proposed by the Treasury is hardly unique.

The TARP being proposed falls somewhere on the other side of both the Resolution Trust Corporation that was created to handle the Savings & Loan crisis in 1989 and the Reconstruction Finance Corporation created in 1932 to deal with massive bank failures and the inability to get credit into the economy.

How did markets respond to the Reconstruction Finance Corp. passage in 1932?

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What about the RTC in 1989?

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And today?

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Keep in mind, the RTC came eight years into one of the the largest bull market in history. Know where the Dow and S&P 500 were eight years ago? 11,388 and 1255, respectively.

Meanwhile, I continue to get questions like the following:

Do you see similarities between what is happening now in the U.S. and what transpired in Japan, in the 90s?

There are some similarities, yes. But there are differences too. The main difference is if the TARP is approved, it could forestall the lingering malignancy of dead banks walking, transferring their bad assets onto the U.S. Government balance sheet. The main similarity is that while the situation may not last as long as the Japanese deflation, the purchase of bad assets by the Government does not make those assets suddenly good.

The problem is too much real estate supply at too high prices compounded by leverage. Another key difference between U.S. and Japan is that the Japanese consumer was a net saver. A critical difference between Japan consumers and U.S. consumers is the extraordinary relative divergence in the personal savings level and personal balance sheet comfort level.

Japan consumers entered a corporate balance sheet recession with very high savings rate, savings that never fell much below 3% even at the very heart of the quantitative easing policy that destroyed savings incentives. The U.S. consumer is entering worse business conditions with an almost 0% savings rate and a very thin cushion. Moreover, this debt unwind has been mainly isolated to Wall Street and mortgage debt and mortgage-related leveraged instruments for now, but it is quickly spreading to other areas of the economy.

There is only one thing necessary to understanding what is happening and it is this: no one at U.S. Banks, no one at the Federal Reserve and no one in politics can accept the reality that real estate assets in this country remain oversupplied, overpriced and overleveraged.

It is that simple.

TAF, TSLF, SuperSIV, TARP, none of that matters. No matter what acronym is created to disguise the fact that assets are overpriced, or what government intervention is created to prop up those asset prices, the market will inevitably overpower it. This time is not different. In fact, it is continuing to play out almost exactly as the Great Depression did. The bottom line is that despite the proposed bailout, whatever form it may take, risk in owning stocks has increased, not decreased.

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No positions in stocks mentioned.

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