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Historic Bailout Vote: House, Senate Vote On Bailout Plan To 'Rescue' Financial Markets – Can It?
Updated 2:19 p.m. Thursday, Oct. 2.
Two days after the failed house vote on the bailout plan sent lawmakers and government officials scrambling, the U.S. Senate passes a so-called “rescue plan” for Wall Street and the U.S. economy.
The original bill was submitted jointly by the White House, the Federal Reserve and the U.S. Treasury, but grew from 3 pages to more than 450 after tumultuous debate in Congress.
A simple majority in the U.S. House of Representatives rejected the bailout plan on Monday, with 205 “ayes” and 228 “nays.”
According to news reports, the Senate added multiple special interest provisions to pacify on-the-fence congress people. But one question remains: Will this bailout plan – or “rescue” effort, if you prefer the government's term for it – save the financial markets?
This article offers excerpts from Bob Prechter and his colleagues, regarding bailouts in general and this bailout specifically.
In his book Pioneering Studies of Socionomics, Prechter speaks poignantly in a chapter titled “When Do Bailouts Occur?” – he identifies a distinguishable trend in bailouts as they relate to market activity.
Figure 1
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Bailouts occur near stock market lows, when the mood is the opposite of that near peaks. As you can see in [Figure 1], Lockheed Aircraft and Penn Central Railroad applied for aid in March and May 1970, as the stock market was crashing into its biggest low in 28 years. (Aid was approved in December 1970 and August 1971.) In another bailout of Penn Central and several other northeastern railroads, Congress created Conrail in 1974, the final year of the biggest bear market since 1937-1942. (It took two separate “federal investments” of $2.1 billion in 1976 and $1.2 billion in 1980, as real stock prices continued falling, to keep Conrail on track.) The government’s initial rescue of Continental Illinois bank came in May 1984, at the bottom of a fear-laden “wave two” stock market correction. (It was completed with a $4.5 billion FDIC package in late July.) Following the 1987 crash and the sluggish, mostly sideways year of 1988, Congress established the Resolution Trust Corporation on February 6, 1989 to bailout a slew of failed savings and loan institutions. Its creation marked the beginning of the biggest financial bailout in U.S. history.
Obviously, these were bailouts of major U.S. companies. The $700 billion bailout, eh’em... rescue plan, is much larger. It involves an entire credit system, not one company. And that distinction matters.
Prechter’s colleagues Steve Hochberg and Pete Kendall explain why that distinction is important, to wit: Bailouts frequently mark
a price low, but not necessarily
THE price low. Hochberg and Kendall have this to say in their
latest issue of The Elliott Wave Financial Forecast.
The bull market is over, but the bailout craze is running at “fever pitch.” In less than a month, the Federal government moved to issue a trillion dollars in U.S. Treasuries to back bailout loans; took over Fannie Mae and Freddie Mac, as well as the world’s largest insurance company, American International Group (AIG); and banned short selling on financial and other stocks. As these pages discussed last month, it won’t work.
Figure 2
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Obviously, we still await the all-important “uncle point” in the government’s bid to stave off decline, but as the September issue of The Elliott Wave Theorist noted, the markets “are not so dumb as to wait for it. They can already see the end of the road, and are moving ahead of it.” Outside of the market, the first concrete sign of an end to the era of moral hazard is the decision to let Lehman Brothers go bankrupt. With more than $600 billion in pre-bankruptcy assets, Lehman was easily the largest Chapter 11 filing in history. WorldCom, the prior record holder, had “merely” $100 billion in assets. Lehman was also bigger and more diversified than Bear Stearns, which was deemed too big to fail just last March. Another signal of the bailout plan’s eventual fate is what happened to the stock market after AIG became the property of U.S. taxpayers. In contrast to the temporary lows that coincided with Bear Stearns’ shotgun marriage to JPMorgan Chase last March and the federal “protection” extended to Fannie/Freddie in mid-July, the stock market greeted AIG’s surprise takeover by falling, and not to just any level. [See Figure 2] It fell below the Dow’s Minor wave 1 low of 10,827.70 on July 15. It did so again early this week after the Feds hatched a plan to create a whole new government agency that will purchase distressed financial assets of up to $700 billion at a time. This action confirms that the bear market is alive and kicking. As EWFF noted here last month, “In a long-term bear market, prices keep declining beneath the bailout lows.” [Figure 2] shows the key break of the bailout low in the NASDAQ.
Another multifaceted indicator of the bear market’s presence and extraordinary downside potential is all the different ways in which the bailouts are backfiring. The effort isn’t opening up the credit markets as so many had hoped, for example; it’s closing them. Bank of America refused to extend any further loans to McDonald’s for espresso machines, citing its financial commitment to take over Merrill Lynch. “Even well-known brands such as McDonald’s face difficulties financing expansions,” says Bloomberg. Then there’s the “reverse auction” pricing mechanism that will use actual market prices to establish a value for distressed assets in the Treasury’s $700 billion bailout plan. As EWFF has previously discussed, the complete inability to establish prices in this environment of obfuscation and manipulation is one of the keys to keeping the fantasy of solvency alive. This step toward more accurately assessing asset values is bad news for regional banks, as it will suddenly give them “a more concrete way of benchmarking just how far their own assets have declined.” The takeover of Fannie and Freddie also cratered the value of their preferred stock, which accounts for 11% of the core capital of the average bank. Apparently the bailout cowboys never saw that one coming. Moreover, one of the more punitive edicts from the Securities and Exchange Commission, the ban on short selling, won’t help liquidity; it will hurt it. This unintended bearish consequence was covered on page 200 in Conquer the Crash:
"Sometimes authorities outlaw short selling. In doing so, they remove the one class of investors that must buy. Every short sale must be covered, i.e., the stock must be purchased to close the trade. A ban on short selling creates a market with no latent buying power at all, making it even less liquid than it was. Then it can dribble down day after day, unhindered by the buying of nervous shorts."
Once the government-sponsored short squeeze of September 19 was over, this is exactly what happened. Stocks dribbled lower through Wednesday. As of the September 18 low, the Dow was down 26% from its October 2007 peak despite one bailout after another, each one weakening the federal balance sheet in ways that will undoubtedly contribute to the severity of the decline.
Finally, there is the whole point of the government’s extraordinary actions, the restoration of confidence. “The government needs to step in and inspire confidence,” goes the oft-repeated refrain. Of course, the harder anyone tries to prop up confidence, the less confident people get. “The only way it will work,” says columnist Jonathan Weil of Bloomberg, “is if people like you, think other people like you, think other people like you, will think it will work.” Here’s how President Bush sees it: “At first, I thought we could deal with the problem one issue at a time. The house of cards was much bigger and started to stretch beyond Wall Street. When one card started to go, we worried about the whole deck going down.” We did a double-take on this statement. Did the President of the United States describe the U.S. financial system as a “house of cards?” Indeed he did, and, in doing so, he took the words right out of Conquer the Crash: “Confidence is the only thing holding up this giant house of cards.” The presidential avowal of a position that was once considered by some to be among the most radical statements offered in CTC goes straight to the book’s main point—at its core, it’s a psychological process. The deflationary depression therein described must surely be unfolding.