The ten percent drop in equities over the last 6 days has left investors stunned and policy makers/government officials looking emasculated. And the hits keep coming with the announcement yesterday that AIG wants to ease it's terms with the US government. CNBC reported that the 80 percent government owned company is in discussions to secure an additional $60 billion in new funds. Today, we have JP Morgan Chase cutting their dividend 87% in a surprise move that is sure to send other companies scurrying to do the same. On top of the rumors of nationalization, there appears to be no end in sight for the market adjustment of earnings expectations and stock valuation.
Today, we'll be reminded of the core issue that is behind the doom and gloom. The S&P/CaseShiller Home Price Index was expected to be down 18.3% and this is the same level of March 2004. This will continue to put pressure on home prices and on the related derivatives held by banks and commonly known as toxic assets. This takes us back to what is the solution for this sector?
- Housing Prices Tumble 18.5% to Another New Low
When things were calmer, the approach was a case by case basis for deciding what to do with the entity under duress. Now, the environment is pandemic and the solution must be the widest possible to ensure a staunching of the pain.
This has led to fascinating and troubling discussions over the nature of the capitalist system and whether the US financial system should be purged of "greed". The former chairman of the US Federal Reserve and killer of 1970s inflation, Paul Volker discussed his vision of what the new form should be. "In the future, we are going to need a financial system which is not going to be so prone to crisis and certainly will not be prone to the severity of a crisis of this sort. Financial systems always fluctuate and go up and down and have crises, but let’s not have a big crisis that undermines the whole economy. And if that’s the kind of financial system we want and should have, it’s going to be different from the financial system that has developed in the last 20 years."
Volker's solution is to develop a financial form of oligopoly to protect a core group of financial firms. This would mean government deciding the winners and losers in the industry, wiping out/merging the others, and then regulating the remaining to ensure stability of "service part of the financial system." This appears similar to what happened to WaMu as common, preferred, and debt holders are all wiped out with the remaining operations merged into another company.
This has disturbing ramifications for the rest of the financial community especially if we are to believe the US Treasury's statement yesterday that the US banks are well capitalized. This raises the question of how will the government decide who loses the most in a plan to save the economy/financial system: Equity, debt, or taxpayers?
Who gets to make these decisions and where will it stop?
While the markets are calling for action, the voters are losing faith, and the government reaches further into the economy, there seems to be a lack of perspective to create a comprehensive vision of where we will end up from these decisions and if this destination is where we want to go.
Let's watch President Obama tonight to see if he clarifies his vision of this new world.