Busch: Law Of Unintended Consequences: Bad L.U.C.!

Barclay's has turned against current progressive thinking and shunned government bailout money. They have decided to raise their own capital by selling GBP 5.8 billion of convertible notes to Middle East investors. Even though this is dilutive for current shareholders, analysts are praising Barclays for being able to raise the funds without government assistance and the shares rose almost 10% today on the news. Why? LUC.

The money from the UK government comes with restrictions on making dividend payments and that discourages investors from buying the shares. This is why Royal Bank of Scotland, HBOS and Lloyds share prices have all been lagging and will be hindered by government officials making decisions on how to run their businesses. Remember, Lloyds raised their dividends to encourage people to buy the stock prior to the government injections.

About 3 or 4 weeks ago, the US Federal Reserve announced a program to begin buying US commercial paper as a way of unfreezing this market. The CP market had begun to contract at the time and eventually dropped 25% in volume as investors stopped buying this asset class. The Lehman bankruptcy triggered the nuclear explosion in the credit markets that led to the "breaking of the buck" by the Primary Reserve Fund. In turn, this scared money market managers to rush to liquidity by only lending overnight and taking US Treasuries as collateral. The Fed did their part by announcing the CP program which contributed to the lack of issuance. Why? LUC. The program didn't go into effect until October 27th. If you were a money manager, why would you take the risk to buy CP before the program started? It's not surprising that the CP market has zoomed $100 billion in issuance this week and that the US stock market had it's best day on the day the Fed's CP program started.

Next up in the LUC category of "We're From the Government and We're Here To Help", the mortgage bailout plan. The FDIC is working with the US Treasury and Federal Reserve on a plan that would share the costs of restructuring loans for home owners to enable them to avoid foreclosure. For 2008-2010, Moody's estimates that their will be 7.3 million defaults on mortgages with 4.3 million losing their homes. However, the program could actually increase the number of home owners defaulting and then attempting to access the program. Why? LUC. Mortgage holders who can are making timely payments, but are under water on the value of the home have every incentive to restructure the contract.

This is why government is more often the problem not the solution. While progressive politicians like to think they are acting in the best interests of the people, they often ignore the best interests of the economy and enact legislation that has ramifications beyond their level of understanding. Let's face it if Ben Bernanke and Hank Paulson have problems with reaching into the economy, what hope do we have that Congress is going to do a better job? In times of great economic uncertainty, the electorate wants protection and what they perceive as they safety of the state. What they will get will be unintended.



Andrew Busch

Andrew B. Busch here