Weekly Biking Playlist: Bailout Edition

Who needs reality TV?

I’m sure readers have read tomes on the bailout and probably have pretty strong negative positions on it already.  It’s sickening all the way around — everyone agrees on that.  I’m less sure that readers truly know what the stakes are.  After all, constant cries of “economic crisis” doesn’t really say much about what specifically is going on.  My take is as follows:

Michael “Mish” Shedlock has been ringing the alarm for months now that the US is going through a deflationary process.  I believe that Bernanke & Paulson are staring deep into the eyes of deflation and this bailout is their attempt to battle it.

What the banks need aren’t more loans or insurance (they have access to both via the various Fed facilities and credit default swaps, though insurance would remove some of the counterparty risk).  What the banks need is capital — money that they don’t need to pay back and BTW, they need a lot of it because there’s a deep black hole in the financial sector.  Capital goes in and doesn’t come back — just ask TPG (WaMu) or the myriad sovereign wealth funds who have bottom-fished in financials only to see their investments plummet — all because quite simply, houses in Sacramento suburbs weren’t worth $500k (try under $200k) and most office buildings aren’t worth billions of dollars.  So that money’s gone and the capital being pumped in so far is just being sucked up by the losses from the previous binge.

Until now, I had never questioned that the inevitable outcome would be the Fed’s triumph over deflation and as a result, I expected major inflation and currency devaluation in the US.  Apparently, helicopter cash drops are more difficult than Helicopter Ben made it seem in his infamous speech.  Now, with the drama manufactured by McCain, Bernanke’s attempts to reinflate the system seem inplausibly at risk.  We may now need to see tangible evidence of Depression-like conditions as opposed to just Paulson/Bernanke verbal handwringing to get consensus on DC for action.

I do not know how this will play out.  I’m skeptical that Paulson’s plan will even work if he manages to get it passed. I do think investors need to ponder the possibility of harsh economic conditions, to imagine reversion back to the days when quality stocks traded at 5 or 6 times earnings with 5%+ yields.  Stocks went nowhere for a whole decade during the 70′s.  Is it possible that the commonly held truism that U.S. stocks always go up over the long run is an anomoly, a by-product of an unsustainable, debt-fueled binge that took root in the 80′s and is finishing out its run now?  Reading some of the older investment books, I am always blown away about folks like Graham talking about how you could buy widely known stocks at 5 PEs or buying stocks for less than net working capital.  Can the markets crash to such an extent that we see those days again?  Who knows but I think it vital that we allow ourselves to imagine that possibility.

I’ve made quite a few changes to my portfolio and have modified some of my investing strategy (actually, enforcing may be more accurate than modifying).  I will detail those in my month-end portfolio update next week.  In the meantime, I spent much of the week listening to financial interviews as opposed to music.

Marc Faber: $5 Trillion Possible in Credit Losses (Bloomberg 09/26/2008)

Here’s the link to the Bloomberg summary; just click the link in the right “Related Video” pane to see the interview.  Faber is not always right all of the time (who can be?) but he is always well-reasoned and frankly, whenever I disagree with him with money on the line, I get VERY VERY NERVOUS.

Minyanville: The Credit Markets Have the Answer (via Mish)

Mish has a nice link to this post that gives you insight into what’s happening in the credit markets.  The stock market has been consistently wrong compared to the credit markets during this crisis.  LIBOR, the TED spread, the bond market have all resoundingly put in their verdict and it’s not good.

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