Tuesday, September 30, 2008

Dude! Where's my meltdown?

I was promised a historic meltdown. Buffett himself promised me one. Where is my historic friggin meltdown?!

With congress rejecting the Paulson bailout plan, the dow dropped by 777 points. We were treated to headlines about "Biggest Point Drop Ever!" Naturally, anybody who has more than a dollar in the market knows that percentage drops are all that matter. A drop 777 points does not make even the top 10 list of all-time point drops; it barely makes the top 20 list at number 18.

Hey congress! Don't you have elections coming up? If I were you, I'd go home and try to get reelected before this legislative fiasco does any more damage to your careers. And stop the fear mongering game. That hasn't been fashionable since Saddam was in power.

Lest I leave you with the wrong idea, I do think that Federal intervention will be necessary to clean up the mess that investment banks have left us with over the past decade. However, the Paulson plan was probably the worst way to approach the problem. Fundamentally, the crisis of confidence stems from the insolvency of the financials. Their balance sheets would have negative net worth if the tsunami of foreclosures were properly discounted, so the Paulson plan did everything it could to prop up the banks with money as well as hide the securities tied to mortgages.

As an investor, why on earth would I return to the market and buy shares in a company that I know was insolvent yesterday, but is solvent today because congress changed the definition of solvency? Furthermore, the companies got themselves into major trouble because of colossal mismanagement of their investments. Having proved themselves to be terrible investors of their own money, why would the Treasury reward them with a $700B investment and think that they have suddenly become great investors?

There is a very straightforward way to deal with these insolvencies. The prescription? The companies should be forced into receivership (the alphabet soup of aid from the Fed is keeping them alive at the moment), then wipe out the shareholders, haircut the bonds, fire the board and CEO, recapitalize, and reboot.

Naturally, the process is painful, but the sooner we get started, the sooner we get back to health.

Finally, I don't agree with everything Ron Paul says, but he delivers a good description of the problem from his testimony yesterday:

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