Buying the Paulson Panic

By Dr. Duru written for One-Twenty

September 28, 2008

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America's democracy still works. Our representatives and appointees in government have crossed ideological divides in a mad dash to save the American economy from financial ruin. This weekend, they appear to have struck a compromise that joins the best efforts of fiscal conservatives, activists for social justice, and lots of folks in between (excluding John McCain's bizarre antics). While certainly nothing is guaranteed until final legislation is drafted and approved by Congress and the President, we should all take a pause and appreciate the constructive (even positive) lessons from this historic moment for our capitalist system and our democracy.

It was the morning of Sept 19, when "Paulson's Panic" became public. Treasury Secretary launched an attempt to ram a quick solution through the halls of government with an ominous call to action:
"The federal government must implement a program to remove these illiquid [mortgage-related] assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion."

Over the following weekend, the Treasury hammered out a mega-bailout plan for presentation to the House Financial Services and Senate Finance committees. This plan was tantalizingly simple but a non-starter given its projected $700 billion price tag. In the wrangling that erupted for the rest of that week, many pundits and commentators insisted that Congress needed to stop discussing, arguing, and analyzing and just hurry up and give the Treasury its blank check to spend as it saw fit. Thank goodness cooler heads prevailed. The machinery of America's checks and balances went to work on the mega-bailout plan. We are now getting a plan that has a much higher chance of succeeding and a much better risk/reward profile. When called to respond, our democratic process can produce results. In this case, we needed the call to respond to come much sooner.

Paulson and Federal Reserve Chairman Ben Bernanke were suppressing their growing fears with an incremental approach that reacted to each financial bombshell as if it could be quarantined from the rest of the financial system. They tried to soften their ever more pessimistic words with pangs of false hopes. By the time Paulson finally admitted that America's financial rot runs deep, he could do nothing but panic...and try to panic the rest of us into accepting his quickly crafted solution. (One wonders whether the $152 billion pricetag on the Economic Stimulus Act of 2008 may have been better spent if we had recgonized the need to attack core problems instead of dressing the symptoms). So now we look forward, past the immediate crisis. Should we buy Paulson's Panic?

I am currently less interested in stock chart technicals because the stock market is more rigged and distorted than ever with the SEC's on-going ban on short sales of an expanding list of stocks. I am not comfortable making proclamations until the rules of the market are stabilized and more certain. But what I do "know" is that investors and traders should never panic. Panic is often a sign that things have gotten about as bad as they will get. Panic happens when the majority can no longer ignore all the bad signs and negativity that have grown over time. We should examine panic for opportunity and not reach for an extra pair of running shoes to join the stampede.

I believe Paulson's Panic was a necessary but not a sufficient buy signal. Once we are on the path of financial stabilization, we still must deal with a looming recession. We are almost 18 months into the official recognition of the sub-prime crisis, there is no official recession underway. Although expectations for a recession seem to increase by the week, I suspect that expectations remain too high for the next earnings cycle beginning in October. Financial institutions must continue to deleverage and hoard capital to heal severely damaged balance sheets. Consumers will finally be forced to start saving more and consuming less in order to build cushions for the coming rainy days. The mega bailout will not resuscitate the storied housing ATM. This means that October could get quite ugly for the stock market. I will be watching the depth of an October adjustment for the next sufficient buy signal. After that, perhaps we continue to avoid a recession and instead enter an extended period of slow to stagnant economic growth as America slowly washes itself of toxic excesses. Given where we are now, such a scenario would actually be a relief. I will be even more confident that the healing has truly begun if the American people get more realistic financial messages that eschew the typical requests to keep shopping at the malls, to keep emptying bank accounts, and to keep adding to debt. Heck, let's see whether more people even start to question the misguided dogma that insists buying a home is always better than renting one.

The buying opportunities in stocks will be in companies that do not heavily rely on debt financing and gimmicking financial statements for basic operations like certain big-cap technology companies. Investments in alternative energy should stand out as governments worldwide scramble for energy security and new sources of rapid job growth. I also think the buying opportunities will be in companies that benefit from weak currencies in general, and a weak dollar in particular - like commodity-related stocks. If the global economy descends into a more widespread slowdown, then all bets will be off.

The final bubble to burst will be the bubble in the national debt. This debt has reached almost $10 trillion, and the mega-bailout is sure to make it worse in the short-term. Hopefully, the national discussion on America's financial crisis has finally prepared us to actively (pro-actively?) wrestle this looming problem to the ground...before it grinds us down into the next panic in another few years.

Be careful out there!

Full disclosure: Long TAN. For other disclaimers click here.

DR. DURU®, 2008