Saturday, December 6, 2008

The Big Three and Beyond

As if there was ever a doubt in any one's mind that it was coming, the government announced on Friday its new plan to bail out the auto companies. They have started the process with what they call a small amount of short term debt, but we all know that it is the first of a ton of money heading toward Detroit to be flushed down the toilet.

The companies can now continue to run their inefficient business models unprofitably as nationalized government entities paid for by the tax payers. Look for billions and billions more to be received by these companies in the months ahead.

With that behind us, what can we now look for in the year ahead? It is going to be a very exciting year with major headlines that continue to stream across the ticker.

One of biggest announcements of 2009 will be the failure and bail outs of both Bank of America and J.P. Morgan. These companies have loaded their books over the last year with toxic debt to ensure themselves of bail out money that is on its way. As their mortgage and corporate debt continues to decline, the amount of money needed to keep them from failing will be staggering.

With the investment banks and auto companies fully supported, who is the next beneficiary of the governments money? Our own states. California announced on Friday that it was now paying out with I.O.U.'s and will be approaching the nation's capital for support very soon. They will be the first of many, as states all across the country move closer toward failure. They will all get the money needed.

Up until now we have seen a very defensive strategy in dealing with our economic crisis, moving from one bail out to the next trying to put out the fires. I think to finish this year and start the next we will begin to see more offense from the Fed and Treasury.

Banks around the world are now flush with cash that has been dumped on them by central banks. The problem is that they are all too afraid to lend to each other, businesses, and consumers.

This poses a major problem for the Fed and other central banks because it is not increasing the money supply fast enough. When banks receive money from central banks, they only need to keep a small portion of that money in reserves. (Usually 10%) This means for every dollar a bank receives they can lend out $10. This has the effect of greatly increasing the money supply, which is not currently happening due to their fear and cash hoarding.

So the Fed will move to step two, which is a process called Quantitative Easing. (Something you will hear a lot about in 2009) What this means is that they will bypass the banks and just start injecting the money directly to businesses and consumers.

They have already started doing this with their use of Fannie Mae and Freddie Mac. By buying their toxic securities in exchange for cash they are essentially giving money to homeowners as that new money can now be lent out. This will be a major part of their new "interest rates to 4.5%" program.

The second part of that was the recent announcement of $200 Billion in credit card debt purchased by the Fed. This allows credit card companies to give new money to American consumers.

A third step, and very similar to the last two, will be the direct purchase of corporate debt. The goal here will be to stimulate business spending which has shut down as everyone has been hoarding cash across the board.

The final step will come from our new man in charge, President Barack Obama. He has said that he wants to hit the pavement running and is already working on a fiscal stimulus in the neighborhood of $500 to $700 Billion. I would guess that the total stimulus will approach $1 Trillion before next year ends. This will be similar to last year's stimulus in which the money will be sent directly to Americans in the mail. (Or dumped from the helicopters in the sky, whichever way they see as more efficient.)

All of these plans will have the effect of printing money and entering it directly into the economy. Along with the Fannie/Freddie and mortgage purchases from the Fed, I would look for a major new program to restructure mortgages. Currently 1 out of 10 homeowners are not paying their mortgage.

Where will the money come from? That's not important yet. You probably won't see that question on the front page of any newspapers in 2009 because people will be focused on bail outs and the government saving them. I don't think it will be front and center until we start 2010 and the real crisis presents itself; our currency crisis.

Either way, it will be fun to watch how long the herd will rush into treasuries before they stop, look around, and realize they have just run off a cliff.

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