Daily Market Reports | Sep 25 2008
By Greg Peel
The Dow fell 29 points or 0.3% while the S&P fell 0.2% and the Nasdaq rose 0.1%.
There was very little volume traded on the NYSE last night, not simply because the short traders are gone, but because the traders on the floor were glued to the Senate hearing on Capitol Hill. There was volatility in a tight range, but mostly because no one much wanted to play and thus any movement up or down ultimately failed.
Australians will be wondering this morning why the news of a US$5bn investment from Warren Buffet into Goldman Sachs did not inspire Wall Street as it inspired Bridge Street yesterday. The answer is because the longer this Congressional hearing on the US Treasury’s plan to save the world plays out, the more the plan looks like ultimately being watered down. Watching the proceedings myself this morning, it is clear a sufficient number of senators do not understand The Plan (or the financial markets) and thus cannot grasp the gravity of the situation, or have enough understanding as to dangerously compromise any potential for success by misconstruing the mechanics of a plan which they still see as “bailing out Wall Street”. Yet others know enough about what’s going on, but are using the opportunity to gain politically popular concessions for those folk on Main Street who remain quite clueless beyond believing it is they who are being forced to dip into their pockets.
The Plan does not involve a “bail-out”. If that is not clear, then one only need reflect on the actions of the most successful stock market investor of the twentieth century.
Speaking on CNBC last night (our time) Warren Buffet explained that he is not an investor who plays the “timing”. He only plays the “price”. Buffet is a long term investor who looks only for value in a company and does not try to pick tops and bottoms in the shorter term. With this philosophy he has made billions for himself and his Berkshire Hathaway fund investors.
However, Buffet noted that it was he who was approached by Goldman Sachs, and not the other way around. Indeed, in 2008 he has had a queue outside his door. On that basis he was forced to make a quick decision, and this time the pieces fell into place. He has every faith in Goldman Sachs as a business and he also has faith that The Plan will work. He was quick to endorse that which many in Congress are struggling with, and that is The Plan is not a US$700bn “expenditure”, just as a government might spend taxes on infrastructure, education or health, for example, but it is a US$700bn “investment”, and Buffet believes strongly that it will be a profitable one.
“If I had US$700bn,” said Buffet, “I would be buying the distressed securities myself”.
On that basis he believed an investment into Goldman was warranted, on the longer term basis. He believes the US government will have little trouble in selling out those securities fairly quickly for a profit. The CEO of one of America’s biggest private equity funds – the Carlyle Group – was also interviewed on CNBC earlier in the week and suggested he is waiting and ready to buy a share those securities from the government as soon as the opportunity arises. Once again it must be appreciated that there is a big difference in the “fire sale” price of these assets and the “hold to maturity” price of these assets. This is a point Paulson and Bernanke have been struggling all last night to get across to the Senate Committee.
The difference is simple: A bond issued at $100 will be redeemed at $100 at maturity (to use the simplest case) provided it does not default beforehand. Such bonds are presently worth about $20, as far as anyone can determine, because (a) there have been defaults at the subprime level and (b) every other security has been tarred with the same brush. As the credit market has continued to collapse so too have has the value of such bonds, irrespective of the quality of the assets behind them. If the credit market can be stabilised, the majority of these bonds will reach maturity intact. No one in the private sector has yet been game to buy more than a handful of these bonds simply because of the weight of numbers on issue and ongoing uncertainty. But if you had US$700bn and could buy the lot, then you’d have cornered the market. This is how Pulson sees The Plan. This is why Paulson believes that not only is it the only solution, it is a solution that will work.
Nevertheless it is clear that The Plan will not become legislation without concessions, and those concessions will involve any or all of caps on Wall Street salaries, relief for distressed mortgage holders, relief from bankruptcies for small entities, and any number of other social compromises. More worryingly there is still a movement to not enact The Plan as an asset buying vehicle, but as an investment vehicle into the banks themselves. Naive Congress members see this as the only way the taxpayer will be rewarded if the banks are “bailed out”.
Thus we are in limbo. Warren Buffet’s seal of approval was a strong positive, and without it perhaps we would have had another big down night on Wall Street as Congress fiddles. As it was we went nowhere because there is yet to be resolution on The Hill, and as I write proceedings have ended for another day. Any sort of resolution is not expected until the weekend, and there are senators even asking for four weeks of consideration instead of one.
Were no resolution to be reached shortly, then one can pretty safely say Washington Mutual would go down (it fell 25% last night as time runs out) and Morgan Stanley would again be in trouble (it fell 11%) despite a 20% injection from Mitsubishi Bank. A quiet stock market means little movement but a quiet credit market means ever increasing credit cost, because no one will lend until they know what will happen. The two-year Treasury swap rate is considered the benchmark measure of market funding, and last night it hit 160 basis points over. The long term average of the spread is 30bps over. To put this into perspective, it would be as if the RBA were to cut its rate but the Australian banks actually raise their rates because the funding cost spread over cash is moving strongly in the other direction.
Again I refer to Caterpillar, which yesterday was forced to pay 120bps more for regular funding required to keep its business turning over. Caterpillar’s other option, if it felt the price too high, would have been to shut down and send all its workers home.
Last night the two presidential candidates agreed to suspend their election campaigning in a show of bipartisan support for the efforts being made by Congress.
We can now only wait.
Last night oil fell US88c to US$105.73/bbl, gold fell US$11.50 to US$880.70/oz, base metals went nowhere, the Aussie went nowhere.
Australian traders have been forced to put the cork back into the champagne bottle after jumping the gun on yesterday’s Buffet news. The SPI Overnight fell 34 points.
