Commentary & Insight

Weekly Markets Commentary — September 22, 2008

David Joy — Chief Market Strategist, RiverSource Investments

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Billions and Billions in Bailouts

"A billion here, a billion there, and pretty soon you're talking real money." It turns out that Senator Everett Dirksen never actually said these words, for so long attributed to him. He apparently never objected to being credited with the memorable turn of phrase, because he certainly agreed with the sentiment.

Senator Dirksen served in the Senate until 1969, when the federal budget was $186 billion, and the gross domestic product was $1.0 trillion. Today, the federal budget is $3.0 trillion and GDP is $14 trillion. Obviously, spending has increased faster than the economy — exactly what the quote was warning against.

A billion dollars is certainly not what it used to be. Today's version of the Dirksen quote might read, "Fifteen billion here, fifteen billion there..." But now we have the Treasury asking Congress for a staggering $700 billion dollars to buy toxic debt from banks, in an effort to clear their balance sheets and get them lending again.

The request is probably necessary. The financial system needs help. But the price tag is enormous. And of course, no one really knows what the ultimate cost will be. Presumably the debt to be purchased has some value, but how the process will work and at what price transactions occur is not known. Nor is there any assurance that the underlying problems, namely falling home prices, will right themselves in response to this initiative.

The hope is that credit conditions will loosen, making mortgages easier to get, thereby jump starting the moribund housing sector. We'll see. Aspiring home owners don't need to be in any hurry. There is plenty of inventory from which to choose.

What the bailout proposal did accomplish was the removal of the threat of a systemic meltdown. That the yield on three-month Treasury bills had fallen to an incredible low of 0.04 percent last week was clear evidence of that fear. There was a time in the late 1930s when rates actually were negative for periods of time, and we were getting close to that again.

The subsequent back-up in yields and the equity rally that occurred in the wake of news of the bailout was a collective sigh of relief by investors worldwide. In early trading on Monday, the three month bill is back up to 0.86 percent.

But there is potentially more to the cost of the bailout than its direct cost. The dollar is once again under pressure as the potential massive increase in outstanding government debt places downward pressure on the creditworthiness of the U.S., at a time of already huge foreign financing dependency. In addition, the inflationary implications of the debt increase won't be fully known for some time, but it can't be good.

Beware of Bottom Fishing

There may be a tendency to believe that bailout of Wall Street means that a floor has been placed under both stocks and the economy, creating a near-term opportunity with little potential downside. The economy still has problems that make such thinking risky.

The U.S. economy is slowing, as are economies around the globe. Even if financial stocks fall little further, by no means a certainty, other parts of the economy are likely to slow, suggesting that earnings estimates beyond financials may need to move lower.