So today, the Dow Jones ended up more than 400 points, and the Nasdaq and S&P 500 (contrary to popular belief, this is the more important index than DJIA is) both closed way over 4%. A lot of the movement happened in the last hour of trading after it was reported that the government may look to put together an entity that effectively buys all of the shitty debt on banks' books and relieves them of their pain.
However, it really doesn't mean much of anything. If there's one good thing that came out of today, it's that Morgan Stanley and Goldman Sachs finally got a reprieve from the rather unjust beating their stock has taken over the past two weeks or so. But in the end, talk of some sort of industry-wide federal intervention to absorb the body blows of declining mortgages and other debt, and the assets that are backed by them, is just that - talk...at least for now.
There were several developments worth noting. First, let's talk about Morgan Stanley's potential merger talks with Wachovia, as well as selling a bigger stake in the firm to China's sovereign wealth fund. In my view, selling a bigger stake to China - even though it will become a punching bag - would be financially better than merging with Wachovia. The North Carolina commercial bank has several problems with the mortgages it holds on its book, and if Morgan Stanley truly has problems with some of its assets and collateral, a tie-up would serve to compound the problems each are facing. Their stock was taking a beating earlier in the day, but it wound up gaining a few percentage points upon the news at the end of the day. Furthermore, with England's securities agency banning the short-selling of financial stocks until the beginning of next year, there will be heavy pressure in the U.S. to do something similar - not to mention that with Andrew Cuomo opening an investigation into manipulative short selling, there may be a notable decrease in the shorting of MS and GS stock.
Next, let's talk about AIG. Did the federal government taking an 80% stake in the company do much good? If you look at their stock price, you might think so...but here are the facts: in today alone, AIG used $28 billion of its $85 billion loan facility from the Fed. That's right, it blew through 1/3 of the amount in 1 day. Now, that's not to say that this is going to happen every day, but if AIG has too many holes to plug, it could end in a very ugly fashion. I'm not sure how much due diligence the Fed and Treasury did before taking over the firm, but they need to start selling their assets quickly. And if $28 billion a day is the going rate for AIG - and at this point, who knows - this weekend is going to be another tense one.
Lastly, there's the reason markets moved way up today. The word is that the government wants to set up some kind of Resolution Trust Corporation-style entity that takes off all of the crappy debt banks and other financial institutions are holding. For those who don't know, RTC was set up by the first President Bush to buy all of the failed real estate assets from the 1980s to liquidate them in an orderly fashion (and for further background, there was a real estate bubble in the 1980s because Reagan created tax loopholes by which it was profitable to build empty buildings and use the loss to shelter your taxes. That's a whole other story). An adjunct to this, proposed by either Chuck Schumer or Hillary Clinton (I forget which one right off), would be to have the same entity renegotiate bad mortgages for homeowners to a fairer level. This is probably the best solution to the problem, and something that should have been considered before several prominent firms failed or were taken over. Yes, it will cost a hell of a lot of money - and a lot of short-term pain to the federal budget - but it would clear up a lot of the problems now, and combined with better regulation, the financial markets would be much improved. Yes, they might not have as much money to play with, but at least they'll have cash instead of holding risky, marked-down assets that are likely to earn them pennies on the dollar when all is said and done.
That being said, I think it's highly unlikely anything will get done. Ben Bernanke and Henry Paulson can't do this on their own; something on that level will have to be pushed through Congress...and given that they are going to recess soon, it's unlikely to happen until after the election. There would also be problems with the GOP in the House; many of the conservatives are beginning to whine about their party's own so-called 'socialist' tendencies. While the free market may end up sorting all of its problems out on its own, it will take a long time for all of the crap sitting on the books of many firms to pass through. More than ever, Democrats in Congress need to step up to the plate and pass a comprehensive plan to get us out of this mess. The government can't be picking and choosing which firms live (AIG) or die (Lehman Brothers) forever, and while Bernanke and Paulson have arguably done the best they could have in this environment, it's time to stop improvising and have a clear way out of this credit crisis. It may be hurting Wall Street really badly now, but the shocks felt from this going on for an even longer time will make Main Street feel the pain, too.