Wall Street rejects $700m bailout plan, crash coming!

Posted on 04 October 2008 with no comments from readers

The US Congress and President have passed the controversial $700 million US emergency economic rescue plan. But the reaction from Wall Street was negative, sending stocks even lower at the end of the worst week for stocks since planes crashed into the World Trade Centre on 9/11.

Will the market now have second thoughts and rally on Monday? There is precious little reason to think it will do. Investors have had a frightening week which started with the largest points fall on the Dow Jones in history.

The mood on Wall Street has changed. The bears have the upper hand. Any bad news is greeted as confirmation of a new downtrend. Any good news is seen in a negative light.

Stocks fall as plan passes

The $700 million bailout plan is a classic example. This plan is supposed to save the US banking system from Armageddon, and you might think its passing into law might be greeted with enthusiasm.

Instead investors reason: things must be bad for such a plan to come into law, and what if it does not work, or works less well than its promoters have been arguing under desperate circumstances?

The even more bearish are saying ‘so what changes?’ after the plan. The US economy has been in decline for more than a year now, and the rate of decline has been accelerating – US house price declines are growing not decreasing, according to the latest data.

If the economy has not hit bottom then has Wall Street? Even a cursory glance at the Dow Jones Index suggests not. The DJI stands at 10,300 points while at the last bottom, which was only in 2003, the index reached 7,000 points.

Dow Theory

Dow Theory – an arcane model for predicting future price movements – has the DJI moving lower because transport stocks are indicating a wider slowdown in the US and global economy. Shipping movements and trucking of goods slows before an economic downturn becomes apparent in the rest of the economy.

The bears have another major argument. The bailout package is now law but will it become reality? This is a lame-duck US administration with less than four months of life. There will be a change of president next month but he will not take office until early next year.

That is a power vacuum at a very bad time for the economy which needs leadership. Will Hank Paulson stay on as treasury secretary? Is it a good idea if he does, seeing as his response to the crisis has been crisis management and not a coherent plan to deal with something that was pretty obviously going to happen a year ago to many observers.

Power vacuum

Who then will be in charge? Ben Bernanke will still be there at the Federal Reserve and can carry on with his hugely inflationary monetary injections to keep the banking system afloat. But what happens now as swathes of hedge funds collapse leaving bad debts to be written off?

Is this a $5-20 billion derivatives bailout coming? Will the T-bond markets absorb the new paper issues, or is the bond market another bull about to go bust?

Wall Street has good reason to be nervous and highly uncertain – the VIX volatility indicator is near a record 45 and inter-bank lending remains frozen. A further crash in stock values looks inevitable.

Credit is frozen, US in cardiac arrest

Let us also not forget the credit squeeze goes on. From Professor Nouriel Roubini’s website…

Yesterday Thursday a senior market practitioner in a major financial institution wrote to me the following:

Situation Report: So far as I can tell by working the telephones this morning:

LIBOR bid only, no offer.
Commercial paper market shut down, little trading and no issuance.
Corporations have no access to long or short term credit markets – hence they face massive rollover problems.
Brokers are increasingly not dealing with each other.
Even the inter-bank market is ceasing up.
This cannot continue for more than a few days. This is the economic equivalent to cardiac arrest.

Will Bernanke deliver a rate-cut before or after the Wall Street opening on Monday to prevent a crash. The problem is that even that may not go down terribly well with investors in their current mood.