Don’s Outlook 9/24/08
Stocks fell for the second straight session on Tuesday as investors questioned whether the $700 billion bailout sought by Treasury Secretary Henry Paulson was the right prescription for the ailing financial sector. The Dow Jones Industrial Average fell 162 points, or 1.5 percent, to 10,854. Industrial conglomerate General Electric declined 4 percent after an analyst downgrade, and Bank of America slipped 2.5 percent. The broader market indexes also lost ground. The S&P 500 retreated 19 points, or 1.6 percent, to 1,188, and the technology-focused Nasdaq Composite Index was off 26 points, or 1.2 percent, and closed out the day at 2,153.
After the market close, Berkshire Hathaway, billionaire investor Warren Buffett’s holding company, revealed that it would invest $5 billion in Goldman Sachs. News of Buffett’s decision sent investors back into the market in after-hours trading and helped the S&P 500 recover nearly half of its Tuesday loss. Buffett, who is perhaps the world’s best-known and most successful value investor, looks for well-managed, undervalued companies with good cash flow and brand equity. Past investments have included large stakes in Coca Cola, Geico and Burlington Northern Santa Fe. But not all of Buffett’s picks pan out, particularly when it comes to the financial sector. Berkshire Hathaway’s investments in reinsurer General Re and Wall Street firm Salomon Brothers were less than successful. Nevertheless, Buffett’s move comes at a crucial moment for the financial sector and could change the psychology of the market.
Yesterday, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke testified before the Senate Banking Committee on the details of their proposal to bail out the struggling financial sector. The current crisis is one of liquidity, i.e., banks are reluctant to lend to one another for the very simple reason that they fear not being repaid. The problem, according to most economists, is that there is too much “toxic waste,” or mortgage-backed debt, still on the books of the big global investment houses.
Originally, the Treasury sought unfettered power to buy up to $700 billion worth of mortgage-related securities currently weighing down the books of Wall Street firms and large multinational banks. Because there is effectively no market for this paper, however, there is no real way to determine whether the taxpayer would be getting a fair price for this debt—or whether these securities would appreciate in value. The most controversial provision in Paulson’s proposal was a clause that would prevent Congress, the courts or any federal agency from reviewing or challenging the Treasury Secretary’s decisions.
Senators from both sides of the aisle were skeptical of the Treasury Secretary’s proposal, and it appears highly unlikely that Paulson’s plan will pass into law without dramatic changes, including the inclusion of oversight provisions. It’s not surprising that lawmakers are resisting the plan in its current form: Its principal advocate played a role in the excesses that led to the current state of affairs. In the mid- to late 1990s, Paulson was the chief operating officer of Goldman Sachs and later became its CEO before President Bush tapped him to head the Treasury Department.
While Congress contemplates how to address the meltdown on Wall Street, the situation on Main Street continues to deteriorate. The median price of an existing home plunged 9.5 percent in August, according to the National Association of Realtors, while the pace of sales slowed 2.2 percent to an annualized rate of 4.91 million. Economists were expecting an overall annualized rate of 4.93 million homes. There was a silver lining in the data. The inventory of existing homes on the market declined 7 percent, to 4.26 million. The number of unsold homes hit an all-time record in July.
