Co-conspirators Ilya Somin and Eric Posner are having an interesting debate (see chained posts) about what the market's near-collapse does, or doesn't, show about the perceived virtues of the bailout bill. It's an interesting epistemological question -- a question about how we know what we know about the world from the evidence presented.
On an ordinary day (and on pretty much every ordinary day) there's a headline in (pretty much) every newspaper that looks like: "Markets Close Lower on Intel Earnings Warning," or "Market Surges on Oil Price Drop," or "Inflation Fears Spur Stock Sell-Off," or the like. It's all pretty much total hooey -- the fact that we see it every day sometimes makes it look like it means something, but it doesn't. The stock market moves billions of shares every day -- over 4 billion yesterday -- as a result of millions of individual trades (over 17 million yesterday). Those are very big numbers. The market moves as a function of the aggregate of each of those decisions. The idea that a reporter, sitting at her desk making a few phone calls, can understand the "why" behind anything other than a vanishingly small proportion of those trades, is nuts.
Back to Ilya and Eric's argument. It seems to me that the following statements are indisputably correct:
1. If traders believed that the government was about to enact a bailout bill that amounted to a naked transfer of wealth from taxpayer to shareholders [Ilya's position, roughly], and had traded in anticipation of such a bill, the market would fall calamitously when the bill goes down to defeat. 2. If traders believed that the government was about to enact a bailout bill that would save the U.S. economy from descending rapidly into a credit crisis of vast proportions [Eric's position, roughly], and had traded in anticipation of such a bill, the market would fall calamitously when the bill goes down to defeat.I don't see any way to distinguish between those two hypotheses without asking a (large) number of yesterday's traders what they had in their heads, and why they made the trades they made (and even that, of course, is deeply problematical, given the enormous difficulties of getting any reliable information from surveys of that kind).
Posner and Somin are on the same page with one basic issue: the pre-bailout market had a premium in-built into prices based on expectations that the bill would pass. Once the bill failed, the premium was removed. But we cannot assume that the premium itself is independent of future expectations, or of irrational panic (or exuberance, though there's little of that evident today). Whether or not the bailout had passed, the market was going to rise or fall based on expectations and emotions.
What's worse than the market falling 6-8% on news that the bailout failed? How about the market falling 6-8% on news that the bailout succeeded? THAT would have been far worse, though I suspect Posner would be claiming that the fallout would have been much worse without the bailout.
Then it also has to exclude hypo 2, because a 700 billion of bailout isn't going to provide rescue large enough to rescue 2.5 trillion of distressed valuations.
The truth is that while the markets are the most efficient way of valuing assets, they are still far from perfect. Whatever valuations the market reaches should be adjusted for short term volatility.
notattribute that to anything else?Or he might not believe either, but believe that the market will move in response to other people's belief in them.
My guess was that the gov't would sell those MBSs back for 80-90% of what they were worth and take equity stakes to cover the rest (losing $100B tops). IOW, the intended effect was not to "transfer" wealth.
However, the existence of the premium does not itself answer the question of whether it was founded on the transfer of wealth to Wall Street or on hope of avoiding catastrophe. It was just a premium, and now that premium has been removed.
To differentiate between a rational premium (i.e. one based on the increase of value attributed to the expected bailout package) and the irrational premium (i.e. the size of the panic caused by the bill's failure), we'll have to wait a few more days until the markets calm down (and unless and until the bill dies permanently). Right now, in light of the Dow's 4% rise today, it looks like the rational premium was about 3%, and the panic value was about 4%.
There had been nothing at all wrong with the underlying assets and nothing wrong with holding them. If they had been kept no loss at all would have occurred.
I suspect a lot of that happened yesterday as people sold into a declining markets, with their selling amplifying both the panic and the losses.
Kazinski: "Then it also has to exclude hypo 2, because a 700 billion of bailout isn't going to provide rescue large enough to rescue 2.5 trillion of distressed valuations."
No, but the bailout might prevent $2.5T of future distressed valuations that would occur if the financial system further melted down.
What I'm saying is that the amount of wealth disappearing, based on its sheer size, has got to be based on the collateral consequences of not acting, not the value of the bailout itself.
I don't get it. The recipe for unsticking the credit markets involved an injection of liquid funds into the market by purchasing illiquid investments, primarily mortgage-backed securities. By definition, there were no traders in that market who were lining up to receive the anticipated massive transfer of wealth coming from the taxpayers.
The government coming in to buy the investments would automatically mean that the seller is getting a premium, otherwise the seller would sell the investment on the open market for a larger price. Furthermore, the action of the government being a buyer in the market will increase the price of the investments because of supply and demand. Sure, it might only be a marginal wealth transfer (smaller than the 700 Billion), but it is still a transfer. On the other hand, it might be a good investment for the government, but if it is such a good investment, why aren't other people making the same investment?
Other people aren't making the investment because:
1) There is no real understanding of what the assets are actually worth
and
2) Firms, at the moment, are very risk adverse; they need to horde their own capital to prevent a run on them or in the event the LIBOR rates go through the roof (both have happened to some extent already)
If the government is going to give a slight premium to the sellers over the market's estimated valuation, let's give the government's loss an expected value of $100 billion dollars, with a big deal of uncertainty.
So let's say the range of outcomes is: ($400 billion) to $200 billion for the government.
What's the cost of a capital market collapse to the economy times the expected probability? Is that greater than ($100 billion)? The market sure seems to think so...
But, the situation is much more complex than you posit. Many traders trade on changes in technical data (volume, price movements, increase/decrease in short interests, etc) and do not pay any attention to the news.
Other traders may have been selling for reasons unrelated to the bailout's defeat, e.g., selling securities they have already made money to generate capital to satisfy margin calls, lock in profits, etc.
I had a case where this one guy who wrote an investment newsletter, and who was purely a "technical" trader, caused a price and volume spike when he sent out his newsletter, recommending a buy of a particular security. His recommendation was based entirely on the price/volume changes which, in turn, were caused by manipulative behavior by others and a phony press release by the company in question.
Frankly, the hypotheticals you posit are not very relevant. The question is: did the market go down because the bailout was defeated. Your hypos assign a bad purpose for the bailout to Ilya and a good purpose to Eric. But, the market is not designed to ferret out good and bad purposes or good and bad government/social policy, it just reflects price expectations.
As one poster noted, the best way to read the market's reaction to news is to see how it reacts the moment the news is announced, if there is an absence of other information.
In some ways this reminds me of the 1987 crash. In the aftermath of that crash, I was working as a phone rep for a very large mutual fund company.
Most customers were in a state of panic--dumping shares and moving into money markets. I will never forget one caller though. Unlike the others, he was very cheerful.
He called it a perfect time to buy--and he was putting his money where his mouth was, moving out of money markets and into aggressive stock funds. Long term, he was absolutely right.
From him I learned a very valuable lesson. If "everyone" (as in your barber, the paperboy, the guy at the water cooler, etc.) is saying "buy" it is a great time to "sell" (and vice versa).
Again, is it too much to ask for your posts to display some semblance of logical consistentcy?
Priceless video of GWB promoting his "ownership society" by lending money to people who can't ever pay it back. He wants the "barriers" to home ownership overcome. Things like a down payment or demonstrated ability to meet mortgage payments. Do the arithmetic and you get the shortfall we face because of bad mortgages.
In my opinion the Republicans would never have let Gore or Kerry get away with this swindle, it took one of their own.
If the traders were "pricing in" a "bailout" that "would save the U.S. economy from descending rapidly into a credit crisis of vast proportions", then prices would have been relatively stable before the vote, then tanked.
Looking at a 5 day chart of the Dow, It went up Thursday, down slightly Friday, down a bit more Monday, then dropped off a ledge when the bill failed.
Looks like Option 2 is correct.
It has always amazes me that these silly people can make such silly statements without being greeted by incredulous laughter from their listeners. How can you be quite so stupid, even with a journalism degree?
If it were so easy to understand the market, anyone could make money on it, and then it would immediately cease to exist, since the entire raison d'etre of the market is to allow people with differing beliefs about the future to place wagers with respect to it. If the wagers all become sure things, once you put a little thought into the matter, then of course no one will take the losing end, and the trading stops.
That is, the continuing existence of the market is a proof by demonstration that it is not possible for the average investor to reliably predict its direction.