Last week I blogged about Warren Buffett’s purchase of preferred stock in Goldman Sachs. Today it was announced that Berkshire Hathaway (the investment firm that Buffett chairs) has reached an agreement to purchase $3 billion in preferred stock in GE.
Again I say, if Warren Buffett is jumping in now we have to be near the bottom of this mess. Who knows how long it will take us to get out but I take comfort in the fact that Buffett doesn’t believe it will all collapse.
How important do the markets think the financial bailout is?
On news that the $700 billion financial rescue plan got voted down in the House of Representatives th Dow Jones Industrial Average fell by almost 800 points.
To put that in perspective, when the markets opened following September 11th the Dow Jones dropped 644 points.
The Economist featured this great article today about the fact that not only financial firms but businesses and individual households will be forced to deleverage over the course of the next few years.
Among the points that I found interest in:
*In the near term delveraging of banks, hedge funds, and households will likely depress asset prices lower. This is because as people sell assets to pay-off debt (deleverage) they will increase the supply of assets in the marketplace.
*Even if the bailout plan goes through the financial industry will likely suffer for sometime making credit harder to come by.
*Thanks to the impact of devleveraging, “a shortfall of bank capital of around $170 million may reduce the potential supply of credit by $1.7 trillion.”
*”Morgan Stanley reckons that total American debt (ie, the gross debt of households, companies and the government) has risen inexorably since 1980 to more than 300% of GDP (see chart), higher than it was in the Depression.”
Brett Arends wrote this terrific article for the WSJ.com analyzing the true cost of the $700 billion bailout. Based on his analysis the true cost of the bailout is equal to, “one-third of 1% of our annual gross domestic product.”
I strongly believe we need to get this bailout done. Here is a link to my rate update today where I also try to put the cost of the bailout in perspective.
In my view the costs of not doing the bailout far outweigh the cost of doing it.
What is the #1 sign that the bailout will work? How about this article in the WSJ which reports that Warren Buffett has reached an agreement with Goldman Sachs to buy $5 billion in preferred stock?
This give me confidence that this plan will make things right for our financial system.
Today we got notification from HUD indicating that FHA loans would also adopt similar guidelines (click this link to view the announcement for yourself).
Essentially, the new guidelines make it harder for home-buyers who have yet to sell their existing home to take out a new mortgage to buy a new home.
What does this mean for home-buyers?
It means that home-buyers who want to buy a new home without selling their existing home either must show enough income to reasonably afford both mortgage payments or plan on selling their existing home before or concurrently with their existing home.
Are there any exceptions?
Yes, if a home-buyer is being relocated for their job and can provide a legitimate rental contract they may use rental income to offset the mortgage payment on the existing home.
Or, if the home that is being vacated has a loan that is no more than 75% of the value of that home then the home-buyer may also use a legitimate source of rental income.
MSN Money writer Jim Jubak wrote a great article today about the importance of the derivative market. Little is known about derivatives outside of Wall Street but he makes a compelling case for government intervention because of the role that these financial instruments play in encouraging foreign investors to invest in US based financial securities.
Put simply, derivatives are insurance contracts that an investor can purchase from a “counter-party” which would require the counter-party to pay the investor a sum of money should a specific event occur. For example, a sovereign wealth fund who was purchasing a large pool of US mortgage-backed bonds could purchase a derivative contract from a financial institution which would pay out a sum of money should defaults on mortgage increase past a certain level (say 5%).
These derivatives then act as hedges for the sovereign wealth fund should this pool of mortgages go bad. In essence, they reduce the risk involved for foreign investors in making investments into an economy they may not be familiar with.
Without derivatives foreign investors who we rely on to buy up mortgage-backed bonds and other US financial securities would be far less likely to invest in the US. Without their demand for our securities we would sit back and watch mortgage rates and other interest rates rise.
Rates are higher this morning.
The Fed & Treasury worked over the weekend on the government’s “bailout” plan for the financial industry. The bill is waiting congressional approval and is likely to allow the government to buy up to $700 billion in mortgage-backed securities from financial institutions.
Mortgage-backed bonds are suffering on the news because of inflationary concerns. In order for the government to pay for this plan they will have to print more money and that does not bode well for inflation.
There still exists a spread between 30-year treasury bonds and 30-year mortgage backed bonds which we continue to believe will converge (meaning mortgage rates will have to go down and/ or treasury bond yields will have to rise).
Rates are unchanged from yesterday’s levels.
Mortgage rates do not know what to do after the government announced “bold” plans to shore up the financial system. This announcement leaked yesterday afternoon which is why the stock market has rallied over the past 24 hours.
Treasury Secretary Henry Paulson announced this morning that the government would work over the weekend to create legislation designed to restore confidence in financial institutions.
The main points behind the program can be seen at this link.
At this point we are going to shift our outlook to neutral until we get more details about the plan.
Treasury Secretary Henry Paulson made it public this morning (this news had leaked yesterday afternoon causing stocks to rally in late trading) that the government would intervene in the financial markets to shore up confidence in the financial system.
According the Wall Street Journal the government’s intervention could become “the largest intervention in the financial markets since the 1930s.” This is great news as the health of the financial system was being called into question over the past couple days.
In fact, over the past two days $180 billion has been taken out of traditionally safe money market funds because of fear that the assets backing the fund would fall below the value of the deposits. This led to investors buying short-term treasury securities with a NEGATIVE RETURN (meaning these investors were willing to accept less money than the money they were investing for the safety of the US government).
Among the measures that the Treasury Secretary announced this morning were-
*Increase the government’s purchases of mortgage backed securities.
*Acquire “bad assets” (risky mortgage-backed bonds) from financial institutions so they can remove them form their balance sheet.
*Ban investors from “short-selling” the stocks of 799 vulnerable financial institutions.
It is unclear what this new intervention will look like in terms of the organizational structure but more details should become available early next week.