Government Intervention

On CNBC, I keep hearing that stocks have bottomed and that bad news is discounted into the current price. While that may be true, I disagree. Let me explain. when the government used to be the "lender of last resort" - taking a loan was a deathknell for the bank holding company or primary dealer. Simply put, your company was in trouble and you needed to obtain a "punitive" loan. This is no different from our individual lives. If I need money and can't get it from a bank because I have no assets as collateral, I will go to an alternative financing company that charges a punitive rate.

Now, however, the government is the lender of first resort. Because all the banks no longer trust each other's books, the FED and Treasury have become the "only" lenders. Now, the automotive industry can no longer fund operations through commercial resources and have turned to the government. Ironically, at least their loan is somewhat punitive, albeit amounting to a slap of the wrist.

Ask yourself this, what happens if the government stopped funding all of this stuff. What happens when the government tries to exit their side of the equation. The answer - they can't. They can't and probably won't. This, my friends, is bad. Right now, the government is the "market" because normal buyers and sellers are not allowed to clear trades. Think of it this way, I have a rotten egg and you see I have a rotten egg. Because of my stupidity, I thought rotten eggs always appreciated in value and I bought that egg for 50 cents. I want to sell it to you for $1.00. You see the rotten egg and offer me 1 cent - because you know it is rotten, but wouldn't mind boiling it to decorate it.

We have a conundrum - at some price between 1 penny and 1.00, both of us will be happy. We argue back and forth and I decide that yeah, I should not have bought a rotten egg and asked 5 cents instead of a dollar. The buyer offers 3 and I take it. So, the prices cleared at 3 times the buyers initial offer and a 97% off what I "wanted." Overall, I lost because I was an idiot. So, let's say that I did this as a business. Well, a couple of rotten eggs later, and I am not making money anymore. In fact, I am most certainly on the verge of bankruptcy. Now, I can't let the eggs go for 3 cents, I need more to stay in business.

If I did declare bankruptcy, the other egg sellers will buy whatever of my business is left that is worth something. Perhaps my egg cartons - and - since I am liquidating, they will get it pretty cheap. However, I complain to the government and they decide to help. They figure that even though they know it is a rotten egg business, they will buy my rotten eggs for 25 cents until buyers return and decide to pay 25 cents. This prevents liquidation where the strong business gets to buy the weak business and the weak business no longer operates.

Folks - that is where we are - except, the rotten eggs are the large banking institutions. If they failed, there would be pieces to pick up - and have no doubt, there would be vultures of private equity to snag the remains. But, the government stepped in to "rescue" us from financial armageddon, thereby preventing the weak institutions from failing.

Initially, this looks good. Jobs are kept, businesses keep operating. However, something happens during failures - risky endeavors are punished, smart endeavors are rewarded. After the cleanup - the smart ones charge an appropriate rate for the implied risk. With the government stepping in however, everyone gets to compete at a very cheap rate. In fact, instead of taking loans from each other or getting private equity money, banks go straight to the government, since they have the best game in town - free money.

So that is where we are - the government is the market. They prevent failures. They essentially take money (taxes) from the strong individuals and businesses and give it to the weak companies that should be allowed to fail.