You might have heard that President Obama is getting a brand-spanking new helicopter That noise overhead? That's just the sound of Helicopter Ben Bernanke doing a test flight while dropping a couple trillion dollars over the landscape.
Bernanke said Friday that the purchases of Treasuries and mortgage securities were meant to address the widening credit spreads. Honestly, that doesn't hold much water with me. As a client rightly pointed out, the Fed is out of their normal arsenal of bullets and is having to bring in other artillery to try to kill the beast. Through the purchase of these securities, they drive the prices up, the yields down - a good move for the mortgage securities, but not really a big deal on the Treasuries. Thirty year Treasuries are trading at a yield of 3.66%, not exactly a problem. On the other hand, the spread between Corporates (high quality and high yield) and the Treasuries is just out of hand. As of 3/31/06, the spread between the 9 year Treasury and the AAA Corporates was 1%, between Treasuries and High Yield Corporates it was 3%. Today, three years and a little credit crisis later, it's 3.5% for Treasury/AAA and 12% for the Treasury/High Yield spread.
I have to believe that part of what they're trying to do is buy in the Treasuries so money managers will migrate those $$ to bonds with more credit risk. However, it puts a lot of currency into circulation really fast. All the stimulus prior to this led me to believe that if we were going to have inflation we'd see it sometime in late 2010 (if at all), given that so much of the money being thrown at the crisis would be used by consumers to pay down their amazingly high debt loads. This new addition has me certain that there's no way that this won't be inflationary at some point, and that point has moved significantly closer - best guess now is early 2010.
I'd suggest that sometime between now and when that inflation hits going to gold might not be a bad idea. Other hard commodities should also do well in that type of environment. The trick, however, is that between now and whenever the inflation hits, I expect a continuation of the deflationary trend we're currently seeing.
In light of the Treasury's announcement Monday, there's obviously another layer of complexity to things, although not much more clarity. The announcement on Monday of a public-private partnership to help clear the toxic waste off of the banks' balance sheets has some good points and some bad points. Essentially, five yet-to-be-named private firms will be approved to bid on "assets" that banks want to sell. The private firm who bids the most for the asset will have to put up a small amount (roughly 7%), the Fed will put up an equal amount and the FDIC will guarantee up to 78%. If the asset goes up in value, the private firm and the government split the profit. If the asset goes down in value from whatever the purchase price is the private firm and the Fed can lose their entire investment and the FDIC steps in to absorb any further losses.
While this will help set some sort of a market price for the toxic assets, the private firms have very little skin in the game and obviously the potential for pretty impressive returns. On the other hand, it uses the expertise of the private firms to set appropriate prices and keeps the government from overpaying (too much anyway) for the assets and they won't be 100% responsible.
Monday's market rally was in my mind more of a "oh, thank goodness they finally at least came up with SOMETHING!" rally rather than specific expectation that this plan will be the saving grace for the economy. I still expect that the significant systemic problems in the economy will take time to unwind themselves. While I know that I'm going against some pretty impressive market experts on this, I don't believe that this is the beginning of the next bull market - I'm firmly in the bear market rally camp. Valuations are still too high. Just because the banks will be more able to lend after the toxic waste is off their balance sheets doesn't mean that a) they will lend or b) that the American consumer really should take them up on any loans offered. The over consumption by American consumers has led to personal balance sheets bloated by debt and lacking in savings. Add to that a 45% reduction in the value of their retirement accounts and at least a 20% reduction in the value of their homes, and I don't see how this economy that is 70% fueled by the consumer can bounce back in a healthy way in the short term. The stock market may bounce... but the underlying economy has more pain to come.