FA ADVISORY NOTE
SEPTEMBER 30, 2008
September 29: A Day in Infamy
FINANCIAL ALLIANCE PTE LTD
“..with the unbounded determination of our people -- we will gain the inevitable triumph -- so help us God.”
Franklin D. Roosevelt's "Day of Infamy" Speech to Congress , December 8, 1941
By now, one would think that this present crisis has taught us to expect the unexpected. Still, few would have expected the House
of Representatives’ to reject the $700 billion bailout package last night— 205 for versus 228 against—after days of deliberation and
Sunday’s compromise. Democrats voted 140 to 95 in favor of the legislation, while just 65 Republicans backed the bill and 133
opposed it. The rejection sent markets globally into a tail spin with the MSCI World Index of stocks in 23 developed markets
sinking 6%, the most since its creation in 1970. The S&P 500 posted its biggest loss since 1987 while the Dow saw its largest ever
one-day point loss, even surpassing the 684 point drop seen in the first trading day after Sept 11, 2001.
Table 1: Stock Indices, Commodities, and Bond prices at September 29 NY close
September 29 NY Market Close Snapshot
Dow
10365
-6.98%
FTSE 100
4818
-5.30%
RTS Index
1194.11
-7.11%
Nasdaq
1983
-9.14%
Dax
5807
-4.23%
Bovespa
46,028
-9.36%
S&P 500
1106
-8.79%
CAC 40
3953
-5.04%
Gold
903.50
+2.93%
1010-Y Bond
3.63%
-0.1950
AEX
323.55
-8.75%
USD Index
77.71
+0.49%
1313-wk TB
0.45%
-0.38
Crude Oil
95.58
-10.58%
CRB Index Fut
343.80
-8.27%
Overnight, equity markets were already on the back foot even before the bailout package setback, as the Federal Reserve and
other global central banks struggled to pry open the frozen credit markets yet again. The rescue of four European banks by their
respective governments— the Belgium-Netherland-Luxembourg’s joint bailout of Fortis, the U.K.’s mortgage lender Bradford &
Bingley, Germany’s real estate lender Hypo Real Estate Holding AG, & Iceland’s 3rd largest bank Glitnir — all within the past 48hours coupled with the takeover of Wachovia Bank by Citigroup, only served to cement market’s fear regarding counterparty
risks. The Fed’s expansion of liquidity this time around —estimated at US$630 billion and the biggest to date— seemingly unnerved markets further as it signals just how dire the situation has become. Judging from previous such interventions, any improvement is likely to be temporary until the collapse of the next financial institution. And increasingly, it is the Fed’s balance
sheet itself which is coming under scrutiny as it continues to injecting billions into the system.
Chart 1: Intra-day movement of Dow Jones Index, September 29, 2008
SEPTEMBER 29: A DAY IN INFAMY
Page 2
What is next?
Honestly, no one really knows. We’ve read reports that the plan could still be passed over the next few days, or at the very least, a
rehashed & more acceptable version could be presented. But what worries us is that the House of Representatives has clearly
aligned itself behind their voters, in singing the tune of “Why should we bail out the fat cats on Wall Street?”. Will all of that
change within a few days? And will Congressmen who publicly voted against the package now vote for it & risk being seen as
turncoats by their voters?
With voters & the next election in mind, we fear that the House is under-prioritizing the implications of the credit crunch, very
much like how the equity markets did months before i.e. there were already signs of a credit crunch from mid-2007 but the equity
market failed to see the implications beyond the impact on sub-prime lenders or a handful of financial institutions. Equity markets did not fully comprehend the situation at hand until towards late 2007 and early 2008 when it became apparent that it was
not being contained and had wider implications. Maybe Congress need not wait too long for hard evidence that the crunch has
arrived on Main Street.
Time is not on the market’s side
Apart from the interbank market, the latest development is expected to result in a further credit squeeze in the U.S. commercial
paper market, where corporate generally issue paper for funding purposes. Already, reports had it the market for U.S. C.P. for
tenures between 1-3 months virtually disappeared the week before, even resulting in the Fed being unable to calculate the yield
for AA-papers. This has raised alarm bells because such corporates generally do not have high leverage and instead have
seen marked improvements in the balance sheet on the back of strong economic growth in recent years. While the CP market is
said to have emerged again albeit at much higher risk premiums, corporates are apparently scrambling to draw down on existing
credit lines with banks which comes ironically at a time when the latter are becoming more reluctant to provide such given the
state of their balance sheet (as it would go contrary to efforts to deleverage).
At this point, the signs of a credit crunch in the U.S. corporate sector are worrisome but a lot depends on whether this is a shortterm or long-term phenomenon, as many are seen able to tide through a short credit squeeze. However, should the situation persist, this could set up potentially a very ugly scenario whereby corporates are unable to access the CP market and are also unable
to utilize their revolving lines with banks, either because these have been withdrawn or have been fully utilized. This is akin to a
skydiver finding that not only has his primary parachute failed but also his secondary one. We now wonder whether the failed
bailout package will see such a crunch become more permanent in nature. The situation in the CP market will be closely looked at
given it could trigger a fresh round of credit rating reassessments of corporates and further downside on the stock market. This
would signal that the crunch has truly arrived on Main Street. Notably, up to now, equity prices have mainly priced in the impact
of slower economic growth but not a full blown inaccessibility to credit which goes to the heart of corporate solvency itself.
Will a new plan be as effective?
We also wonder how much more will the present compromise plan put forward by Treasury Secretary Paulson be diluted. Already scaled down from the original brought forward by Paulson, a “3rd draft” could seriously impede the effectiveness or
workability of the plan. And if we read his post-vote comments correctly: “We believe that our plan, and the plan that we developed with congressional leaders and worked so hard, is a plan that works. And we need a plan that works”, this is a concern.
Separately, the finger pointing has begun not only across party lines but within the parties themselves, especially the Republicans, and could see a future re-vote revert back along party lines.
Alas, the damage could already have been done. Only history will be able to judge whether last night’s events would be lauded as
democratic representation at its best, as the people’s representatives carried through voters’ opposition against the use of tax payers’ money to bail out Wall Street...or would it be seen as how the House lost its best opportunity to address the credit crisis & in
the process sealed the country’s economic fate?
What now?
Equity markets are clearly set for lower ground until it becomes clear when and what is likely to happen with the new attempt to
table the bailout package. Likewise, focus is increasingly on gold going the opposite direction as the yellow metal exhibits its
undisputed safe haven appeal.
We had previously called for the Dow to trade to 10,000 (see report “Dow 10,000: It has begun”) which at this rate, looks likely to
be breached given the present downward momentum. Nevertheless, we believe long-term investors should start nibbling sub10,000. While few would dare venture into the market at present, one has to remember that the capitulation & feeling of despondency seen presently is very much in line with what one would experience around market bottoms. Yes, we may sound bearish at
present but one should take a step back and differentiate the short- & long-tem. As long as one has a sufficiently long time horizon to see this through and the holding power to ride out any unexpected sharp downswing, the risk/rewards are to us, getting
increasingly attractive.
This article is contributed by Mr Sani Hamid. Financial Alliance Pte Ltd is a licensed Financial Adviser and exempt General Insurance broker regulated by the Monetary Authority of Singapore. We are licensed to provide financial planning and product advisory services. Please seek the advice
of professionals when reviewing and implementing your financial plan and evaluating financial products. The information contained in these pages
is not intended to provide professional advice (whether financial, investment, insurance, tax, legal or otherwise).
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