An interesting test

By Carl

It should be interesting to see the market reactions today to this:

An economic stimulus package that President-elect Barack Obama is expected to announce Monday will not likely have a major impact on manufacturing until the end of 2009 or later, an analyst said Monday.

Obama is rolling out a plan that will require congressional cooperation even before he is inaugurated Jan. 20. His plan is likely to exceed the $175 billion he proposed during the campaign and would include an infusion of money for infrastructure projects, new environmental technologies and tax cuts for low- and middle-income taxpayers. It will not call for tax hikes for the wealthy.

Analyst Ann Duignan of JPMorgan said in a note to investors that machinery companies such as Caterpillar Inc., CNH Global, Deere & Co. and other manufacturers would not begin to feel an impact from federal spending until 2010.

(emphasis added)

Given that the market has basically spit up the Bush recovery scheme like a cat with a poisoned furball, Obama's plan should see some welcome positive reaction in the market place. Which I'm sort of hoping for because I started buying stock again on Friday. It will be hard to segregate the reaction to Obama's plan from the reaction to the Citigroup bailout, but my suspicion is stocks will reach pretty high, other things being equal.

Curious thing about Citigroup: they are the largest bank in the United States (at least, they were before all this merging started in the wake of the Bear Stearns debacle), and had just received a $6 billion capital infusion from the House of Saud, and, indirectly, the bin Laden family. They seemed poised for a commanding position in the banking community.

And now we're finding out they were already $300 billion in the tank in subprime mortgages alone, which we have agreed to guaranty.

Looking back now, the market mechanisms made this situation nearly unavoidable: subprime mortgages were making money hand over fist, and the repackaging of mortgages into derivative securities (sorry for the jargon, folks) made it a double-dip scoop of ice cream on top of the slice of pie.

The first Ponzis in were earning money hand over fist each quarter: Countrywide, Ditech, all those guys who advertised relentlessly on the TV, were making earnings that dazzled even the most suspicious bankers, who are generally thought to be sober fellows. Realistic bankers who wanted to sit on the sidelines, and make money the old fashioned way (ripping off widows and orphans), felt enormous pressure from the shareholders and market analysts to jump in with both feet into what was clearly a lucrative business.

It became a self-feeding cycle: banks would lend money, people would mortgage their homes, banks would then scrape for even more money to lend to borrowers who were slightly less credit worthy and the erosion of the credit markets began. This was all fine so long as the historical axiom that housing prices always rose, long term, was in effect.

Here's the problem: the way loans were structured, it was in the homeowner's best interest to move every five years or so. The mortgage models were based on thirty year ownership. Over the long term, yes, homes were a really good investment. But not so much in the short term.

You'd borrow on an adjustable rate mortgage with a teaser intro rate AND interest-only payments for the first five years. Before the end of five years, you'd sell this home, buy a new one on a brand spanking new five year adjustable mortgage with a teaser rate and interest-only payments and use the proceeds to pay off your old mortgage.

Once housing prices peaked and began to slide, now people were being asked to pony up significant amounts of principal to pay off the shortfall in the sales proceeds, thus taking dramatic amounts of money out of both the mortgage market as well as the consumer market.

Citibank is heavily involved in both markets. I suppose $6 billion was just a bandaid on an amputation.

(Cross-posted to Simply Left Behind.)