In the past eight years since I’ve kept track of financial markets in the US I have never seen as much volatility as today. In fact a volatility gage called VIX today hit one of its highest if not its highest level ever. Higher than 9/11!! In one of my earlier post I talk about the volatility, in general, of todays markets being the new normal as emerging economies, investors, and consumers interweave their demand and money into the global financial system. But the kind of volatility that we saw today is far above and beyond anything normal or healthy. Its absolute pandemonium to a degree unseen since the great depression and (frighteningly) with good reason. Less than a week after the passage of the 700 Billion “bailout bill” that was supposed to ease credit markets why is the situation not just unimproved but worse? There are two primary reasons:
1) As much hype of relief as the bill had, the money is not immediately available. The government must go out into the world markets and offer the first hundreds of billions worth of IOU notes- generally called Treasury bills. Once that happens the checks are written and the Treasury can start hiring people to analyze the toxic bonds and start buying them.
2) Lack of a legal and temporary “bailout” not involving the government interfering in the markets. While at the end of the day investors and tax-payers everywhere will probably be glad that the 700 Billion bill passed, the financial markets in the US are dealing with a severe change in the rules of the game. At the end of 2007 the government board that regulates accounting standards radically changed the way companies are required to report the value of their investments mostly due in part to scandals like Enron and Worldcom etc… The new rules say every four months the company must give an exact value of how much their investments would be worth if sold right then. Sounds fair right? Right… and wrong. The onerous new rule sought transparency but created massive problems because long-term investments could at any short-term be worthless while on a long-term they be worth a lot. Before the rules changed, banks and insurance companies showed financial analysis to prove that although temporarily low in price their different investments have and would prove to be worthwhile and thus could be counted as collateral (value someone could cash in if not re-payed) for credit or as a basis to lend out money.
In a rough analogy, its like you are a professional fossil collector and you want a loan, the bank asks what they might take if you don’t re-pay your loan and you show them some rocks which you know have fossils that need to be carefully extracted and are worth thousands of dollars. Under the old rules the bank looked at your past history in selling the fossils and sees that you do have valuable rocks and uses that as collateral for your loan. Under the current rules the bank sees the rocks and says “no loan, those are just worthless rocks”. So while the 700 billion bill will help the financial system by buying those “worthless” rocks for the few precious fossils that do remain in there, the price to investors will be very high as the government takes part ownership of the firms for the “bailing out” help until it sells the rocks to someone else much later on. This obviously castigates top executives but rashly hurts all stockholders. Investors are not happy with the bill because the cost of helping them is hurting them almost more. It bails everyone out but makes everyone pay a high price for the excesses of a few. And at the end of the day the accounting rules will show them as having worthless rocks and not the valuable fossils that they know they have in the long-run.
This is why the market is so jittery, their supposedly worthless rocks are not being bought up yet. They are running out of cash and have little or super expensive access to credit. And once the rocks are bought they will have to pay bucket loads to the government when a few elite individuals are the ones to blame. And to add insult to injury whatever rocks the government doesn’t buy will still have to be valued at whatever low price (better than zero at least) the government buys them at regardless of their long-term value.
- The accounting rule is called Mark-to-Market accounting and I super-simplified it so it could be better understood. If you think my explanation sounds like a mix of accounting rules for “work in progress” and investment assets you are right, but for purposes of understanding how MtM is affecting the situation right now I hope my analogy helps.
- The VIX index is usually around the high 20’s +- 5. On 9/11 it hit 49.35 Today it hit 59.06!
- The treasury curve is one of the best indicators for how scared investors are. If its low it means that investors are willing to buy these gov. bonds for almost no return (putting money under the mattress as Henry Paulson said). If its high, investors are finding stocks and other investments that are attractive. The yields according to Bloomberg.com for today are a paltry .6% That is less than 1%, lower than inflation!