Nov 29

Two Key Questions about The Great Re-Leveraging AKA Bailouts


Let’s take another look at The Great Re-Leveraging AKA US Government bailouts, which tend to generally take one of three forms (or some combination):

(1) Government guarantee (as seen with money market funds, some bank loans, increased FDIC deposit coverage and, of course, a special guarantee for Citi’s ‘bad bank’ assets)

(2) Direct loans or preferred/quasi-common stocks investments (as seen with AIG, and the innumerable amount of banks that got the first half of TARP money).

(3) Liquidity sources (as seen with many of the Federal Reserve programs, designed to take assets – with ‘haircuts’ so questionable they make ‘comb overs’ look good.)

Add these up and what do you get?  Well, according to Bloomberg, we’re at $7.7 trillion and counting ( and that was as of last week.  That’s about 1/2 of U.S. annual G.D.P.

Want another view of things?  Just take a look at the Federal Reserve and the FR Bank’s balance sheets ( — all very complicated, but they boil down to one plain fact:  Where the Fed once backed those green Federal Reserve Notes in our wallets with US Treasuries, we now have a Fed that has now ballooned its balance sheet by a factor of nearly 3 times versus a year ago due to bailout related activities.

One can argue all day about the importance of, the amount and the type of bailouts that have occured thus far, but one issue is clear:  The US Government is re-leveraging to combat the ‘Greatest Deleveraging in the History of the World’.  One hopes that this will all end up well and the US Government and economy can eventually get back to normal.  However, two major questions linger:

1 – How many more bailouts, of how much, what type and for how long, and….

2 – How (and when) might things ‘get back to normal’?

An answer to question one will require a coherent strategy – something not yet divulged to ‘we the people’.  I would seriously recommend the new Administration propose such a strategy for all to view and understand.

An answer to question two will allow investment managers to develop tactical strategies (to go with strategic asset allocation decisions) that take into account when the force of ‘mean reversion’ might return to the fore.  Remember that nearly all investment manager decisions are based upon long term relationships reasserting themselves.  However, in the current liquidity and credit challenged markets, long term relationships have been virtually thrown out the window.  Thus, how and when things ‘get back to normal’ is perhaps the most challenging question facing investment managers today….and worthy of detailed discussions with your manager as it relates to your company’s portfolio. 

As for the USA, a larger unknown that could be solved by the answer to question two is the probability that, at some point, investors and other countries might rachet up their assessment of US Government currency and/or credit risk.  The result might be a much lower dollar and a higher yield demanded on those ‘risk less’ Treasuries.

Yes, Virginia, there may be a Santa Claus, and sometimes the US Government tries to act like St. Nick when it comes to bailouts.  However, bailouts don’t come down our collective chimney without a cost.  Perhaps by answering the two questions noted here, we might get a better idea of what we are truly receiving.