By Simon Maierhofer
Growing up and going to school in a little village in Germany, I had a big advantage - a big brother. Not only was my brother twice as old and tall as me, he was also twice as tall as all the other boys at school. If needed, he could be my 'Get out of jail free card' - or at least so I thought.
No matter how old you are, having the backing of a big brother is always advantageous. Even huge multi-billion, multi-national banks (NYSEArca: KBE - News) and financial organizations (NYSEArca: XLF - News) needed the help of a 'big brother' earlier this year.
In this case, the government stepped up and took the place of a big brother. There were, however, no family ties involved in this relationship. It was strictly business. On numerous occasions, the government had to bail out banks (NYSEArca: IAT - News) that had gotten into trouble.
On October 2, 2008, the House granted final approval of the first $700 billion bailout package.
On October 9, 2008, $37.8 billion were given to AIG (NYSEArca: AIG - News) in addition to the previously granted $85 billion. This package was increased to about $170 billion in November. On November 24, 2008, the FDIC and U.S. Treasury announced to back more than $300 billion worth of Citigroup's (NYSEArca: C - News) non-performing assets.
On February 17, 2009, the $787 billion bailout was approved followed by the Fed's announcement to buy up to $1.2 trillion worth of government and government agency (i.e. Fannie Mae, Freddie Mac) bonds on March 18th.
On March 23, Secretary Treasury Geithner announced a plan to create the Public Private Investment Program (PPIP). On May 8, the long-awaited bank stress test results were released and quickly modified.
The above, complicated as it may seem, is just a small synapses of what happened. But it beautifully illustrates the point that the government was ready to come to the rescue whenever needed.
Willing, but ineffective?
A picture says more than a thousand words and the chart below shows the effect, of the bailouts. Every bailout was received by major market declines. Following the initial bailout, the Dow Jones (DJI: ^DJI), S&P (SNP: ^GSPC) and Nasdaq (Nasdaq: ^IXIC) dropped some 30% in 45 days.
Within 20 days of the second major bailout, the Dow Jones (NYSEArca: DIA - News), S&P 500 (NYSEArca: SPY - News) and Nasdaq (Nasdaq: QQQQ - News) tumbled 15% or so. Dozens of other initiatives in between had no noticeable positive effect either.
On March 23rd, the Dow soared 496 points, allegedly because of the PPIP. The government stimulus plans probably infused some confidence into the market, but they certainly were not the only catalyst to send stocks soaring. The PPIP and the Fed's bond buy-back program weren't launched until the middle/end of March.
In early March, amidst this doomsday atmosphere, the ETF Profit Strategy was one of the only bullish advisory outfits. Via a special Trend Change Alert sent out on March 2nd, the ETF Profit Strategy Newsletter recommended to start buying long and leveraged long ETFs, expecting the onset of a massive rally.
While the buy alert worked, the same thing can't be said for the various bailouts. Nevertheless, most investors' believed that big brother would step in once again, if needed, to prevent a major collapse. This may be true, but the issue is not one of willingness, it's one of effectivity.
The primary goal of the composite of stimulus packages was to shore up banks and re-inflate the economy. For money to be inflationary, however, it has to reach the consumer. We know that banks (NYSEArca: KRE - News) received plenty of money. But where did this money go?
Injecting $2+ trillion into the economy sounds good in theory. Unfortunately, it appears as if the bailout funds handed to banks never really reached the economy, or the consumer. As the chart below shows, cash assets of all commercial banks have grown four-fold over the past 18 months.
In other words, banks pocketed the money, but didn't share the wealth. Banks are hoarding rather then lending. The purpose of the bailouts' were to inflate the credit markets. As long as money remains on banks' balance sheets as cash, it simply cannot do its job of inflating the economy.
Too big even for big brother
In a special bailout report, issued on September 2008, the ETF Profit Strategy plainly revealed the flaws of the initial, and all subsequent, bailout initiatives.
Aside from those inherent flaws, the U.S. government faces a problem that is simply too big. Yes, too big, even for the U.S. money-printing machine.
According to an Asian Development Bank research report, the value of global financial assets including stocks, bonds, and currencies (not including real estate) fell by more than $50 trillion in 2008. IHS Global Insight estimates that $14 trillion worth of wealth was destroyed in the U.S. alone.
This is more than five times the amount of the Fed's current balance sheet. Additionally, and more importantly, the total world derivatives market (the kind of leveraged financial instrument that has caused this massive deflation) is estimated to be worth about $800 trillion.
In the face of record government deficits, President Obama has a hard time getting a $1 trillion +/- health care bill approved. Would it be reasonable to assume that permission would be granted for another trillion dollar bailout? More importantly, could the U.S. government afford another trillion dollars plus bailout? It doesn't seem so.
This time it's different
A quick comparison of the post 2007 downturn with all previous recessions shows that the only parallels to retain any value are those to the Great Depression.
Concerns about a similar outcome - an 80%+ drop in the U.S. stock markets (NYSEArca: VIT - News) - are quickly dismissed. 'This time it's different, the government can print its way out of trouble.'
That's true, unlike the 1929 - 1932 period, the US dollar is not backed by gold (NYSEArca: GLD - News) anymore which opens the door for more fiat money to be printed and debt to be monetized. At first glance, being off the gold standard may seem like a blessing.
In reality though, it's a curse. Due to the endless amount of fiat dollars, there is an endless mountain of debt out there, toxic debt. The $800 trillion in derivatives floating around would never have happened with a gold-backed U.S. dollar.
In summery, yes, the government can now print money seemingly at will. Nevertheless, the problem at hand is simply too big to be monetized. Eventually, the piper will get paid. This will have far reaching financial consequences.
Every issue of the ETF Profit Strategy Newsletter includes a detailed short, mid and long-term analysis of the stock market and other asset classes, along with common sense strategies to survive and thrive in the current financial environment.
Unlike the banks, many of us don't have a big brother to erase our financial mistakes. It's up to you and me to get it right the first time.