Paulson’s Flip-Flop

11/25/2008 12:42 pm EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, says that the Treasury secretary’s reversal on buying toxic assets has spooked investors.

Treasury secretary Henry Paulson [recently] announced a major change to the $700-billion financial bailout package.

Initially, the rescue program called for the purchase of troubled mortgage-backed securities, but in a candid admission, Paulson said that was “not the most effective way” to use the money.

Instead, the Treasury will buy securities backed by credit card debt, student loans, auto loans, and housing and government debts. The objective is to restore the routine borrowing and lending to consumers that banks and other financial institutions have been reluctant to do over the past year or so.

Paulson noted in his statement, “Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans, and credit cards. This is creating a heavy
burden on the American people and reducing the number of jobs in our economy.”

Many economists had been critical of the previous plan because the “toxic” mortgage-related securities were virtually illiquid, and without a viable market, setting prices would have been extremely difficult if not impossible.

By switching its focus to consumer-related securities, operationally it will be much easier to execute. The Treasury hopes to free up loans for credit-worthy borrowers looking for car loans, student loans, and other consumer purchases. According to Paulson, approximately 40% of US consumer credit is provided through these loans and “has for all practical purposes ground to a halt.”

While there are still many aspects of the plan that are unclear, one thing that is apparent by the Treasury’s about-face from its original proposal is the uncertainty and complexity in fixing the economy. An audible has been called and what was initially approved by Congress is now something different.

It has been our contention over the past month that the October 10th intraday lows would hold. After losing 678 points on October 9th, the Dow Jones Industrial Average dropped another 800 points during the first half hour of trading on October 10th, dropping all the way down to 7773 intra-day; however, by the close of trading, the Dow had regained 678 points of the lost ground. The Standard & Poor’s 500 index exhibited a similar pattern, dropping 7.6% on October 9th and losing another 7.7% in the first half hour the following day.

Since October 10th, the excessive volatility has continued unabated, but [as of this newsletter’s publication], neither the Dow nor S&P 500 have closed below their October 10th intraday lows. (They did close below those lows on Thursday, November 20th—Editor.)

Despite [the recent] dramatic rally, it is still a bear market. Investors who feel they are overweighted in stocks are advised to continue to sell all rallies. Our January 16th sell signal remains in effect—stay on the sidelines in money market funds.

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