The Government’s $8.5-Trillion Bet

12/08/2008 12:00 pm EST

Focus: MARKETS

Nick Atkeson

Partner, Delta Investment Management, LLC

Nick Atkeson and Andrew Houghton of ChangeWave Options Trader say the US government has put all its chips on the table to stop the financial crisis.

At the table of life in the high-stakes game of financial meltdown poker, the US government has gone "all in."

The total relief package is now up to about $8.5 trillion. The entire US debt at the end of 2007 was just above $9 trillion; $8.5 trillion is about 60% of the gross domestic product (GDP).

Here's a summary accounting of the $8.5 trillion:

. Federal Reserve: $5.5 trillion committed, $2.1 trillion used

. Federal Deposit Insurance Corp. (FDIC): $1.5 trillion committed, $149 billion used

. Treasury Department: $1.1 trillion committed, $597 billion used

. Federal Housing Administration (FHA): $300 billion committed, $300 billion used.

The $8.5 trillion chip stack is what the government pushed into the middle of the table. Not until the hand is played to the end will we know the fate of that bet. This all-in bet could be a winner.

The US government has removed its sunglasses and is looking the world directly in the eye, as it has shoved this humongous chip stack into the pot. Staring right back is a cast of unsavory financial characters and negative economic forces. These are the same characters and market forces that have won every hand so far—market forces that spell "deep recession" and financial speculators willing to purchase credit-default swaps and then short the equities into the ground.

The bet the government is making is to flood the troubled parts of our economy with support money to allow natural market forces to take effect in a controlled, gradual manner. Slowing the rate of economic deterioration may allow some healing economic forces to gain traction.

By placing a safety net under the falling economy, confidence and fresh private investing may begin to sprout.

Most of the bailout money is going into loans or loan guarantees, as well as asset purchases including preferred stock investments that potentially could see positive returns. Treasury borrowing costs are now down to 1% or less for a two-year term.

With corporate bond yields now at about 9%, the spread is at historically very high levels and leaves a lot of room for profit if the default rate does not become excessive.

In some sense, the government has rigged the game in its favor. It is capturing profitable spreads with one hand and using the other hand to keep the default rate under control through loan guarantees and direct liquidity injections.

The next administration may be even more aggressive in playing this hand. With increasing confidence, the government is truly committed to an "all-in" bet, and the equity markets may finally be restored to pricing equities based on earnings expectations rather than guesses about the next exogenous shock.

Our chips are on this table. The question we have to ask ourselves is, who is the smart money?

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