Investing Daily

With the seizure of Washington Mutual yesterday and the continued foot dragging on a federal bailout, all three indexes once again posted sizable losses for the week. The Dow Jones Industrial Index, including its newest component Kraft Foods--which replaced AIG Sept. 22--gave up 2 percent for the week, the S&P 500 took a loss of 3.2 percent and the Nasdaq Composite plunged 4 percent.

With all of the political bickering going on, the bailout plan working its way through Congress didn’t come in time to save WaMu. The troubled savings and loan was seized over night--marking the 13th bank failure so far and the largest failure in US history--after customers withdrew $16.7 billion since Sept. 16, leaving the bank undercapitalized and unsound. JP Morgan Chase came out on top of the deal, however, acquiring more than $307 billion and 2,300 branches, bring its branch total to 54,00 with about $900 billion in deposits--the most of any US bank.

The seizure of WaMu, coupled with JP Morgan’s troubling assumptions about the true value of the failed bank’s mortgage portfolio, led to a lower open this morning. In a presentation made by JP Morgan on its acquisition, it forecasted a 58 percent peak-to-trough slump in California home prices if the nation enters a severe recession, with home prices nationwide possibly falling 37 percent. It also immediately wrote down the value of WaMu’s assets by more than $30 billion because it expects losses on mortgage holdings to be greater than previously forecasted.

WaMu’s failure and the troubling assumptions made by JP Morgan on the health of the mortgage market helped drive share prices of Wachovia down by more than 30 percent today. Speculation on the health of the bank’s loan portfolio has caused its shares to lose more than half their value on the week, with some analysts musing that it could be the next to fail. There are reports that Wachovia is in initial talks with Citigroup to explore the possibility of a merger, a situation that may be resolved by Monday.

All of the turmoil has again applied the brakes to interbank lending, with the London interbank offered rate, the interest charged by banks to lend to another, has continued to climb to an all-time high. The TED spread, the difference between three-month LIBOR and the three-month Treasury borrowing rates, is standing at 2.92 percent after hitting 3.1 percent earlier today. Just a month ago, the spread was at 1.11 percent.

That demonstrates how little confidence financial institutions have in one another as they continue to carry troubled assets on their balance sheets and banks continue to fail.

That makes it even more imperative that the federal bailout plan is completed soon, since the formation of an entity to buy up the bad mortgage debt will provide much-needed capitalization for financial institutions, even if they have to sell it at a discount. It will also negate the worries that borrowers might be sitting on loads of bad assets, helping to restore confidence in the system and bring down interbank rates.

At this stage of the game, relief is vital to the functioning of the financial system, making it particularly worrisome that politicians are allowing partisan considerations to slow the process down. And worries that the deal may not get done are continuing to weigh on the markets.

I wouldn’t expect the gridlock to last much longer, however. President Bush is applying subtle pressure to get the deal done. Politicians also seem to be realizing that the public is running out of patience with their bickering; investors just want some relief and don’t care who takes the credit or who takes the blame, particularly since both parties are culpable for the mess and any consequences of the resolution. With news reports continuously stating that an agreement is near, I wouldn’t be surprised if the government released another Sunday announcement.

That would be particularly critical for the housing markets, with sales of both new and existing homes plunging in August. On a month-over-month basis, existing home sales fell 2.2 percent to an annual rate of 4.91 million, with new home sales down a huge 11.5 percent to an annual rate of 460,000 units sold.

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Mortgage applications also declined 10.6 percent last week, with mortgage rates rising off their lowest levels last week. US Treasury yields, which influence mortgage rates, surged last week as investors sold them off in anticipation of the bailout. The proposed federal action also served as a stark reminder that all is not well with the markets, unnerving potential home buyers.

The average contract interest rate for a 30-year fixed-rate mortgage rose to 6.08 percent from 5.82 percent; 15-year fixed-rates came up to 5.84 percent from 5.54 percent and one-year adjustable-rate mortgages (ARM) rose to 7.01 percent from 6.95 percent.

Jobless claims rose to an almost seven-year high last week, with initial jobless claims jumping nearly 7 percent to 493,000 new filings. That’s the largest number of weekly claims since the last time they soared in the wake of the 9/11 terrorist attacks. Continuing claims also continued their rise, up by 63,000 to 3.542 million. The spike in initial claims should be temporary, however, with Hurricanes Gustav and Ike helping to boost the number.

Orders for durable goods plunged 4.5 percent in August, falling to $208.5 billion according to the Commerce Dept. Among the largest decliners were orders for metals, factory machinery and transportation equipment, which fell 8.9 percent.

The final word also came down on second quarter GDP, with growth tempered from the initial 3.3 percent down to 2.8 percent. As previously announced, exports helped along by a weaker dollar largely drove the gain, but the complete data used to compute the final number showed less of a contribution. Consumer spending also turned out to be even weaker than initially thought.

The data is continuing to show a dangerously weak economy, with real estate markets suffering in particular, though that’s hardly a surprise. Stock markets could catch a break next week, given that political expediency demands the bailout package to be completed soon. Again, I’m looking for an announcement on Sunday or possibly Monday, though that’s more a function of my gauge of the overall mood than any inside track.

Yiannis Mostrous delved into the economic crisis yesterday in Growth Engines. He pointed out that, although there are parallels between 1929 and today, there are some key differences as well.

As I browsed Lehman Brothers’ Web site a few days ago, I came across fertile material for fans of irony: “The history of Lehman Brothers parallels the growth of the United States and its energetic drive toward prosperity and international prominence.”

Well, let’s hope that what’s past isn’t prologue because Lehman is no more.

Much commentary of late has been focused on the potential demise of the US economy, with many observers talking about a repeat of the Great Depression. As is often the case, the newly converted perma-bears are the most adamant on the issue.

It’s understandable that investors are looking for historic parallels in an effort to grasp the magnitude of the situation. The current mess isn’t shaping up to be anything nearly as catastrophic as the Great Depression. And it’s becoming quite clear that we’ll likely avoid such an outcome.

For starters, the Federal Reserve has been extremely proactive this time around. It’s true that its moves haven’t been met with a lot of success, but the central bank has been proactive nevertheless. It was the Fed that opened the discount window more than a year ago, but financial institutions were afraid of the stigma and didn’t embrace the effort.

When things got worse, Treasury Secretary Henry Paulson grabbed the reigns. Difficult times require strong leadership, which is what Paulson is currently providing.

There will be bickering and ridicule from the chattering classes, but positions of power entail certain responsibilities, and this is what Paulson seems to understand well.

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People also forget that America has been through crises before, and it’s also endured restructuring phases for its financial system. One crisis concerned the deposit insurance scheme, which wasn’t in place in October 1929. As a result, people lost confidence in the banking system.

This isn’t happening this time around, allowing for easier navigation while authorities inject liquidity into the system. And with the Fed’s assets at around USD900 billion, the argument of a stretched balance sheet is rather naive. Current actions will certainly hurt the balance sheet, but it won’t be demolished.

Finally, the rest of the world is willing to provide any assistance possible in order to avoid the demise of the global financial system. Most important, the world has the financial muscle to perform this task, allowing even more flexibility.

The assumption here is that politicians will stop playing games and allow Paulson to proceed with his plan. It’s no longer time for rigorous oversight; now is the time for action.

Make no mistake; the consequences of the current turmoil--particularly the loss of confidence in the system’s purported invincibility and superiority--will be long lasting. And although the US economy will remain the biggest in the world for a long time, its credibility will suffer immensely. Along with its debtor status, that will pose a challenge going forward as the US addresses other nations on economic matters. History has shown that a debtor has no luck when lecturing its creditor.

Expect foreign creditors to eventually look for some level of management control or other concessions if they continue pouring fresh money into the system.

Looking at the future of the global economy, Asia provides the best possible place for long-term investing.

A lot of people would like to forget that the current crisis started in the US. It didn’t originate in some far off emerging economy. It’s the US financial system that needs serious repair. The Asia banking sector could suffer some collateral damage, but any repercussions should be easily contained.

Because of the cathartic phase Asia passed through after the financial crisis of 1998, its financial system is now in position to not only support the domestic economies but also to give a helping hand to failing financial institutions in the US and Europe. And, of course, the US Treasuries these countries snatched up over the years allow US authorities a more flexible approach to monetary policy.

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