I don’t usually do a lot of “naked” linking — that is, just citing someone else’s material with little commentary of my own — but this article by John P. Hussman, manager of the $3.5 billion Hussman Strategic Growth fund (and one of the very few people to have recognized the extent to which the market was both overvalued and overlevered) is really worth a read in full:
The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner — I’ve got a lot of respect for our President, but he’s been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke’s head playing “we let the banks fail in the Great Depression” and “we let Lehman fail and look what happened” are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to “fail.” Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we’ve suddenly become Venezuela.
Make no mistake. Buying up “troubled assets” will not materially ease this crisis, nor will it even improve the capital position of financial institutions (see You Can’t Rescue the Financial System if You Can’t Read a Balance Sheet). […] We are simply protecting the bondholders of mismanaged financial institutions, even though that bondholder capital is more than sufficient to cover the losses without harm to customers. Institutions that cannot survive without continual provision of public funds should be taken into receivership, their assets should be restructured to better ensure repayment, their stockholders should be wiped out, bondholders should take a major haircut, customer assets should (and will) be fully protected, and these institutions should be re-issued to the markets when the economy stabilizes.
The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured. There is no other option — but the markets are going to suffer interminably until our leaders figure that out.
Hussman also has some thoughts on both short- and long-run market valuations over at his site.
The general theme I’m trying to get at with these various posts on the markets is that Wall Street doesn’t necessarily know what’s good for it. Someone like Hussman didn’t get to manage a multi-billion dollar fund by following the crowd; he did so by being smarter than your average bull, and getting them to take the stupid side of a lot of stupid trades.