Doubt over 'the boys at the Treasury'

November 16, 2008|By Gail MarksJarvis | Gail MarksJarvis,chicago tribune

Investors have been fixated on Humpty Dumpty.

Or at least it appeared that way last week, after Treasury Secretary Henry M. Paulson Jr. left the impression that perhaps all the kings' men weren't sure how they were going to put the economy back together again.

Paulson said he changed his mind about how to use some of the $700 billion Congress provided for an emergency rescue of the financial system. Instead of using the money to buy the tainted mortgage-related securities that have infected the worldwide financial system, Paulson said he needed to apply quicker medicine and decided to pump money into financial companies instead.

"This might well be the proper focus ... but the level of confidence that the boys at the Treasury know what they are doing is at a low ebb," said Vince Farrell, chief investment officer of Soleil Securities Research, as the Dow industrials tumbled more than 400 points the day Paulson spoke.

Last week, Paulson said the funds he'd poured into the financial system were making a difference, and he was "comfortable" that the $700 billion Congress provided is "what we need."

But Farrell asked: "How does one know? Have the facts really changed? Or are we banging back and forth off the walls, hoping we get it right?"

During all bear markets, investors lose confidence and trust. The lowest point in the 2000-2002 bear market came after investors found out that Enron's finances were a fiction and Tyco International's chief executive had been spending corporate funds on elaborate toga parties.

This time, there are no toga parties.

Instead, there is greater complexity as Paulson and Federal Reserve Chairman Ben S. Bernanke dig through an arcane financial system for solutions to help the world escape a serious recession.

There is no longer the expectation that a recession can be averted. The question is how long and how deep - and how that could drag the stock market down.

The market is adjusting to the earnings outlook for corporate America. While some observers say the weak conditions are built into stock prices, each dour warning from a company causes stock prices to fall.

In a conference call last week, Global Insight economist Nigel Gault told investors that no matter what stimulus is applied to the economy, at this point, "they can't prevent a recession. We think it will be the worst since World War II."

He envisions gross domestic product declining about 1.5 percent from the end of the second quarter 2008 through about a year later. He thinks a more serious recession is possible, saying a 3 percent drop could occur by the end of 2009.

And though he expects unemployment to peak at about 8.25 percent by the end of next year, it could go over 9.25 percent by the middle of 2010.

That would make the rate far worse than the 6.3 percent in the aftermath of the last recession. Gault notes that often in recessions, people give up looking for jobs and unemployment figures consequently don't reflect the full impact of joblessness.

This time, he said, unemployment numbers will rise sharply because people are so pressured by their debts that they can't give up looking for jobs.

The stresses in the economy were clearly showing up last week. Global stock markets have lost $29 trillion in value, according to a Bloomberg News report. And Germany, which is Europe's largest economy, officially fell into a recession.

Based on U.S. housing and stock market losses, Gault figures net worth for Americans has declined by just under $8 trillion since 2007.

That was showing up in gloomy reports from retailers last week.

Standard & Poor's analyst Howard Silverblatt said that estimates for corporate profits this year "still paint a rosy picture. They are likely to be cut significantly by the end of November."

Silverblatt estimates profits for the third quarter will be down 13.4 percent after the last companies report. Yet analysts had been expecting earnings growth of 14.2 percent when the reporting process began.

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