Imagine running a bank that was at the center of the mortgage explosion and as a result is now teetering on the brink of bankruptcy. You are working furiously to save the very institution that you worked so hard to build.
Capital is raised and still your company flounders. Crisis sets in and you scramble once again to find a solution. In the middle of it all Wall Street is on the brink of collapse culminating with the rescue of the largest insurance company in the world, American International Group, Inc. (AIG).
At the same time the government is on the verge of a massive bailout that potentially could save your bacon. You’re breathing a little easier, right?
Nope. Instead you get on a plane after the market closes on your way to Wall Street in pursuit of a solution. While you are in the air the government seizes your company.
That’s what happened to Washington Mutual (WM) last night. The government, negotiating for a sale of your assets for weeks behind your back, found a willing participant in JP Morgan (JPM).
They made the move official last night seizing the large thrift and doing so without notifying WM management.
Essentially the government is saying here forget about your efforts, forget about your solutions and forget about going forward on your own. Game over. You are done.
Can you imagine being in that position? I know it’s hard to have any empathy for management that created the mess, but you have to feel something for these guys.
WM equity owners are essentially wiped out in this deal. Shares of WM are down some 90% as a result. I wouldn’t bet on any return here even though some value remains.
Now if you are JPM, the gifts just keep on coming. First you are able to purchase Bear Stearns with the help of government guarantees and now you are handing a banking franchise at a fire sale price.
Why not do this deal? JPM immediately obtains a footprint in markets where they were weak. With the purchase JPM becomes the largest bank in the country by deposits. (See also: "How to Play the Wall Street Bailout.")
More importantly they get a deal for WM at a time when a bailout will significantly lower the risk of owning the bad assets on WM’s books. As I have said before there will be winners and losers as we come out of this mess…
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JPM will be one of the winners. Its banking assets become all the stronger with the risks of loss lower with the government providing an important backstop, assuming a deal gets done.
Early in the day yesterday the proposed $700 billion bailout looked to be heading for bi-partisan approval. Announcements from the administration, Democrats and Republicans seemed to indicate that a negotiated agreement would be approved shortly.
That was then, this is now. Late in the day a White House meeting went very badly with participants essentially stating that there was no deal. Even more stunning was word that a new proposal with less regulation and little in taxpayer dollars invested/spent was being circulated by House Republicans.
There had been plenty of skepticism of the Administration’s plan, but nobody could have predicted this. Even though Paulson and Bernanke claimed that the abyss was near if their plan did not pass, Congress appeared to be ready to face the consequences if a deal did not pass.
Such a move is the ultimate in high stakes poker. Will the market collapse if a deal fails to materialize? Those opposing the bailout are betting that the market will be just fine without government intervention.
They have good reason to feel this way. Thus far the market is behaving very well (too well in my opinion) considering all that is transpiring. Every day that passes without a deal, it very well may be possible to avoid the disaster scenario that is expected by the administration.
Assuming that Presidential politics are not in play here (I know, bad assumption, but cut me some slack for the moment), my best opinion is that the opposition to a government bailout is somehow waiting to see how the market reacts today before making the next move.
If there is a real threat of a deal not passing, the market performance as a result may be a preview to what happens without a deal. Should the market manage to avoid a complete wipeout then it may be quite possible that the dire consequences of a non-bailout scenario fail to materialize.
Why bailout then?
Well the market is hanging in there today. If indeed this is a big bluff, the opposition to a deal may be strengthened as stocks avoid the abyss. The problem of course is that the game is rigged at the moment. (See also: "Why It’s Okay to Sell.")
Bans on short selling have removed the significant downward pressure on pricing. You can’t really know what will happen if a deal does not pass. That said, one must trust the experts in Paulson and Bernanke that the absence of a deal will result in chaos or worse.
We have major problems here even if a deal ultimately gets done. Today though is a poker game. What happens from here is a crapshoot.
Be careful with your investing.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com.
