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Markets Remain Apprehensive as U.S. Bailout Plan Rolls Out

15 October 2008 - Markets - Editor

Following the euphoria of Monday, U.S. markets drew back a little on Tuesday with the Dow Jones Industrial Average, the Standard & Poor’s 500 and the Nasdaq composite index all ending the trading day down by 0.8%, 0.5% and 3.5% respectively. While investors are hopeful that this is an indication of a return to some sort of normalcy, given the extreme volatility of markets in recent months, they may very well be hoping in vain.

What has become apparent, especially in the past two weeks, is that the market has been driven by irrational investor decisions that have been based on fear and fueled by media reports of bailout plans and emergency interest rate cuts. Although only time will tell, it could be that Tuesday’s market performance is an indication that investors and their portfolio managers have returned to basing their buy and sell decisions on the fundamentals and performance of individual companies, their ability to make money and the true value of their stocks, rather than on media hype.

It is more likely, however, that the market will remain subject to uncertainty and some level of volatility as governmental authorities enter uncharted territory, and rescue strategies are put into practice around the world. In the United States the first part of the $700 billion bailout plan is being put into action, as $250 billion is made available to nine major banks, including Bank of America, JP Morgan and Citigroup, in an effort to get them lending again and thereby preventing the U.S. economy from grinding to a complete standstill. In exchange for this much needed cash injection, the banks will sell $125 billion preferred shares to the taxpayer and commit to using the funds for lending. An additional $125 billion will be made to smaller banks and will be subject to the same terms. In what is seen by many as a move to appease American taxpayers, the banks are to pay a guaranteed annual dividend of 5%, becoming 9% after five years, on the money they are receiving. Moreover, the Treasury has structured the deal in such a way that banks will be motivated to buy back the shares from the government through the raising of private capital.

Other steps being put into action immediately that will not be at the American taxpayer’s expense include the guaranteeing of certain business-related bank accounts above the current $250,000 limit. Also, a new FDIC program known as a “Temporary Liquidity Guarantee” will guarantee lending between banks. It is anticipated that these measures will reassure both banks and businesses that it is safe to borrow and lend.

The $700 billion financial sector bailout package has changed somewhat from the initial proposal to buy troubled mortgages from deeply troubled financial institutions. With $250 billion already allocated elsewhere, and analysts estimating that mortgage-related bad debts add up to more than $1 trillion, taxpayers are left wondering whether the government still intends to buy the bad debts, and if so, where the money is to come from, and most importantly – how it will impact on embattled taxpayers. Many questions remain unanswered, especially for the average hard-working, tax-paying American citizen. Is the bailout plan going to assist with re-mortgaging homes, thereby stopping the flood of foreclosures? Will job losses, bank closures and business failures cease? Many believe that only concrete, reassuring and believable answers to questions like these are likely to restore public confidence in the government’s ability to pull the country through the current financial crisis.

 


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