We congratulate the estimated 80,000 homeowners who could conceivably benefit from the mortgage bailout announced on Friday, but our guess is that not many big lenders, including the banks of Europe and Asia, are sharing their sense of relief.  On hearing the news, Wall Street responded initially with a gratuitous 200-point rally in the Dow. It was not a sense of rejoicing that caused this effusion, however, only yet one more short-covering panic by bears worn to a frazzle by the ongoing dog-and-pony show of crisis management as practiced by the Federal Reserve, and now by the Bush Administration, which announced the plan. 

Sanity seems to have returned near the end of the day, when practically half of the stock market’s gains evaporated in the final 30 minutes. The selloff suggests that at least some investors’ obsidian hearts may be in the right place after all – i.e., in the pits of their churning stomachs.  But while the Fed would have us all see a rash of manageable problems in the mortgage sector, there evidently are a few gimlet-eyed observers who can make out the specter of Godzilla looming in the fog.

Surely no one would have been fooled by the spin that President Bush, Helicopter Ben and HUD Secretary Alphonso Jackson tried to impart to the mortgage situation in their separate speeches to the nation on Friday morning. All insisted that the rescue package was designed to help the little guy rather than those damnable real estate speculators who brought this ugly mess upon us. In truth, though, and by and large, we are a Nation of Real Estate Speculators, and any policy that would seek to ameliorate the woes of one kind of speculator before those of another has ventured chest-deep into the quicksand of moral hazard.

Didn’t Read Fine Print

According to HUD's Mr. Jackson, the mortgage relief program was designed to alleviate the plight of homeowners who evidently failed to read, or at least to fully comprehend, the fine print on their adjustable-rate loans. A quite large subset of borrowers, to be sure. They are borrowers, he said, who were making their mortgage payments on time until a few months ago, when ARMs clauses began to show their ugly side in unfamiliar -- and to some, scary -- ways.

Now, we wish the borrowers well as they attempt to navigate the shoals of an FHA-arranged refinancing.  But as one MSNBC interviewer observed, these particular borrowers, even the ones among them who had the very best of intentions, are not especially good credit risks at this point. And that means the government – i.e., the taxpayer – quite possibly will be throwing good money after bad. Considering it is just  80,000 debtors who are involved, America could probably afford to write off the whole amount.  But we shouldn’t kid ourselves that the bailout has not implicitly obligated the government/taxpayer to help other mortgage borrowers, possibly millions of borrowers, in their impending hour of need.

Meanwhile, in Europe…

Nor should we infer that the so-far token relief measure will have placated foreign lenders, either public or private. For both are growing increasingly nervous about the effect our credit problems are having on the rest of the world, most particularly Europe.  The eurobank in recent weeks was forced to inject huge amounts of printing-press money into the financial system because banks there, most worrisomely in Germany, were not getting paid on time by U.S. banks that owe them money. Without these short-term official loans to bridge the widening intraday gaps, the market for commercial paper in both Europe and the U.S. would dry up in mere days, causing business itself – i.e., the global trade in goods and services – to seize up.

The world’s financial system is closer to the brink, probably, than at an any time since 1929, and lasting remedy will not be found in such carefully orchestrated reassurances as we received on Friday from officaldom.  Nor, ultimately, will the markets be fooled by Orwellian-lite spin-control, notwithstanding the short-squeeze reflex that has come to dominate and distort price action on the NYSE in recent weeks.  As you can see for yourself, this was no less true shortly before the Great Crash, when the following appeared in the New York Times, on September 1, 1929 (courtesy of our friend Bob Hoye at Institutional Advisors):  

“Traders who would formerly have taken the precaution of reducing their commitments just in case a reaction should set in, now feel confident that they can ride out any storm which may develop. But more particularly, the repeated demonstrations which the market has given of its ability to ‘come back’ with renewed strength after a reaction has engendered a spirit of indifference to all the old time warnings. As to whether this attitude may not sometime itself become a danger-signal Wall Street is not agreed.”