Nationalization Fever

Today was quite a momentous day on the stock markets throughout the world. The Dow surged 936 points, the largest percentage gain since the 1930s. So is it time to wade back into the waters and go long? NO! This was just a correction and I have a feeling we aren't even close to bottoming out. There were a number of factors contributing to today's rally. For starters, there was the short squeeze factor. A lot of traders probably woke up today and figured it was time to close their short positions and buy back the stocks they had shorted, pushing the market up. Then there is the oversold factor. The market just plunged too much too fast and was due for a bit of a rebound. Thirdly, hedge fund, who need to liquidate to meet investor redemption calls are not going to be selling in this market as it will only increase their pain. As a result, a lot of hedge funds have probably stopped selling and are merely waiting for a pop in the markets to unload more assets. Finally, there was the good news coming out of Europe, coming from the G-7. While at the time, letting Lehman fail to stamp out "moral hazard" may have sounded like a good idea at the time, in reality it was probably one of the biggest blunders of this crisis. Now the EU has been forced to pledge $1.8 Trillion to ensure that there isn't a repeat.

The bankruptcy of Lehman Brothers sent waves of fear crashing through the financial sector unprecedented in modern times. A few times last week, it looked like the entire financial system was about to collapse right in front of us. Nevertheless, the G-7's assurances that there is not going to be a repeat of Lehman Brothers have assuaged these fears. Don't worry, though, we're still in for a nasty recession and there is plenty of pain to come on the markets. In any case, I guess Citi and Morgan Stanley won't end up going bust after all, but as I called it, they are probably going to receive some huge government equity injections. Still, these government bailout plans raise a lot of questions. Firstly, who are they going to bail out? Secondly how are they going to bail them out? With equity injections? With what kind of equity injections? Common? Preferred? Warrants? Finally and most importantly, will the participating governments be granted voting rights in the companies they are bailing out?

As the past few months have certainly proved, investment banking is inherently a very risky business. While risk-taking shareholders of even currently profitable firms like Morgan Stanley and Goldman Sachs have been fleeing en masse over the past few months, due to the riskiness of the assets. How will more conservative national governments feel about being on the hook for a prop trader's losses. Then there are questions about banks' derivatives business. While I personally think the dangers of derivatives are seriously overstated, many misinformed politicians and journalists have been constantly railing on them over the past few weeks. How do you think some of these politicians will feel about supporting a bank's derivatives operations after a bailout? It's no secret that business and government tend to work best when separate. If you want to argue with that, take a look at Russia. Even if the federal governments around the world buy up preferred shares with no voting rights, they are about to pony up a bunch of money. It's quite natural for them to be concerned about losses as they will ultimately be the ones paying for them. There are certainly more than enough politicians out there in the world, who want to curb the "reckless and irresponsible behavior that led us to this crisis." (I am not even going to bother addressing that assumption. While in the long term, this government intervention will likely be far better for the world economy than the alternative, there are still many questions about how this will reshape the banking system of the future.