Analysis: Capitalism's raw edge on display

Bolaji Ojo (09/23/2008 11:38 AM EDT) URL: http://www.eetimes.com/showArticle.jhtml?articleID=210603345

U.S. Treasury Secretary Henry Paulson says the era of "raw capitalism" is over. He is mistaken. Google Inc. CEO Eric Schmidt also claims the latest financial debacle on Wall Street "is in New York, not here. It's business as usual at Google." He is equally mistaken. Capitalism is not a government-driven process. It is a system that has taken hundreds of years to evolve and, like a hurricane, it is directed and moved by the forces that shape it and not by the whims of mere mortals.

Economists believe the financial problems Paulson and other government officials are trying to resolve will deepen the U.S. economic recession, constrain government spending, lower corporate earnings, jack up taxes for everyone, raise lending costs for consumers and corporations and take many more years to clean up. "For the here and now, look for steeper losses to be reported, look for equity to become highly dilutive," said David Rosenberg, an economist with Merrill Lynch & Co. Inc. That's the message the equity market forcefully passed on to Paulson on Monday (Sept. 22) when the Dow Jones Industrial Average resumed it's free fall witha 373-point decline, down more than 3 percent, despite a massive government bailout plan that should have been perceived as a positive.

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Investors across the globe studied the plan and sneezed hard. Equity markets plunged, the dollar weakened even further and crude oil prices swung wildly, dipping first below $100 per barrel and then racing back above $130. By Tuesday crude oil prices were sharply lower again. Here's why the market is unnerved and why you also should be concerned, whether as an individual or as a business manager.

By assuming effective control of Fannie Mae and Freddie Mac, the U.S. government has already dramatically increased its public debt obligations by as much as $5 trillion (yes, trillion) since the two institutions together account for more than half of total U.S. mortgages. This doesn't necessarily mean the U.S. government now owes $5 trillion in addition to the already huge $9 trillion or so in public debt. Rather, the implication is that the government is now on the hook for any defaults arising from the mortgages held by Fannie Mae and Freddie Mac.

(However, mortgage interest rates have dropped since the U.S. takeover of Fannie Mae and Freddie Mac.)

In order for Congress to approve the Bush administration's bailout plan, it also would have to increase the U.S. government's borrowing limit to more than $11 trillion. Additionally, the new funding request is bound to push up the federal budget deficit to as much as $900 billion in 2009, according to Merrill Lynch economists, who had previously estimated the deficit would rise to a record $500 billion without the bailout.

"So, as a share of GDP, the deficit will soar from 3.1 percent this year to 6.2 percent next year, surpassing the 1983 peak of 6 percent," noted Rosenberg. "This is akin to fighting another Iraq war in terms of the financial cost to the public purse, and will severely limit the fiscal flexibility of the next administration and Congress."


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In fact, some analysts are already factoring the messy investment environment into their models for corporate revenue growth, earnings and equity price targets. Technology analysts at Morgan Stanley said they expect demand for high-tech products to slow down sharply. They also see problems for semiconductor companies as well as equipment vendors as companies seek to tamp down operational expenses and reduce R&D as well as capital expenditures.

"We expect companies to guide to worse-than-normal revenue growth for the December quarter," said Kathryn Huberty, a Morgan Stanley analyst. "We also see additional earnings-per-share downside if the current state of capital markets further limits the ability to finance share repurchases, invest for growth and finance customer purchases." Added Huberty: "We adjusted models for 21 tech hardware and equipment companies. Overall we cut 2009 revenue by 3.1 percent, and earnings by 5.6 percent." She also projected "less than normal seasonal growth for global PC and handset shipments" during the second half of 2008.

On top of everything else, it now looks like there will be coal in a lot of Christmas stockings.

Lots of "value" is evaporating into the fog from which it came. So this piece, while correct, understates the magnitude of the problem.