Friday, September 19, 2008

The One Thing Markets Hate Worse Than Losses?

The last two days offer a vivid illustration of the raison d'être of the UCC (and commercial law generally). The one thing that markets hate worse than losses is . . . uncertainty.

The Dow has risen 779 points--over 7%--over the past two days (really, the past day-and-a-half), with financial stocks enjoying impressive gains (from the CNN story: "Merrill rose 28%, Bank of America gained 17%, AIG rose 51%, Morgan rose 25%, Goldman rose 20% and WaMu rose 28%."). All this on news that these very financial companies are going to be allowed to sell their worst assets to a newly created federal entity at a huge loss. Wait, can that be right? Hooray for losses???

The CNN story quotes one financial expert as saying that "the fundmentals have changed and that's going to support markets going forward." What fundamentals could this odd loss-accelerating proposal implicate?

Well, the most important fundamental, apparently: certainty, or at least the lack of obvious uncertainty. On Wednesday, the bailout of AIG created not certainty that the end of this crisis was nigh, but fears about which financial giant would be next on the Fed's discount shopping spree through Wall Street. No one knew who would be the next victim of uncertainty with respect to the value of the mortgages and mortage-backed securities at the heart of this problem. Beginning with rumors yesterday and confirmed today, the market finally started to glimpse the light at the end of the tunnel. If we have to run over hot coals barefooted to get to that light, so be it, but just tell us when we've hit rock bottom! Though the details remain shrouded in secrecy, the thrust of the plan is to drill down to bedrock by goosing some sort of market mechanism that will force banks and investors to admit once and for all how depressed the value of their mortgage-related assets really is (i.e., auctions to see who can offer these toxic assets to the Feds for the lowest price--I'll sell for 50% face value; no I'll sell for 40% . . . what a spectacle that will be!). Once the culprits of the housing crisis are forced to eat crow and turn over these assets, one hopes the feds will follow the FDIC-IndyMac example and start responsibly writing down the principle on overvalued mortgages, keeping people in their homes, and stopping the downward spiral in home prices. The end is near . . . . ?

O.K., O.K., another fundamental is involved here, too, I guess: liquidity. A Fed purchase of these uncertain payment streams will result in a huge infusion of liquidity into the market, having the double benefit of easing fears about the value of the assets and dousing loan markets with the cash that they have so desperately needed to get back to financing business and consumption on reasonable loan terms. That being said, my sense is that the infusion of certainty is much more central to this recovery (one hopes, long-term) than the expected infusion of liquidity.

It's hard for us to offer ready examples to students of why the certainty of HIDC status or Article 9 so facilitated the growth of commerce in the olden days, so let's point out the amazing effects of the promised exorcism of uncertainty this week.

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