Economists: Stock market recovery will take time

DES MOINES, Iowa — If you had hoped this week would bring significant recovery to the stock market, you’ve clearly been disappointed. Many investors are wondering why approval of the government bailout plan didn’t have an immediate impact on restoring confidence in the economy, leading to this week’s question:

Q: Why hasn’t the stock market recovered even after the government bailout plan was passed and should I plan for a lengthy market downturn as I look at options for my retirement savings?

A: The problem facing investment banks and other financial services companies is deeply rooted in the record number of home mortgage failures and the potential for more to come. Banks and brokerages wrote down about $400 billion worth of toxic mortgage investments since last year. Analysts believe write-downs could reach $1 trillion as rising home foreclosures further erode the values of mortgage-backed securities.

That has contributed to a shortage of available bank capital, reducing the ability of banks to lend money to one another, to businesses and individuals. It has created a credit crunch in an economy that has come to depend upon borrowing to function smoothly.

Small and midsize companies, typically the engines of growth in the U.S. economy, cannot function without credit. They lack the cash to drive hiring, equipment purchases and new construction for expansion, so they must turn to banks to borrow.

“Everybody’s broke. The government has a lot of debt. Most folks have no money,” said Michele Gambera, chief economist for Ibbotson Associates, a Morningstar company. “The banks have a lot of debt. The assets they have are not salable and we don’t really know how much they’re worth.”

That’s why the market didn’t react much to the $700 billion government rescue package signed this month by President Bush, he said.

Gambera believes buying bad mortgages from banks is an indirect way of solving the problem and there is significant doubt it will solve the credit problem.

Nobody knows how much the government is going to pay for those bad debts, he said. If it buys mortgages at a very low price in the hopes of getting taxpayers some return on their money, many banks may become insolvent because at a low price, the banks will not recoup enough cash to stay afloat.

“If the government overpays, the taxpayer gets ripped off,” he said.

Gambera said the government should just buy shares in the banks to infuse immediate cash into them, but he acknowledges that is politically sensitive because free-market advocates oppose government ownership of companies.

However, the Bush administration did signal this week a willingness to use a portion of the government bailout to infuse cash into U.S. banks in exchange for ownership shares.

Banks that do have capital are hesitant to loan money because there are signs the economy may be slipping into recession and they don’t want to take the risk, Gambera said.

“Banks are very scared and have no confidence in lending to one another. If they don’t trust each other, they trust businesses even less,” he said. “They have their money and they’re going to sit on it.”

Once enough capital is available, lending will loosens up and businesses will be more willing to expand because it will be cheaper to do. Only then will the stock market begin recovering.

The need for financial services companies to quickly shed debt is different from other recent stock market declines, said Mark Freeman, portfolio manager for Dallas-based Westwood Holdings Group Inc., a registered investment adviser.

Companies looking to get out of debt and raise capital must sell assets. The only problem is everyone is trying to do that at a time when few are willing to buy.

Freeman said problems with credit markets tend to take longer to resolve than earnings or equity problems because they add an extra layer of ambiguity and uncertainty, he said.

The market is struggling because no one knows how long the downturn will last.

“A lot of investors aren’t sure how to factor that into their analysis,” he said. “How does this play out?”

Many investors are dealing with the insecurity by getting out of the market, giving up returns in exchange for safety.

People are investing in products offering 2 percent or 3 percent returns, or in some government securities with practically no returns, in exchange for safety.

“That’s a great barometer that speaks to the fear level in the market,” Freeman said.

Tom Ricketts, president and CEO of Chicago-based Incapital, which underwrites and distributes corporate bonds, government securities and certificates of deposit said he’s seen sales of broker-offered certificates of deposit soar in recent weeks.

Last week, brokers Incapital works with saw 10 times the volume of business they normally see in a given week, with much of that coming from investors putting their money into CDs with a maturity of 12 months or less as a way to keep their assets somewhat liquid.

“I don’t think panic is the right word,” he said. “In these kinds of markets, obviously the first reaction is to circle the wagons and make sure you know what you have and be sure it’s safe.”

Ricketts said he doesn’t believe it’s time for a wholesale exodus from stocks.

“At this point, the damage is done. If you don’t need the cash, the whole point of having stocks is holding them over the longer term and keeping them for enough of a time horizon where the asset has a higher return than inflation,” he said. “I don’t think it’s time to bail.”

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