Wednesday, July 23, 2008

Wall Street Likes the Bailout plus Drill, Drill, Drill

Can bad Washington policies sometimes work to the benefit of financial markets? In the short run the answer is certainly yes. Nothing illustrates this point better than the gigantic Fannie-Freddie housing bailout bill that will soon pass Congress and be signed into law by President Bush.

This is a perfect example of Washington’s new too-big-to-fail corporatism, or even semi-socialism. Fannie and Freddie are getting their dream wish lists of expanded loans, expanded debt, a full-fledged explicit government guarantee, and virtually nothing in the way of real reform, all in return for Uncle Sam’s imprimatur.

The only remote possibility for future GSE reform of political lobbying, huge compensations, and a downsized internal portfolio, or even future privatization moves, rests solely on the new regulatory powers embedded in the bill. But the chances of a strongman regulator actually succeeding in changing these government housing banks are slim to none in my view. Democrats running the House and Senate banking committees will never permit it. The GSE political pressures are too strong. And no reforms were codified in the actual bill.

As for the $300 billion FHA housing bailout — with its ACORN-like community slush funds and tax credits and subsidies for existing and new homeowners — well, it’s just a big bailout. Oh my gosh. Between Fan and Fred and the FHA, U.S. taxpayers are gonna be on the hook for potentially gargantuan sums.

And yet, bank stocks are roaring ahead on Wall Street for the simple reason that in the short run the Fan-Fred guarantee from Uncle Sam stops the potential run against the financial stocks and the banking system. It’s very similar to the Bear Stearns story, when the Fed stepped in to open the discount window to prevent a run against the investment banks.

In fact, not only are financial stocks rising, but the near-term credit-preserving impact of the Fan-Fred backstop is strengthening the dollar and punishing the gold price. So Wall Street is cheering big government’s big expansion, at least in the short term.

More constructively, the growing possibility of a drill, drill, drill oil bill, even with some mild anti-speculator attachment, is contributing to a bear market in oil prices. Ever since President Bush unleashed last week, oil has been falling. It’s now down to $126, a little more than a $20 drop. This oil sell-off improves the outlook for lower inflation and better economic growth, which in turn is strengthening the dollar, pushing down gold, and driving up share prices.

The drilling issue in Congress is a huge election-year debate. It could well be the Republican’s last hope for November. The Democrats don’t want to drill, even while the public does. This could be a Democratic waterloo and could actually help elect Republicans, narrowing anticipated GOP losses in the election. But the Republicans have to launch an all-out fight nationalizing this issue, taking it to the public with a large media ad-buy, lots of speeches, and daily presser sound bites from Washington. Mitch McConnell is the right leader in the Senate — he’s one of the best tacticians ever. The votes are there for a drill, drill, drill compromise, with probably a dozen Democrats coming along.

As Michael Franc writes today on NRO, the House version of drill, drill, drill is a tougher uphill climb against Nancy Pelosi, who may be putting her speakership on the line against the drillers. Using a discharge petition is a tough road to hoe, though not impossible. But my thought is that a Senate victory might just blow Pelosi out of the water and open the floodgates to Democratic defections in the House.

If a drilling bill ever passes Congress, oil prices will keep on plunging — perhaps all the way to $75 a barrel, which is the profitable break-even point for lifting the extra barrel of oil. That would drive the Dow to somewhere between 15,000 and 16,000, and it would have a huge tax-cut effect on the economy. And, of course, it could completely change the November election outlook in a highly favorable way for the GOP.

The conventional wisdom says Republicans are gonna get clobbered again this fall. But drill, drill, drill would overturn that wisdom. More drilling today would have the potency of the Reagan tax cuts 28 years ago in the 1980 landslide race. But the GOP has got to make the case. And deregulating oil, which is great policy, would offset much of the bad policy pain coming out of the Fannie-Freddie housing bailout.