Tuesday, November 25, 2008

Tainted Tylenol in Financial Markets

What did Johnson & Johnson do when poisoned Tylenol hit store shelves? They pulled it, all of it. That action saved the market for their painkiller.

Securitized loans, credit "peace of mind", and corporate annual reports are today's Tylenol. America's financial sector keeps cranking out products that burned the investor. They're finding few buyers. What does the public realize? I suggest they sense that:

Credit ratings mean little, given the history of investment pigs obtaining AAA ratings.

Balance sheets are suspect, due to off balance sheet items and accounting practices.

Pretend J & J kept Tylenol on the shelf and asked the federal government to buy back 5% of the stock. What would that do to public confidence? Nothing. It wouldn't impact the probability of their container holding tampered, deadly goods.

What if they J & J kept their production line going, with elevated attention to the quality of ingredients? Who would line up to buy their product? Very few, as 95% of the bad stuff remained on the shelf and the company had no idea of where tampering occurred.

Would a guarantee by the Food & Drug Administration make a difference? Very little.

The FDIC will guarantee $5 billion in corporate bonds packaged by Goldman Sachs in conjunction with Citibank and Morgan Stanley. Who's paying the bond issuance fees? If it's Uncle Sam, we're sending revenue to ex-investment houses, in addition to liquidity and capital injections.

Why should the Federal Deposit Insurance Company guarantee bank bond debt? I thought they were chartered to insurance individual depositors, not the debt of deposit institutions. NYT's Dealbook reported:

Goldman Sachs is expected to be the first firm to tap the F.D.I.C.’s new program. The F.D.I.C. on Friday approved a program to guarantee to banks’ new senior unsecured debt, potentially allowing the firms to issue debt with top “AAA” ratings.

The market could see roughly $50 billion in issuance per month until the deadline for debt issuance next June, Bank of America estimated in a report.

The Temporary Liquidity Guarantee Program is expected to fill a financing gap for banks shut out of the corporate bond market by skyrocketing yields.

We know J & J took clear, strong action to ensure a safe product to the consumer. The financial implosion is a much bigger problem, and it may not be feasible to buy back all the defective financial products or failed loans. But the Tylenol situation can point to possible consumer reactions to the government's interventions.

Poor quality killed credit and corresponding investment in credit products. The future of securitizations, credit derivatives, and corporate financial statements is profoundly unclear. Yet, they continue, with a shelf life that remains to be seen. Painkiller or market killer? Monitoring will reveal the public's decision.

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