Reflation Is the Only Option

[excerpted from Bill Cara's Week-in-Review]

Does anybody really think our culture is going to change overnight because of a little $55 trillion CDS problem? The fact is that very few of us even know what a Credit Default Swap is and even fewer understand that the source of the global financial, business and economic crisis is the CDS.

I warned about this problem more than two years ago. I was reminded of that this week as the world’s three biggest CDS players crashed and burned. Citi ((C) -60.4%), JPMorgan ((JPM) -34.1%), and Bank of America ((BAC) -30.2%) all plunged in price.

The Big 3 banks are the link to consumer borrowing. Yes, I am also focused on the retailers – as I stated a week ago -- because that’s the link to consumer spending.

Borrow and spend. Isn’t that what America is about? Frankly, isn’t that the universal culture today?

Speaking of the Big 3 Banks, you will see that I have been saying that we do not face an economic crisis today; rather, we face a potential economic crisis. We are, however, directly staring at the results of a real financial crisis within the three largest banks in the U.S. Their share prices this week tell you that.

The CDS problem, by the way, is one you are not going to hear much about because (i) the world’s biggest bankers don’t want it discussed, (ii) it was a type of Ponzi scheme to begin with, and (iii) the whole concept, which was created only ten years ago by JP Morgan and legalized eight years ago, has never been understood, and, intentionally, never been regulated.

The bottom line is that a CDS is an intangible built on the once trustworthy reputation of bankers as a party to a financial transaction that would always make good on their promises. As long as bankers were lenders and agents, all was fine. But, as principals, unfortunately, many bankers were greedy and some were liars.

Politicians, who now have to clean up this banker’s mess, have no option. They will tell you that it’s a matter of reflate or sink into Depression.

No, no, no. There will be no Depression. You heard it here first. Because of globalization, economic depression is not an option. Reflation, which is the printing of money by borrowing on the credit of our sons and daughters, and their sons and daughters, is the only option.

Even now, late in the year 2008, the term reflation is just beginning to get traction. When I first referred to it here, people thought I meant inflation.

For the record, on the subject of reflation, the CDS problem, and the Big 3 banks, here is what I wrote on October 16:

Today the Swiss government injected $5 billion into UBS and the Swiss National Bank bought almost $55 billion in UBS’ toxic assets. A couple days ago, the UK government did the same for HBOS and Royal Bank of Scotland (RBS), while Germany did the same for Deutsche Bank (DB). In the U.S., the Treasury and Fed have arranged a quarter trillion dollars in support for a select group of America’s biggest banks.

Why the panic bailouts? The answer lies in the $55 trillion dollar Credit Default Swap market that is unraveling day to day. Banks and central banks are totally focused on the breaks to the credit ring when up to $400 billion of Lehman Brothers CDS obligations come due in the next week, with nobody at the teller window to pay up. Lehman Brothers is, as you know, bankrupt.

What this means is that unspecified banks holding the Lehman CDS derivatives will get nothing, and then they will be unable to meet their obligations to other banks. At stake are the Money Market Funds on deposit in these banks. The entire system could collapse, so banks do not want to be in the position of lending to one another. The credit market has failed.Economists like Roubini and Feldstein and so many others have no clue what they are doing in setting fires here. If you listen carefully to their rants of economic forces coming to bear to form a perfect storm that can only result in another Great Depression, you will not hear an iota of news. We heard all their theories – the precise same ones – three months ago and more, back when the credit ring had not broken because Lehman Brothers had not yet failed, and equity markets were much stronger.

So, what these economists are doing, at this point in time, is almost criminal.

Have you failed to notice that Bloomberg TV is not interviewing the leading bankers who do know what is going down within their walls today. These bankers do not want to talk like the former CEO of now dead Lehman Brothers, Dick Fuld, who told the world that his bank was strong when just a couple days later it filed bankruptcy.

Fuld didn’t know how quickly the CDS failures would take down his bank, and now his peers on Wall Street are keeping their mouths shut. Bloomberg reporters are missing the story. But think about it: how is it that finance ministers and central bankers can together inject over $1 trillion into banks in the past week and yet have these few major banks still not lend to one another and still have their stocks teeter on collapse?

This is not an economic story; it’s a financial story that is centered in the viability of the largest banks of the world. These banks are calling loans of hedge fund clients and selling holdings like oil and metal futures. Risk taking has died, and these banks are responsible.

Now, what to do? As I continue to say, keep your head clear of all that crapola you read and hear from mainstream media. They are merely facilitating Speaker’s Corner for every Tom, Dick & Harry who is touting his book or his high-priced banquet speaking engagements. Watch, instead, the price and volume data series for the three biggest banks in the world that control well over 90% of the CDS market: JPMorgan Chase (JPM), Citigroup (C), and Bank of America (BAC). Several months ago, I listed the extent of their CDS involvement in these pages. Nothing’s changed except Lehman Brothers has failed, and the financial system has moved to the brink of collapse. It will be saved; the only issue is how big will be the burden on future generations.

Watch this chart of the Big 3 players in the CDS market and you will see that Lehman Brothers started to look shaky at the start of May, which caused a plunge in the share prices of the Big 3 until Lehman was forced to declare bankruptcy and Henry Paulson needed to appeal to Congress and the G-7 for emergency help. The fact the crisis was sold to the public as an economic issue and not a crisis and bail-out of the banks was another criminal act. These people must think they control all media, but the truth in time comes out.

Following the start of the bailouts in July the share prices of the Big 3 banks have been volatile, but side-tracking, while other key non-bank stocks have been trashed as no-nothing media Talking Heads ran their mouths. The result is that the pensions and other holdings of Mom & Pop have been hammered beyond all comprehension, and I sit among you saying keep your head about you, there is a turn at the cycle bottom and a new Bull is being born from the injection of mega-trillions from all governments and central banks.

This crisis will soon be over – but first the bankers must show us they have survived the next wave of CDS obligations coming due this week and next. The answer will be in the share prices of JPM, C and BAC. Don’t watch anything else for the answer to how this crisis will be played out this month. Here is the chart again.

I think it is the best judgment at this point in time to wait until the share prices of these banks show a rebound. Then jump on board the equity market rocket. There will be another lift-off, and there are many stocks – I have listed over 100 – that will be passengers on what will be seen as another moon-shot. One of these events will result in the new Bull market being as obvious to you all as it is to me today.

The weather here in Nassau is rather nice, although a bit breezy. The few tourists are enjoying themselves -- wedding parties mostly. A year or so from now, there will be additions to these new families, and life will go on.

Have a good day.

Who else writes stuff like this? I do. Others are capable, but there is a reason they don’t. You know, the world is full of smart people being misled by even smarter people. Full stop. That’s the reason why the financial world is in trouble today.

Anyway, I just enjoy myself on the beach in The Bahamas trying to get people to focus. Watch the volume and the prices. Follow the money flow. Look for clues in the trends and cycles.

No, I’m not Deep Throat. I’m just an observer who can point you in the right direction.

Let’s look at the state of the equity market today. In the past 12 months, with the exception of General Motors ((GM) -88.4%), which is an auto manufacturer that can’t sell autos to consumers who have no money or ability to get a bank loan, and Alcoa ((AA) -76.0%), which is the major supplier of aluminum to GM and the other auto manufacturers, the three biggest losers in the DJIA index are the Big 3 Banks: C -87.7%, BAC -72.8% and JPM -44.2%. That says it all for the week and for the year.

In any case, today’s Week-In-Review includes the Value Line analysis of the Big 3 U.S. banks as well as American Express (AXP) and Microsoft (MSFT) (although the AIG report was dropped from the calendar), which many say are all banks too.

That’s the trouble these days --- everybody is a bank or wants to be a bank because banks hold the unfair advantage, and when they screw things up, they have the U.S. taxpayer to bail them out. I saw this problem coming 20 years ago so I incorporated myself as William Cara Investment Bancorp Ltd and got regulated as a Limited Market Dealer before people in the industry saw I had slipped under the radar. “Are you really a bank?” they would ask. But, it took them ten years to start asking that question.

I try to be early.

On April 8 this year, I blogged about the next economic crisis in America, which I opined would be unemployment. The Jobs Report for March showed a rise in jobless from 4.8% to 5.1%. I opined it would grow to a peak of maybe 8.75% in the following 24 months. That raised a lot of eyebrows. Let’s just say I had my skeptics. Well, on Friday this week, the Goldman Sachs research department forecast a jobless rate of 9.0% by the end of 2009. So, now that a “legitimate” economist has finally come out (almost 8 months later) to tell the truth, I can move on.

Do you recall when I used to publish a table in the blog sidebar about the foreclosures, writing at the time that millions of Americans would be pushed by their bankers out of their homes onto the streets? There was a reaction to that too. But I no longer post these things because, well, why tell you something you already know. My job is to give you a heads-up – at a point you can do something about it.

This week I gave you the “Trade of the Generation (TOG)”. I recommended selling bonds, which proceeded to tank, and buy gold/goldminers, which proceeded to soar.

Yes, I must have a lot of readers because on Friday $GOLD (+$43.10 +5.8% to 791.80) and $XAU (+26.1% to 88.80) both had moon-shots. As rayg already reported,

Bill,

Thanks for the TOG call on Thursday. Here are the results:

Gold-up 53.3 to 802.20
PHLX gold/silver-up 26.71%
Gold miners- up 20.28%

One year returns in one day....AMAZING!!!

Tks

Ray
Posted by: rayg at November 22, 2008 9:28 AM

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Bill,

On the bond side:

30 yr T-bond down 4 9/32
10 yr T-bond down 2 2/32

Again, nice call. I know the bull call has had its doubters....but a bottoming of the mkt is a process....it doesn't happen in one day...and isn't realized until AFTER it has happened.
Keep up your fine work here.

Ray
Posted by: rayg at November 22, 2008 9:32 AM

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It was just Wednesday November 12 that I gave you my Report on Goldcorp (GG). When the price was $17.75, I said we went long and with put writes our cost basis was well under $17. Seven trading sessions later, GG closed at $24.22 (+41%). The gain Friday, after I gave you the TOG, was +27.3%. With put and call option strategies, you would have made your three-year Bull market performance target this week.

We all have our crosses to bear. At a wine tasting on Friday evening, I was asked what I do for work. I replied that I am a securities trader. “Why?” the person wanted to know, “the prices are all falling.” Rather than get into a heavy discussion, I politely said that some traders do well at such times, and asked what that person worked at. Why was I not surprised when the answer came back, “I invest too – in real estate. I buy a home, live in it for about four years and sell it. I have done that about seven times and made a lot of money. Never lost money.” “Good luck for the next four years,” I replied.

But, not to be rude, I did say that there are parallels between real estate and securities investment. I pointed out that in both cases we are seeking quality in the asset, value in the purchase price and high cash on cash returns. Why, again, was I not surprised by the rejoinder? “Well I don’t understand the stock market.” I quickly moved on to the Cabernet Sauvignon table where the Napa Valley CA Cakebread Cellars was the closest thing to a house investment I could see.

Capital markets, fine wine and a Caribbean beach lifestyle… now that’s the life.

Comments

[mik123:]

I don't see one analyst stating to sell any of the big three financials. In fact I have seen Dick Bove and Mayo say buy with price targets 3-6 times Citigroups current price. These are two of the top 3-4 analysts who rate the stock. Mayo came out Friday after the close and said the minimum value would be $9+ .
Citigroup and the other two are only in this predicament because of Paulsons decision last week to abandon the whole purpose of TARP - to purchase troubled assets. When he made the announcement, he said some of the same original banks will now need additional injections. What is he waiting for. Citigroup, Bankamerica,JP Morgan, lost up to half their value with Citigroup being the worst. If you eliminate short selling, Citigroup would rally. What's happening is you have a huge amount of short selling and at the same time their buying cedit default swaps. Watch what happens to the stock if the SEC re-instates a ban on short selling on financials. Christopher Cox of the SEC has a conference call Monday regarging this. Citigroups financials are actually better than Bankamerica and JP Morgan since both purchased companies with very bad financials. These are the three largest financials in the United States. Once Citigroup gets through 2009, it will get back to earning 25 billion per year. You don't panic because profiteers are trying to destroy the stock so they can make a quick buck. Nothing has changed with Citigroups financials in the past month when the President of the United States, Fed chairman Bernacke, FDIC chairwoman Sheila Bair, Treasury secretary Paulson all agreed that Citigroup would takeover Wachovia.Go to the FDIC's website and read the Sept. 29th press release. They were obviously healthy enough then. Citigroups financials will begin to improve quickly with gas prices cut in half. Eighty percent of the country lives paycheck to paycheck. With your average couple paying $50 less per week in gas, that's $2,600 extra for mortgage and credit cards that wasn't there in August when it was still $4 a gallon. Consumers only had this price break for the past 8 weeks. If the price of gas stays down, that's huge for them

2008 Nov 23 12:39 PM

[John Ryskamp:]

"No, no, no. There will be no Depression. You heard it here first. Because of globalization, economic depression is not an option. Reflation, which is the printing of money by borrowing on the credit of our sons and daughters, and their sons and daughters, is the only option."

Not an option? For whom? Literally, NO amount of "reflation" will keep the economy from collapsing. Your $55 trillion figure is what banks report, and WAY underestimates the CDS problem. The real problem is, how to keep $70 trillion in losses from being realized during the next 3 months. That's what they're trying to do, and it simply won't work.

But don't worry. The world can do without any income whatsoever for the next year and a half. Just tighten your belt.

As for Obama and his rat pack of pay to play shysters, what do you think is in that idiotic "stimulus" package of his? More bridges to nowhere, with kickbacks all along the way.

Same old same old mafia Democratic politics. It isn't even a drop in the bucket. And a year from now, Obama's ratings will be even lower than Bush's are now.

That is, if Fitzgerald--the dolt--doesn't indict him before then under 18 USC 1346 for his role in that criminal conspiracy known as the 2003 board legislation. See online for more on Barack's criminal activity in this regard.

Don't people realize that Obama is an empty suit, an organized crime front man and idiot? They will soon enough--as they stand in the bread line!! Ha ha!

2008 Nov 23 03:49 PM

[Paul Bogdanich:]

Reflation as the man calls it is the only option at this point. If one keeps the nominal value of the national debt and assets like houses stable then there are no nominal losses to write off and the debt as a percentage of GDP becomes more managable. The trick is to make sure that GDP and personal income of the bottom 80% grow in tandem with the M3 money supply. Hence all the stimuli packages. So if a house nominally costs $500,000 but cab fare from Laguardia to Midtown is $200 then $500,000 is not that much compared to current incomes. Of course retirees and people holding non-productive assets get screwed but we have no other viable alternatives given what has already happened in the preceeding eight years (doubling of the debt, wars while doling ouut tax custs etc.). The debt is already too high to be honored in full without some trickery so we reflate.

2008 Nov 24 12:12 PM

[derryl:]

China is starting to spend $600B of its savings to fund and thereby stimulate domestic consumption and this investment will probably multiply through its economy. Chinese are savers and as they have felt confident about their incomes this past decade or more a middle class consumer culture has developed, spurring demand for houses, cars and all the other things Americans recently borrowed to buy. Declining exports threaten Chinese incomes but Beijing has lots of money to replace export-oriented production with domestic-oriented production to keep the middle class growing.

Obama's stimulus spending will put money in people's pockets to pay down their debts, not consume more. So stocks with an obvious near term upside are anything that provides commodities and equipment to supply infrastructure projects, both in America and China.

In the long term I agree with Mr. Cara and Peter Schiff--buy and hold gold, the real stuff, not certificates.

2008 Nov 24 09:52 PM

[Mr. Math:]

"first the bankers must show us they have survived the next wave of CDS obligations coming due this week and next"

As documented by Barrons:

1) $400B in nominal Lehmans CDS value
2) 8 cents on the $ bond settlement
3) $6B changed hands

Is CDS really the problem, or is it just the Boogie Man of 2008?

2008 Nov 24 11:49 PM

[Ronald Pires:]

@ Paul Bogdanich Nov 24 12:12 PM

"Of course retirees ... get screwed but we have no other viable alternatives ..."

Retirees happen to vote in far greater percentages than all other groups. Screw them out of their money, and they will still do so, only they will get VERY ugly. No one in DC is unaware of this.

I'll bet you thought they were going to privatize Social Security too.

2008 Nov 25 02:26 AM