The Government Sponsored Bubble

The consensus clearly believes that the worst is now behind us.

In fact, given the bold shape of the capital “V” recovery in the S&P 500, I think it’s safe to say that the consensus believes that the economic panic experienced during the fall of 2008 was an overreaction… overblown… even… an opportunity to buy on the cheap!

Why not?… all good “investors” know value when they see it… they know that they should be buying when people are fearful… That’s what Warren Buffets says, right? When people get fearful you would be smart to buy… it's automatic.

If it were a formula, it would look as simple as the following:

People fearful = buy

Of course, there is a corollary to this supposedly “tried and true” investment approach: the selling when people are greedy. Even Warren Buffet missed this simple rule in 2007.

So, how do you tell when people are fearful or greedy?

The answer is that in reality, “investors” simply can’t tell… or possibly they don’t even care. The overwhelming majority of investors, including icons like Buffet, never know the peaks or the troughs.

So much for collective wisdom.

“Investors” mispriced the dot-com boom, they mispriced the housing-boom and they are mispricing today’s government sponsored bounce.

Back in the fall of 2007 the writing was on the wall. Yes, there were plenty of greater fools like Jim Cramer or Larry Kudlow or Brian Wesbury on CNBC speculating about “goldilocks” and no recession in sight, but the end was in full view for anyone that was inclined to look at things sensibly.

Today, the same sensible analysis should leave one with the same outlook: The American economy is in a very difficult position.

Yes, we have now witnessed the collapse of institutions like Bear Stearns and Lehman Brothers and even the fall of the giants Fannie (FNM) and Freddie (FRE) that had been so long and anxiously anticipated.

Yes, we witnessed a classic financial panic.

Yes, we have seen our government go to extraordinary lengths to prevent this natural correction, backstopping, guaranteeing, propping… bailing… borrowing and spending.

But… fundamentally the real depressive aspect of this process is only now beginning. Only now are people realizing that the good days will not be coming back anytime soon.

That their home is worth a quarter to a half less than what they paid for it… that their job could be in jeopardy at any moment… that their income is not really growing or more than likely in decline… that their “investments” have been down for ten years…. that they are woefully unprepared to fund retirement or their kids education or anything else for that matter.

Soon the phony “boom” that occurred in the wake of the dot-com recession will be all but forgotten, replaced by the sense that the bust and turmoil of phony internet startup era and phony Enron/Woroldcom and phony housing sham, phony stock market and phony Wall Street with its phony billionaire bonuses are all related.

And now we have the stock market climbing on the phony government-sponsored recovery.

Comments

[CautiousInv...:]

Treasury and congress have pumped an extra $1.5 trillion or so into elite banks and things that benefit labor unions and those who receive transfer paymenst; and the Fed has monetized about $1.5 trillion of debt and is lending money to the elite at almost nothing so they play in the world's largest capital (casino) markets. And the FDIC has loaned Treasury's balance sheet to the tune of $8 or so trillion for a couple of basis points to guarantee debt issued by the elite.

The rest of the world has undertaken similar actions, but the dollar is getting pounded because we are duty bound to act in the interests of the world's defacto reserve currency and our own economic interests........but are not doing so. This tsunami of money is sluicing into just about every financial asset and historical correlations are falling apart because there have never been such oceans of money sloshing about. Since Jan. 1, 61 of 82 country equity indexes tracked by Bloomberg have outperformed the Standard & Poor’s 500 Index of U.S. stocks, which has gained 18.6 percent. That compares with 70.6 percent for Brazil’s Bovespa Stock Index and 49.4 percent for Hong Kong’s Hang Seng Index.

Meanwhile corporations have slashed employment to to goose earnings; lending is contracting; unemploymnet is growing; international trade is collapsing; we are facing over $9trillion in deficit borrowing over the next decade; reserve holding of dollars is declining; and NOTHING has been done to reform the banking system because the banks own congress who own the administration. No wonder the elite have done well.

Oct 13 01:58 PM

[The Geoffster:]

As I write, The Senate Finance Committee has just announced that it will take its "Health Care Reform" Bill to the Senate floor for passage. If you care about personal freedom and responsibility write your Senator and demand a NO vote on this bill. Passage will result in the largest entitlement in history and the end to market based reform. Capitalism has not failed health care. The free market has never been allowed to function in the realm of health insurance which has been saddled with government mandated coverage requirements. If this bill passes, tell your children to find a government job because the private sector is going to be crippled by taxes.

Oct 13 02:40 PM

[Victor84:]

Even accounting for inflation, housing has been a positive-sum game for decades. For everyone who is underwater or lost significant value on their home, someone else has gained as much as you have lost. The author is surely right that America has a difficult road ahead, but casually blaming government for this "bubble" is ignorant at best and fearmongering at worst. Acknowledging the severity of the crisis and concluding that the reason for the Great Depression was due to the meekness of the response, the government has gone "all in" in an attempt to avert disaster. Now whether they did more harm than good will be left for history to decide.

Oct 13 03:36 PM

[User 353732:]

The Roman Emperors in their rancid decline were more honest than our own tyrants. They called it bread and circus: the bribe and the diversion; the suppression of truth and the denial of reality. It did not save them.....and the world was eventually a much better place for it.

Our Emperors call it entitlements and stimulus; the same strategy of bribes and diversions. The same fetid and morally bankrupt suppression and denial that leads to an accelerating decline.

For America to recover, renew, rebuild and redeem the hope of its founders and the promise of its Constitution, the current US Regime too must follow the path of all degenerate and depraved Emperors. It must have its grotesque excesses and then fall. America and the world will, eventually, be a better place.

Patience , fortitude and a belief in something more noble than their bellies have always been the allies of a beleagured people. So too with Americans.
All nights end, all hurricanes spend themselves, all tyrants die.....or are deposed.

Oct 13 03:37 PM

[Jason Rines...:]

I really like your insights not just because they are accurate and big picture, but you provide a bit of hope as well. This time period is very dark for so many American's but after the darkest night comes a new dawn. Let us just hope they do not literally take 100 M with them when they finally exit.


On Oct 13 03:37 PM User 353732 wrote:

> The Roman Emperors in their rancid decline were more honest than
> our own tyrants. They called it bread and circus: the bribe and the
> diversion; the suppression of truth and the denial of reality. It
> did not save them.....and the world was eventually a much better
> place for it.
>
> Our Emperors call it entitlements and stimulus; the same strategy
> of bribes and diversions. The same fetid and morally bankrupt suppression
> and denial that leads to an accelerating decline.
>
> For America to recover, renew, rebuild and redeem the hope of its
> founders and the promise of its Constitution, the current US Regime
> too must follow the path of all degenerate and depraved Emperors.
> It must have its grotesque excesses and then fall. America and the
> world will, eventually, be a better place.
>
> Patience , fortitude and a belief in something more noble than their
> bellies have always been the allies of a beleagured people. So too
> with Americans.
> All nights end, all hurricanes spend themselves, all tyrants die.....or
> are deposed.

Oct 13 05:59 PM

[bob adamson:]

The measure of the crisis that reached its low point during the first quarter of this year was not the drop in the stock markets or the failure of major investment banks in the US, UK, and Western Europe but rather the near collapse of the inter-bank and commercial credit markets precipitated by the investment bank failures. While Japan and, for different reasons, emerging economies in Asia, Russia and Latin America had suffered major recessions following stock market and bank crises, the US, UK etc had been able during the years between 1986 and 2002 recover quickly in the face of threatened banking and stock market panics. The current crisis is different in that the major mature economies were only able to stave off deflationary depression chaos at great expense to government and with great difficulty through coordinated fiscal and monetary stimulus. While this has stabilized the global economy, reflated to some extent the debt bubble and made that bubble manageable for the time being and allowed a resumption of normal patterns of business activity (major achievements in the circumstances), much work remains to be done to resolve the debt bubble and redefine the nature and scope of investment banking to better guard against a recurrence of bubble formation.

Arguably these points follow:
1. The growth of government debt over the past 15 to18 or so months was really an assumption by government of a greater share of the accumulated multi trillion debt bubble resulting from real estate, corporate debt, government debt, securitized loan debt and derivative debt practices over the past generation. The only practical short term alternative to government assuming this greater share was massive default and all the chaos and misery that would have entailed.
2. It took many years for this bubble to reach its current size and banking, corporate, consumer and government practices were fundamentally shaped over this period to accommodate this bubble formation. It therefore stands to reason that it will take several stages and several years to resolve this bubble and change those practices appropriately.
3. It is true that the current retreat from the crisis abyss remains dependent on continued government stimulus and the difficult tasks of economic reform have not yet really begun in earnest, this is more an indication of the delicacy and difficulty of the stabilization process of the past months (i.e. implosion of the banking and credit markets was too close to becoming a reality). Counterintuitive though it will seem to many, government deficits must continue through the early stages of the recover.

In short, stimulus was a necessary tool but was never a solution in isolation to the crisis. Higher taxes, more regulation, higher interest rates, slower growth and difficult and unpleasant measures to resolve the debt bubble itself (i.e. assumption and monetizing of part by governments, default of part by its holder institutions, carrying of the rest by government and corporations until paid down etc.) will all play a part at the appropriate stage. There is no quick surgical solution that avoids negative impact on savers and investors, even those whose actions did not cause the debt accumulation set the stage for the current problems.

Oct 13 08:35 PM

[Denis Gould:]

Great note which has attracted some interesting comments. The title really does bring home that this bubble is different and more pernicious than ealier ones because it is so blatantly bubble blowing. For the dot.com boom and bust interest rates may have been left too low for too long but there was probably little intention to actually inflate a stock market bubble. Once that burst there was more intent to inflate a property bubble but at least it was only done by making policy settings favourable for such an outcome.

I think this bubble is different because it is totally focused on inflating a bubble, any bubble. And in doing so it is destroying the country's finances for generations to come. Everyone knows governments don't spend money efficiently because they have no incentive to do so, in many cases precisely the reverse in fact. And yet the government is going to be a larger and larger part of the economy. And as more people become dependant on the state for their income, either via their job or welfare, the ability to change becomes smaller and smaller.

And with unemployment heading ever higher, there seems no alternative to social unrest and a consequent move towards a police state.

Oct 13 08:41 PM

[Roger Knights:]

"And now we have the stock market climbing on the phony government-sponsored recovery."

Suppose there is a semi-collapse of the dollar, and it loses a quarter of its value in a week. Wouldn't that boost stocks? Maybe that's what the big players in the market are guessing will happen. (Maybe they KNOW--they're acting like it.)

Oct 14 03:32 AM

[punk_ash:]

sadly, civilizations know of no other way to grow economically, other than by increasing the money supply. For happy days to come back, the money supply must start increasing again...

Oct 14 05:27 AM

[TCK:]

Even though the market has risen on the falling dollar, have you really gained anything ?

Oct 14 09:40 AM