Time to Cut Your Exposure to Investment Banking and Mortgages

I always try to separate my views of what I think the FOMC will do, versus what the FOMC should do. It’s hard for me now, because I think the FOMC is pursuing the wrong strategies. The yield curve is steep enough now, that further easing will not yield much incremental benefit. Further, a loose monetary policy only stimulates healthy areas of the economy that can absorb more borrowing, not areas with impaired balance sheets.

But what will the Fed do? Loosen. Aggressively. Don Quixote would be proud. They will make the TAF permanent and big, and the discount window will be a relic of a simpler age.

Let’s think of the short run versus the long run. In the short run, the FOMC wants to get the economy moving again, and is willing to tolerate negative real interest rates in order to do so. The Fed funds target is already 1%+ below the CPI, and the argument is over whether the next move will be to loosen 50 or 75 basis points. Negative real interest rates promote goods and services price inflation. (I don’t know about everyone else, but when filling up my gas tank nears $100 I begin to worry. Eight kids — 15-seat van, 10 cylinders…) In the long run, the FOMC will have to deal with price inflation. Even with the current yield curve, I can tell you that goods price inflation will worsen, leading to monetary tightening that will be painful, or no tightening, and inflation that rivals the 70s.

The Fed could target lending to the weak areas of the economy, while leaving monetary policy alone. That would invite charges of favoritism, which is why it won’t happen.

So, in my opinion, asset deflation will persist, and goods price inflation will increase. As for me, I will likely sell my positions in Deerfield Capital (DFR), Royal Bank of Scotland (RBSPF.PK), and Deutsche Bank (DB) on Monday, replacing the exposure with an index for now. I have agonized over the seemingly cheap capital markets names for some time now, and I have been the loser there. I will return, but for now, it is safer to have no investment banking or mortgage exposure. The asset deflation is hitting them hard, and lending is contracting.

Full disclosure: long DB RBS DFR

Comments

[whisperonth...:]

Others may feel differently, but I'm trying to figure out which is more excessive... the 8 kids or the 15 seats in the van.

2008 Mar 09 10:33 AM

[HedgeTruth:]

i think the real question is whether the us govt. can AFFORD a bailout of fannie...

this whole mess is still just getting started...i think this week will bring carnage like we have never before seen...

bear stearns is insolvent...

lehman is close...

fannie and freddie common are both going to ZERO...

and commercial banks wamu, wells fargo, national city and several others are headed to ZERO...

there is a reuters story out saying that investment banks could LOSE $325 billion MORE from loans they made to hedge funds...

this has not been factored into anybody's models yet...

2008 Mar 09 03:00 PM

[FIG trader_:]

This is comical. Seems like the perfect contrarian signal, when poster after poster talks about selling the mortgage and broker stocks now, when they are anywhere from 50% to 75% off the highs.

2008 Mar 09 11:47 PM

[jurp:]

Please remember the 30 trillion house market includes the 30-35% that are fully paid for. Therefore 47% equity drops to only 32% if you look at mortgaged houses.

this means that second mortgages are dead. If someone needs cash, sell the ATV, the boat, the RV, or the 2nd vacation home (if you can)

2008 Mar 09 11:49 PM

[Harmony monkey:]

I think we've a few more shoes to drop as far as banks - regional and moneycenter - writing off losses the haven't yet even been able to calculate! Don't forget SKF (Ultrashort Financials)!

2008 Mar 09 11:52 PM

[tjschoenlein:]

Some folks I think wake up each morning and decide if the sky is falling now , In the afternoon or maybe it will be night time.. make no mistake - to these folks the sky is always falling.. opportunity is not allowed in their world.
I bought copper (TGB) when it was at .60 cents a pound - yes I had to be patient and wait for copper to rebound. Many people thought I was not too bright at the time. Copper has paid me very nicely.. thank you. The banks are dogs today, tomorrow they will be back and making money for those who are patient. Just a Missouri boy views.

2008 Mar 10 01:43 AM

[Rep07:]

Two words: S&L Crisis.

en.wikipedia.org/wiki/...

Over 1,000 S&Ls failed. Total government bailout of $125 billion. Went on for years and years.

That's the closest thing to what's happening now. Except that this probably cost taxpayers $125 billion just in the last 3 months. This is potentially like, 10x bigger $$ than the S&L bust. Maybe more.

Let's hope we don't end up with 1,000 companies going down in this one. Because that would mean that it's only just barely begun.

2008 Mar 10 05:10 PM