What's Left to Spend in the 'Credibility Bank'?

by Jack Crooks

Lately, I've been trying to find information/data to prove the dollar won't retest its old lows. But it seems the facts just keep getting in the way.

Take Friday's triple-whammy. We saw a run from all U.S. assets including bonds, stocks, and the dollar. Oh yes, it was definitely looking scary for most of the trading session.

You could feel the panic riding on the back of Paulson's Fannie (FNM) and Freddie (FRE) announcement, Indymac's spectacular failure, and more rumors that Lehman could be carried out the backdoor.

Is It Any Wonder Lehman Brothers (LEH) Has Traders Talking?

Two Unlikely Heroes

But Monday morning we woke to a new world of opportunity. The pre-market S&P was up 17, crude was off a whole US$1.50, the birds are singing, and the dollar is bouncing higher.

And once again we owe our good fortune to our shining heroes on the Hill, also known as Hank and Ben. Fannie and Freddie are safe thanks to our heroes.

I guess the moral is that despite the constant criticism of authorities, never underestimate our heroes' ability to stage a good market bounce. But how many times do the players in the market watch the financial system tiptoeing to the abyss, only to pullback at just the last moment before falling to its death by the authorities?

What's Left to Spend in the "Credibility Bank?"

As brilliant as both Treasury Secretary Paulson and Fed Chairman Ben Bernanke are, how much credibility do these men have with the list of things they've had to say in the past?

I'd say their credibility bank is running on empty, considering what we've heard from these two...

• The economy is fundamentally sound.
• Sub-prime is just a minor problem in a small corner of the U.S. real estate market.
• The economy is fundamentally sound.
• Bear Stearns is only a liquidity problem, their assets are still solid.
• The economy is fundamentally sound.
• Fannie and Freddie's asset base is solid.
• The economy is still fundamentally sound.
• IndyMac will reopen soon. Its assets are still intact — it's a liquidity crunch.
• The economy is once again fundamentally sound
• Short-sellers are the reason for Lehman's trouble. Its asset base is solid.
• The economy is still, still, fundamentally sound.
• "Fill in the blank....."

There was US$596 trillion in nominal derivative value outstanding at the end of 2007. That value represents 10.8 TIMES the value of global GDP (see chart below). Even if only a small portion of these derivatives are radioactive (and could disrupt the financial system), it seems we could have many more blanks to fill in above.

That's especially the case when our remaining key repository of collateral value — the stock market — is in trouble.

See Derivatives Swell

[For perspective, look back at 1990 and you will notice the nominal value of global derivatives represented a paltry 26% of global GDP.]

Two points here:

1. Despite Mr. Paulson and Bernanke being serious men with good intentions, they are seriously outgunned by the level of debt in the system.

2. The credibility bank is now very low. It's the "fool me once" scenario. Bernanke and Paulson, you told me everything would be okay after Bear Stearns was backstopped — and now this happens. What other hidden bombs are still out there?

The Only Trick Ben and Hank Have Left Up Their Sleeves

Being vastly outgunned, the authorities only have faith and credibility on their side. Basically, those are their only tools to fight off the crisis of confidence. That's the real danger. If such a crisis attacked the markets, it would lead to a self-feeding spiral of assets sales. Investors would get stuck in a feedback loop repeating something like:

1. I am overleveraged
2. I must sell collateral (stocks) so that I can reduce leverage
3. Stocks are going lower, my collateral is following, I must sell more stocks
4. ...(repeat)...

This is the ugly business teetering into the abyss scenario. It would have a nasty impact on the real economy already reeling from loss of a key wealth driver (known as "housing") and loss of available credit.

We all know this must be avoided at all costs. The question is: Does that matter...especially when the stock market and the dollar are freefalling?

A Pair of Depressing U.S. Assets — Your Dollars and Your Stocks

For all our sakes, let's hope our heroes have more left in the credibility bank.

Comments

[bbzz24:]

Well it matters. Would you want to compete globally with Chinese workers that make average of $250 a month? It is simply the equivalent of total destruction of the U.S. and rebuilding it anew, only that resources and skills are no more here.

2008 Jul 16 06:03 AM

[lavalyn:]

Or you could say that this is just desserts for a nation that pays hundreds of millions to CEOs that run companies into the ground, millions to professional sports players... and somehow gets paid more for less production than people in China.

The "Chinese worker that make [an] average of $250 a month" produces the things Americans use. The question that it raises is normally phrased "why should the Chinese be paid so little?" when the real question is "Why should Americans be paid so much?"

2008 Jul 16 08:27 AM

[Jon T.:]

America used to be so powerful that the double talk and the meaningless rhetoric of American ecomists, bankers, and govt. officials could move the global markets, regardless of the underlying reality. The fact is, this techinque is no longer working and those bully pulpit tenants look less like the steering committee of the global economy and more like a deer in the headlights. It's as if they just can not understand why their tried and true technique of obfuscation is no longer working. It's not only the content of what they are saying that is losing it's credibility. It's also the the delivery vehicle. Reality has been crowded out for too long and it is demanding a seat at the table.

2008 Jul 16 12:26 PM

[Mojito:]

Meh. We could use a close shave and haircut, after years of living like elitist, entitled greedy hedonistic pigs.

What did we think was going to happen when we happily switched from a producing/creditor nation to a consumer/debtor one? That the frat party could go on forever, and the world was obligated to keep stuffing our fat faces at their expense?

This will be good for the Republic, burn away the self-absorbed garbage in our lives, make us take personal responsibility again instead of waiting for the nanny state to wipe our chins and burp us.

2008 Jul 16 12:58 PM