No Happy Endings in the Credit Crisis 12 comments
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The banking crisis is becoming like a particularly gory episode of ER; the patient has been wheeled in with limbs dangling and blood spurting after a horrific car crash (self inflicted, he's a drunk driver, and has wiped out an innocent family, but our medics don't moralise), and the dashing heroes, Dr. Paulsen and Dr. Bernanke, start barking out orders. They pump in blood transfusions, inject morphine to kill the pain and adrenaline to boost a flagging heart, but the patient is in full cardiac arrest. Stand back while Hank the Hunk gets the pads and gives our expiring patient a high voltage jolt. And another one. And yes, we get a faint heartbeat, that monitor bursts into life, our heroes have saved the day, or have they? Get real, you know this one won't have a happy ending.
As hedge funds get nuked by short selling restrictions on financial stocks, and vague details emerge of a Federal toxic debt dump to store the nasty stuff oozing out of bank balance sheets, an oversold market rallied spectacularly. In fact the greatest manipulation by short selling hedge funds has been in the illiquid and opaque CDS market, which has driven equity performance as a proxy for insolvency risk. The socialisation of US financial capitalism I've discussed before continues to accelerate, with little consideration for the longer term consequences (see The People's Republic of America). This week has seen a total collapse in confidence and trust in the global banking system, and there is no instant fix for the fear and paranoia now stalking the markets. However, as I said a couple of days ago, 'a short-term respite is possible for US equity markets, as we have seen the spike in risk aversion I expected as reflected in a VIX above 30, soaring gold, and 2 year Treasury yields at their lowest level since the Depression.'
But this will indeed likely prove to be only a respite, which may last a matter of days or even a couple of weeks before the grim reality of slumping global growth in 2009 reasserts itself (the greatest deflation threat is in forward S&P earnings, $70-80 may prove a good result rather than the consensus $100 plus) and stress migrates from the private financial sector to US government bonds and the dollar. The unwinding of the real estate asset bubbles (commercial and residential), deleveraging in the private financial system and in household balance sheets as well as the unwinding of current account and consumption/savings imbalances between the US and Asia will be a protracted and messy process.
An RTC style fund is certainly a suitably radical move (and one suggested by shrewd observers such as PIMCO), as it finally tackles the root cause of this crisis rather than the symptoms; it would soak up dubious bank assets to restore liquidity in interbank markets, allow orderly restructuring over a period of years without destabilising fire sales and keep more people in their homes by reducing foreclosures. Sound too easy? Unfortunately, it would be hugely complex to assess, value and manage these RMBS and other derivative products (just ask an ex Lehman risk manager) and would probably cost north of half a trillion dollars to absorb them onto the US public balance sheet (even assuming a realistic 20-25c on the dollar valuation). US government bonds have remained strong despite the tab for bailing out the economy soaring by the day (the Fed's emergency balance sheet infusion of $100bn has almost been lost in the frantic drama), supported by a flight to safety surge in inflows.
The medium term demand outlook for an avalanche of new Treasury issuance remains grim, particularly as recent events have shocked crucial Asian investors from central banks down to those Japanese online granny traders. Their faith in US assets and financial stability may have been fatally shaken. I'd rather be in European governments and blue chip non-financial corporate bonds right now (and Gold nearer $800; the rally this week is technically very significant). There will be no systemic Depression style economic collapse thanks to the safety net put in place by Fed actions and falling commodity prices and global interest rates, but when this latest bear rally runs its course, we will see a climactic capitulation in US equity markets. Unless we start seeing a sequence of 90% up days (which even yesterday's spectacular reversal wasn't) with well above average market volume, I stick with my strategy of selling the rallies.
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This article has 12 comments:
I must be missing something....
The question is: what are the consequences of this huge liquidity injection? Inflation. We are already in a global inflationary environment and this will just make it worse. High inflation + flat salaries + increased unemployment = depression?
The question is: what are the consequences of this huge liquidity injection? Inflation. We are already in a global inflationary environment and this will just make it worse. High inflation + flat salaries + increased unemployment = depression?
Our elected officials would then be allowed to openly make a profit from their political actions and the values of their stocks would reflect how they are doing.
A stock would be issued for each official and the stock would be traded on the New York Stock Exchange.
On November 4, whichever government official's stock had the highest value would become president, the next highest valued stock representative would become vice-president and so on down to local dog catcher.
Don't laugh. The idea has merit. (I don't believe we would be allowed to short these stocks, however. That would smack of communism.)
You know, we often talk about a correction in the stock market. A correction is needed to weed out inefficient and poorly run companies. It may also be needed to weed out obsolete industries. But, what has been corrected so far? A few small banks have been weeded out. Lehman Brothers has been found wanting and is now gone. A few other inefficient or poorly run companies, such as Bear Stearns and Merrill Lynch, have been merged with other companies. However, the vast majority of troubled financial companies have been preserved. Or, maybe it would be more correct to say that their structural dry rot has been papered over with newly printed dollars so they look just fine. But, the underlying problems have not been dealt with properly.
How many inefficient and poorly run Government programs or agencies have felt the pain of a 'correction' and been eliminated? One can hardly think of any. So, when the Government steps in to 'save' the financial industry, why would anyone think it would do any different for industry than it does for itself? So, Congress stays in session to do what in knows best, to cobble together a rescue package costing additional hundreds of billions of newly printed dollars. Like they do with obsolesce or inefficiency within the Government, they are frantic to preserve the status quo.
The free market system has natural and proven way of dealing with bad businesses - bankruptcy. If the Government is going to intervene, what Congress should be doing is developing a way of identifying the financial firms that need to be eliminated and cutting out the dead or dying financial 'tissue.' Either way, to cure the patient, it would be painful. As long as the Government chooses to paper over the financial 'patient' with dollars, we might have a pretty looking financial system patient, but it is still sick and maybe even dying as we know it now.
On Sep 20 11:02 AM carey_jim wrote:
> Congress and the President and his cabinet should be allowed to go
> public and each official should have a stock that is traded on the
> New York Stock Exchange in his or her name.
>
> Our elected officials would then be allowed to openly make a profit
> from their political actions and the values of their stocks would
> reflect how they are doing.
>
> A stock would be issued for each official and the stock would be
> traded on the New York Stock Exchange.
>
> On November 4, whichever government official's stock had the highest
> value would become president, the next highest valued stock representative
> would become vice-president and so on down to local dog catcher.
>
>
> Don't laugh. The idea has merit. (I don't believe we would be allowed
> to short these stocks, however. That would smack of communism.)
On Sep 20 12:18 PM bowman711 wrote:
> What else would one expect from a Government that thinks the solution
> to every problem is to spend money, whether it has it (from taxes)
> or not? What's a few billion dollars if it saves Bear Stearns?
> What's a few hundred billion (possible trillion) dollars to bail
> out Freddie and Fannie? What's $84-billion dollars to save AIG?
> What's umpteen-squillion dollars to save the 'financial system' in
> the Mother of All Bailouts?
>
> You know, we often talk about a correction in the stock market.
> A correction is needed to weed out inefficient and poorly run companies.
> It may also be needed to weed out obsolete industries. But, what
> has been corrected so far? A few small banks have been weeded out.
> Lehman Brothers has been found wanting and is now gone. A few other
> inefficient or poorly run companies, such as Bear Stearns and Merrill
> Lynch, have been merged with other companies. However, the vast
> majority of troubled financial companies have been preserved. Or,
> maybe it would be more correct to say that their structural dry rot
> has been papered over with newly printed dollars so they look just
> fine. But, the underlying problems have not been dealt with properly.
>
>
> How many inefficient and poorly run Government programs or agencies
> have felt the pain of a 'correction' and been eliminated? One can
> hardly think of any. So, when the Government steps in to 'save'
> the financial industry, why would anyone think it would do any different
> for industry than it does for itself? So, Congress stays in session
> to do what in knows best, to cobble together a rescue package costing
> additional hundreds of billions of newly printed dollars. Like they
> do with obsolesce or inefficiency within the Government, they are
> frantic to preserve the status quo.
>
> The free market system has natural and proven way of dealing with
> bad businesses - bankruptcy. If the Government is going to intervene,
> what Congress should be doing is developing a way of identifying
> the financial firms that need to be eliminated and cutting out the
> dead or dying financial 'tissue.' Either way, to cure the patient,
> it would be painful. As long as the Government chooses to paper
> over the financial 'patient' with dollars, we might have a pretty
> looking financial system patient, but it is still sick and maybe
> even dying as we know it now.