Taking Stock
Thank Goodness It's Saturday. Because Friday was a bear.
By blackhedd Posted in Economy — Comments (30) / Email this page » / Leave a comment »
Financial markets around the world are closed for a much-needed weekend rest. Although US stock markets finished yesterday with a small gain for the week, there's no denying it: This was a deeply frightening week.
The stories that will dominate the mainstream business news are: 1) the huge coordinated central-bank interventions that took place on Thursday and Friday; and 2) the Main St. economy is just fine, thank you, so stop worrying.
Let's unpack this a bit, shall we?
More...
In the first place, no one knows if the dollar-liquidity crunch that struck in Europe while you were asleep last Wednesday night is over, or whether it will resume tomorrow (Sunday) night. Here at RedState, we sounded the alarm on Thursday morning. At that point, the European Central Bank (ECB) had created about 100 billion euros in brand-new money, and they created almost 70 billion more on Friday. Central banks in Japan, Canada, Australia, Switzerland, and Norway also got into the act. (Not the Bank of England, though.)
Meanwhile, the Federal Reserve's printing presses went into overdrive too, creating $24 billion on Thursday and $38 billion on Friday. In an extremely unusual move, the Fed's open-market operations on Friday consisted of repo (repurchase) agreements in which they purchased mortgage-backed securities, the very securities that are the cause of the whole situation.
As I've said many times, the problem here is not a credit-quality problem. Rather, it's a liquidity problem. The issuance of highly-rated investment-grade securities backed by subprime mortgages has completely stopped. As long as the housing boom continued, these securities were issued in huge numbers, and were purchased by financial institutions around the world.
But there never was a large secondary market for mortgage-backed securities. Like residential real-estate itself, mortgage-backed securities are illiquid. Once people buy them, they don't trade them around to others like they trade shares of stock.
That wasn't a problem as long as new securities kept being issued, which gave everyone an indication of what they were worth. Free-market transactions involve both a buyer and a seller, and they generate a price, which is an indicator of value, which is otherwise hard to measure with illiquid assets. That's why you get all perky when you hear that your neighbor down the block just sold his house: you want to know what the price was, because that gives you a pretty good idea of what your own house is worth.
But now no one is issuing new subprime-mortgage backed securities. And suddenly there are doubts about the actual value of the securities that are sitting in portfolios of large and small financial institutions around the world. In the absence of pricing data, risk becomes uncertainty, and can no longer be measured or hedged.
That leads to everyone at once becoming suddenly very concerned that their capital reserves may be inadequate. No one can sell their mortgage-backed securities (because there were no buyers until the Fed stepped up to speak to 38 billion dollars' worth yesterday). So they have to raise cash instead.
That's where the "global liquidity crisis" is coming from.
One of the things you need to keep firmly in mind is that there is no "credit" crisis here. There's a very good reason why mortgages are among the safest securities around: because individuals will go to almost any length to avoid becoming homeless. Even in the subprime sector, the number of defaults, while larger than usual, is not large in absolute terms. As I and others have said, this is a liquidity crisis.
So why do you out in Main Street care about what in reality are highly technical and arcane gyrations in the financial world, far away from the real world of jobs and goods and services (and houses)?
Because the global business world depends on orderly financial markets.
It's completely true that the US Main Street economy is in reasonably decent shape. (It's not doing gangbusters as Republican politicians want you to believe, but it's ok.) And the global economy is still roaring ahead at very high rates of growth. Most large American businesses have a great deal of exposure to overseas markets, so their profitability should remain good for the foreseeable future.
But when the focus in the financial world shifts to meeting margin calls, it shifts away from providing the credit needed for normal business activity. What's incredibly disruptive about episodes like this is not that asset values get destroyed. They don't.
Instead, liquidity gets parked in the US Treasury market and away from any kind of riskier asset. Eventually, the situation calms down, and people put money back to work. (In the Long-Term Capital Management crisis of 1998, this process took about two months, from October till about year-end.)
But a great many assets will be in different hands. A lot of players (most of them probably hedge funds) will be unable to meet their margin calls and be forced out of business. Their distressed assets will show up in other people's portfolios, and start coming back up to more realistic valuations.
While all this happens, funding for normal business activity can suffer. That's the real-world risk in this situation.
In the political realm, a lot of idiots (exhibit A: Hillary Clinton) are going to jump up and down to blame President Bush for the whole mishugas. They might as well blame the man in the moon.
You'll also hear this from a great many people: should the Federal Reserve be bailing out millionaire and billionaire hedge fund operators? That's a darned interesting question, and worth some careful thought. But not now, in the middle of a crisis.
Do you remember the final scene of the movie The Matrix? When the hero suddenly understands that the whole "real" world is nothing but computer programs, and he finally discerns the key to controlling it? I think the relationship of the financial world to the real economy is more than a little reminiscent of that.
I have to tell you, gentle Reader, that I had my heart in my mouth for most of yesterday (Friday). It was as frightening a day as I've ever seen in the financial markets. The day ended on a reasonably calm note. I hope it was because market participants have decided that the concerted actions by the world's central banks to ensure liquidity means that the immediate crisis is over.
It may have been just because it was Friday afternoon in the summertime, and time to go home. We'll see what happens on Monday morning.
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Taking Stock 30 Comments (0 topical, 30 editorial, 0 hidden) Post a comment »
long term, people wallowing in BID (Bad Investment Decisions) will have to take their lumps.
Hedge funds cater primarily to the wealthy and to institutions. These are the people who are supposed to be savvy investors. Unfortunately, they aren't on many occasions.
In addition to the mortgage situation, the financial press is now paying a lot of attention to CDO's, Collateralized Debt Obligations, whose collateral (including mortgage-backed securities) allowed the rating agencies to give the senior tranches of this debt investment grade ratings. On closer examination, the collateral value can be questionable and so can the rating. More sloppy work by the analyst community.
In Wall Street, caveat emptor, as always.
...so I'm not going to pile on. Plenty of other people made mistakes too, as you point out.
Leave aside that people like S&P and Moody's issue their ratings based largely on credit risk, whereas what happened here was an explosion of market risk. If you were sympathetic to the ratings agencies (I'm not saying that I am), you could say that their assessments weren't wrong.
Another huge problem is that being under-exposed to risk is every bit as bad as being over-exposed. When the subprime mortgage market was booming, you couldn't not be in it. This is a fundamental feature of free markets.
I've said elsewhere that the current crisis is on par with the worst in history. (A colleague of mine who lived through the Long-Term situation said that this one is far worse than Long-Term because it's much bigger and it hits many more players.)
The difference with the big breaks of the past is that the banking system is now closely managed by the Federal Reserve. (Ditto with the banking system in Europe, and the ECB.)
That's why Arkie Liberal can pop up with a straight face and say that his account balances are looking pretty healthy. If this had been 1929 or 1907 or 1893, there's a good chance he'd be about to lose his job and/or his life savings.
True, the rating agencies are entitled to seek forgiveness, which we all need at various points in our lives.
Just don't make it too easy for them!
They're just one cog in a very large system with a lot of deep and poorly-understood interconnects.
I learned the hard way many years ago that when speculating in derivatives, the market will never run out of surprising ways to wipe you out. Especially when you thought you had everything hedged. And it just happened again.
As I said, it's still far too early to be drawing Larger Lessons.™ But I think it will be worth revisiting the question of whether or not we should have free markets.
Especially among us conservatives. For their part, the Lefties (if they're smart) are going to revive the debate of the early Thirties, which led to the American people happily agreeing to hand control over the banking system to the Federal power.
I'm finding myself thinking, with great trepidation, that if our financial markets actually were free instead of the heavily-regulated hodgepodge they are, this would have been a heck of a lot worse.
(or make like they don't like) serve to stabilize markets. For example, some would have seizures at any mention of coordinated activity by central banks.
But what works, works.
I am probably less forgiving than you when rating agencies say something is investment grade when it most definitely isn't except under the most optimistic of scenarios.
...of the people that accepted the ratings and calculated their reserve requirements based on them. They're the "millionaires who made stupid decisions" that we've been hearing about, and that we're being told we shouldn't bail out.
All perfectly fine as far as it goes.
But rewind about twelve months. Back then, if you weren't investing in asset-backed paper, your limited partners were climbing up your backside, and asking you what they were paying you for.
I'm getting more sympathetic to the view (heard often during the Long-Term crisis) that panics like this are a fundamental feature of capital markets, and no amount of being smarter or more-regulated or less-regulated will change that.
I'm under no pressure to buy anything I don't feel like buying, and I sleep at night except for occasional feline requests for attention.
But I'm still nervous. Nervous enough to consider (but probably not act) putting my 403b equities into the money market until after October at least.
On another note, what makes me really nervous is that all of this is supposedly managed by central bankers etc. But no one really knows if they know what they are doing.
And what makes me really, really nervous is the specter of protectionism taking off around the world. That will help no one.
In 1979 the US Government bailed out the Chrysler Corporation. The danger was not that it wouldn't work. It was that it would. Unfortunately, it did.
Chrysler could not have survived in a competitive market. To use a boxing metaphor, the company was stumbling with 2:30 left in the third round. Courtesy of the US Government, the American public was made to underwrite a 1.5 billion dollar loan to keep Chrysler alive. Chrysler stayed alive.
I wish I could get the Government to guarantee a $1.5 billion dollar loan to me. I wouldn't go out of business either. I probably wouldn't be all that profitable, but neither is the Chrysler Corp.
So the public bailed out Chrysler. It was just the beginning. $1.5 billion looks cheap compared to what's come down since that time. Just look at the last six years.
We bailed out the Airlines after 9/11. They were hemorrhaging billions before 9/11. The moment the planes struck the towers, their PR departments started working overtime. They lobbied Congress heavily. They hit the airwaves nation-wide. They exploited the disaster for their own benefit. The public gulped down the airline industry's propaganda. Never mind that if security at American, United, and Boston Airport had done their jobs 9/11 would have been a day like any other. When the gulping was completed, a fat payout was coughed up. It was no time to question the wisdom of this--after all, we were facing a crisis. The cost, if I remember correctly, was around $20 billion. Makes the Chrysler bailout look like a bargain.
(Quick side note--China recently executed their Director of Food Safety. It was over something about a handful of American and European dogs being poisoned by tainted dog food. If you ever wonder why Chinese kids and Chinese workers seem to be a little more motivated than those in the United States, here's your answer. In America, if you screw things up badly enough, you get a fat promotion or a fat payout. In China, you get a bullet in the head. Incentives work, apparently.)
So in a fit of Patriotism we bailed out the Airlines. Then we bailed out ADM. When the INS found Tyson's slaughterhouses chock-full of illegal immigrants, they were given a slap on the wrist and their fines were reduced. The policy of subsidizing their labor was backed up with a policy of subsidizing their criminal sentence. If the statistics hold up, 85% of those workers were given a court date, released, and never heard from again. Juan Diaz of Lichtern, KS became Jesus Marquez of St Louis, MO. Once again we see that incentives work. Illegal immigration is subsidized, therefore there is more of it. Shocking the way that happens, isn't it?
The profits generated by the Federal Reserve are privately owned, but the risks are born by the public. It's a great business model if you can get it, or so I hear. Ask the ownership of your local professional sports teams what they think of the arrangement. The overtaxed public forks over for the stadiums, the additional infrastructure, and the salaries of the big players. The owners pocket the tens of millions generated by their business acumen. The leagues, the players, and the owners are happy as hogs in the slop. They look like hogs in the slop, too.
So now the privately owned, but publicly supported, Federal Reserve bails out a few thousand shockingly foolish investors to the tune of $38 billion. Sounds like more of the same to an observer like me.
The American public must have an affinity for subsidizing crises. There are a million ways to justify it, I suppose. The effect is just what one would expect. Investors and managers screw up, write themselves a fat paycheck, and wait for Congress or the Federal Reserve to pony up when the bill comes due. If not, the lawyers will just have to tie up the bankruptcy courts for the better part of a decade. One more way for the hardworking public to subsidize the foolish and/or dishonest.
When crises are subsidized--whether security-related, financial, or demographic (in the case of illegal immigration)--they will become larger and more common. The proof lies in our national papers. It looks like a destructive policy to me.
But this is a crisis and no time to question, right?
I would point out that Chrysler paid the government back...every penny. SO, in retrospect, it might have been a good idea after all, since Chrysler bacame SO profitable that Daimler gobbled them up in a "merger of equals" and raided Chrysler of its cash.
The airline bailout has not been and will never be paid back, as most of that cash went into mismanaged companies that had no business NOT going bankrupt...and opening up the field to more profitable companies to take their place.
As I pointed out, the real problem is that Chrysler did pay the money back. Now the incident can be invoked every time. It's a good deal for the corrupt in Washington. Congressman X takes a few rides in the corporate jet, spends a few days in Bermuda with an expense account on the company dime. It costs Corporation Y a few grand to pay for all this. They are repaid to the tune of billions when things seem to go wrong. All our beloved Congressman has to do is bring up the Chrysler episode at justification time. That's if there is a justification time, which there frequently is not. Like I said, it's great work if you can find it.
Big time screw-ups are subsidized, so we get more of them. If history and human nature are any kind of indicators, they will continue to become bigger and more common.
Large investment firms do not become large by choosing the worst managers they can find. They look for those who they deem to be the most trustworthy. It probably works most the time. They look for signals that display those characteristics. Those signals can be faked. Those who do the hiring have good reason not to look to deep. Screw it up big enough, and the public will bail us out.
This doesn't happen all the time, not yet anyway. But as it becomes more common, so-called crises will also become more common. You get more of what you pay for, or so it seems.
The principal monetary aid the airlines received was government compensation for shutting down the nation's air transportation system for several days.
American and United were also exempted from legal claims resulting from the destruction of the Twin Towers, as this was the result of an act of war, not an airplane accident.
The airlines were also compensated for security-related improvements they made on their aircraft, such as "hardened" cockpit doors.
No way did the airlines receive $20 billion of cash.
The government also set up a fund to bail out troubled airlines in the wake of 9/11. A few carriers, including America West, successfully petitioned for relief. United was turned down, as the regulators said they did not furnish a realistic business plan. United (followed by Delta and Northwest) eventually went through Chapter 11 and the markets accomplished the restructuring. American never asked for bailout money and restructured without going through bankruptcy.
Banks and hedge funds make hay while the sun shines, but depend on our politicians to wrap up the chaff at sunset, and deliver them neatly tied up forgiveness of debt.
One might also mention the biggest ($125-150 Billion) bailout in history: the Savings and Loan Crisis. Many a politician (or their law firms) bought up distressed S&Ls at a BIG discount, from the Resolution Trust.
One can only hope that the Fed relieved the gamblers of their mortgage-backed securities at a discounted price that might actually make our government a few bucks, as it did with Chrysler.
But you can bet that outfits like CalPERS (the California State Emplyees' Pension Fund) will soon be screaming for relief from their hedge fund investments. They haven't minded pursuing 20% returns, but they sure as heck aren't willing to acknowledge the risk.
We shouldn't have to wait long for Nancy Pelosi to start demanding more chewing gum and baling wire to "fix" the latest "crisis" at taxpayers' expense.
the liquidity needed to restore order to the market.
An orderly market will mark down troubled securities to their (approximately-no market is perfect) true value.
A disorderly market with panic selling is in no one's long term interest, including Main Street's.
...prices for so-called troubled securities. When they're as illiquid as mortgage-backs are, the process takes time. Disorderly markets don't give the process enough time (for reasons anyone can easily understand by simply imagining himself as a holder of such securities in such times) and panic ensues.
The point of central-bank intervention is to give everyone a bit more time. Markets work by implicit consensus, not by leadership.
Trying to call the bottom of a market like this is often described as trying to catch a falling knife. Whoever manages to end up with a pile of mortgage-backs purchased at distress prices is probably going to be very, very happy. (Of course he'll be surrounded by the carcasses of people who just missed.)
Short primer: Ingredients of the bad stew:
Money creation, no longer the exclusive domain of the Fed/Treasury. M3 (total dollars in the system) has been mushrooming via easy credit/investment/bank institutions for years. Too many dollars created chasing so many profits to be made (Stock market of the late 1990s and the recent housing bubble).
Prices and profits can not go straight up forever. Eventually common sense and concern (fear) take over.
Gobs of loans for home purchases given out over the last 5 years to gobs of people with no more credit qualifications than a pulse and an application. Mortgage companies saw a new way to make more money!
The new "innovation" or marketing all this high risk loans to investors around the world.
Interest rates creep up. House payments (ARMs) go up. Banks get nervous and raise credit standards. Sales slow. Housing prices start dropping. Foreclosures begin.
The new "innovative" investments begin looking shaky and credit starts tightening and/or being cut off to the market players off, as margin calls are not met by the Bear Stearns of the world.
A little fear and panic (common sense) take over. Sell those bad investments. Stocks drop.
And once again the Fed and central banks of the world pump in money, more money than they did after 9/11!!! At least the ECB. They must be worried... very worried.
Moral hazard (as a big investment company no real worries, the Fed will bail out the markets... so take the high risk road...) is raised to new levels in the markets, unbalancing our financial system even more.
Unfortunately many small guys are getting burned. The dollar is debauched even further.
But.... Be happy, don't worry declare all the gurus on CNBC and at the Fed.
a guesstimate is that it will take 4.5 years for all these sub prime loans to clear. Don't know where I read about warnings about these type of loans and the danger that they present,( a Bloomberg story about a DBbank analyst betting on declines in subprimes back in 1995 rings a bell so my guesstimate is based on vague memories to stuff I've read that I don't know where to link to.
So, who else will this affect and for how long?
I'm sticking with the guesstimate of 4.5 years for this to clear.
Blackhedd,
I always look forward to your posts. Thanks.
You said, "I have to tell you, gentle Reader, that I had my heart in my mouth for most of yesterday (Friday). It was as frightening a day as I've ever seen in the financial markets."
Was your concern simply a fear of a market meltdown? Could you elaborate more on what it was that made Friday one of the most frightening days you've seen on the street?
Also, completely unrelated, Cramer loves Mitt Romney. Just curious, are you a Romney fan too? I thought Cramer touted valid benefits of Romney, though not enough to shake me from my loose hold on Rudy.
***********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_
...the gut feeling that there might not really be a bottom underneath the market. And I've been smelling the rot in this situation for weeks now. (My first "sky is falling" post here on RS was back in May, iirc.)
Tuesday and Wednesday were very healthy days. Then Thursday morning all hell broke loose. Usually when selling waves come through, bargain hunters show up at the bottom. Then when they're not there, you get a very sick feeling. By mid-day Friday, things really started to have a healthier tone to them.
I'm not in favor of Romney for President at this point, but I haven't decided whom to support yet. All I can say for sure is that it won't be Hillary Clinton, Barry Obama, or John Edwards.
You know of course that Jim Cramer is a hard-core liberal Democrat? Just checking.
That makes sense. Of the little money I do invest, I've had it in cash for the last couple weeks until things straighten out. If/when the market goes much lower, I'd like to buy my way back in, but I just can't figure out what to buy. The stocks I liked in the past were cyclicals, and if this subprime mess does spill over into a recession (Trump announced on CNBC Thursday his expectation of a recession by the end of the year, adding another high profile name to a growing list of businesspersons, including Greenspan, who is expecting a recession), then I just don't want to be there. I keep hearing street folk on CNBC and Bloomberg tout tech stocks, but even they are getting beaten up, with a few exceptions.
Cramer is liberal, though I wouldn't really call him hard-core liberal. He's encouraged fiscal restraint (both lowered taxes and spending), though he does support more government involvement in the economy than I'd like to see. Socially he's liberal. I know he and Marty Peretz from TNR are old pals.
**********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_
enough people to go along, we could make that recession happen! Most people on TV care more about their predictions coming true than anything else, and if they predict a bad thing, they don't care if their predictions aid and abet it.
Mike Gamecock DeVine @ The Charlotte Observer
www.race42008.com
www.hinzsightreport.com
www.theminorityreportblog.com
"One man with courage makes a majority" - Andrew Jackson
...so I have no response to your points about specific sectors.
My expectations at this point are that we'll have a few calm days, as the reassuring effects of the central bank interventions (which may well continue next week) damp out some of the panic.
However, part of the calming effect may be due to an expectation that the Fed will lower its target overnight interest rate from 5.25% to 5%. That move is anticipated sometime between now and September 18. We also have a key inflation number coming out next week, which many are expecting to be on the low side, which would reinforce expectations that the Fed will ease.
I wouldn't be surprised to see the inflation number come in way low, not just somewhat low. However, I also wouldn't be surprised if the Fed chooses to stand pat on the target funds rate, choosing instead to continue to rely on open market operations to keep the banking system liquid.
I'll let you connect the dots. But keep in mind that I can't predict the future any better (or worse) than Greenspan or Trump. I expect a recession to come, simply because the markets are discounting it very clearly and have been for weeks.
But with all the rich and famous starting to call a recession, you have to consider that a contrary indicator. Markets just love making everyone look stupid.
There's one thing you can take to the bank, however: as far as the mainstream, elite media are concerned, the recession has already started, regardless of whether it actually happens. And like all recessions during Republican administrations, it's already the worst in history.
Not a problem. I'm not really looking for investment advice per se; I'm trying to learn the market and was expressing my frustration in trying to find a bull somewhere.
Kudlow and his guests yesterday were disclosing concern that should the Fed cut rates prior to their September meeting, a panic could ensue. Bartiromo expressed a similar sentiment to Cramer during his now famous "market meltdown" rant last Friday, saying it could cause "Armageddon." If I remember correctly, Kudlow even suggested a cut at the September meeting could have a similar impact. You don't share their concern?
**********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_
Mike Gamecock DeVine @ The Charlotte Observer
www.race42008.com
www.hinzsightreport.com
www.theminorityreportblog.com
"One man with courage makes a majority" - Andrew Jackson
True. And there are other companies, such as oil drilling companies, that I think will turn a nice profit. However, I'm not as concerned about finding corporations that will turn profits as I am finding companies whose stock price will go up.
***********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_
Which I think is the more likely outcome, by the way (I mean that I think they won't cut rates). Because at this point, an expectation of a quarter-point cut seems to be baked into the market. If it doesn't happen, it would be very disappointing.
an aria! (sp? right?)
Mike Gamecock DeVine @ The Charlotte Observer
www.race42008.com
www.hinzsightreport.com
www.theminorityreportblog.com
"One man with courage makes a majority" - Andrew Jackson
BTW, Cramer does seem to support Romney over Hillary and Edwards. He doesn't bring Obama into the mix, but the way he talks here, it wouldn't surprise me if he voted R should Romney be the Republican nominee. Here's Cramer on Hardball:
http://www.youtube.com/watch?v=99BDVzU7pxA
***********************************
And statesmen at her council met
Who knew the seasons when to take
Occasion by the hand, and make
The bounds of freedom wider yet
- Tennyson, _To the Queen_
1. I checked my 403b with some trepidation, but the damage was minimal.
2. If a bunch of hedge funds go out of business, that means it might be a good time to buy a nice yacht, gently used, cheap.
3. The decline of real estate values is not all bad news--people who were priced out of the market may be able to get in. Presumably, some people have been renting and putting the savings aside for a down payment on a house.