As in, "checks and balances." Remember those? What happened to them? Did I go Rip van Winkle there, and miss the re-write of the Constitution?
Fed Chairman Ben Bernanke announced this week that the Fed will spend $600 billion to buy crap investments from money market mutual funds. This is outside of the $700 billion TARP.
On whose authority?
The Fed is broke - it's borrowing money in the markets, by having Treasury issue bonds, which they're doing at a gluttonous pace. So where will the money come from?
You know where.
The FDIC (which is also near-broke) already turned money market funds into bank accounts, by covering them with deposit insurance. Never mind the fact that money market funds aren't banks, which are the purview of the FDIC. And never mind the moral hazard of rewarding people who sought the higher yield of a money fund relative to a bank account, perfectly willing to live with the risk of placing their money uninsured.
Until, of course, they actually start losing it.
Banks are also the purview of the Fed. Not mutual funds. What's next, equity mutual funds? Hey, why not?
But what I really want to know is, where does Ben Bernanke get the authority to spend 600,000,000,000 taxpayer dollars? And why is no one outraged about this, besides me?
************
Meanwhile, on a related note, Hank Paulson has now announced that he'll use the TARP to buy into insurance companies too. What's next? This guy really does look like a buffoon these days - running around like a chicken with its head cut off. He has no earthly clue what he's doing, or what he'll do next. Might as well make some popcorn and just sit back and watch the show.
************
I was watching Bubblevision a few days ago, and Mark Haines was interviewing Mohamed El-Erian, the co-CEO of PIMCO, which is the largest bond-fund manager in the world. El-Erian is a smart dude, by the way. Haines asked him how the recent equity market carnage was going to impact the psyche of the average American.
El-Erian (I'm paraphrasing here): "Well, they're going to open their 401(k) statement, and they're going to decide to cut back, and consume less. And for the next five years or so, we're going to move to a more savings-based economy."
Haines (looking aghast): "If we move to a savings-based economy, what kind of economy do we have?"
A healthy one. The kind that, in 1982 when the savings rate was about 10%, spawned a nice, long, sustainable period of economic and stock market growth, with nary a bubble. Guys like Haines are part of the problem.
************
Did anyone else watch The Blame Game this week? You know, that entertaining game show on C-SPAN where our elected leaders waste more of our money by calling the "culprits" on the carpet and asking them inane questions, trying to obfuscate the fact that it is actually Congress itself that is to blame for most crises?
Now, I'm not saying that Alan "Mr. Bubble" Greenspan has no culpability in this mess, though his sin was not in opposing regulation so much as it was in encouraging speculative risk-taking by keeping money artificially cheap too long. The Godfather of Leverage should learn what a friend and I were discussing today at lunch: if you fill the ocean with chum, the sharks will feed. The sharks are doing nothing wrong in this instance; they are merely doing what sharks do. They do not need behavior-modifying regulation. They need their food source restricted. Stop dumping the chum, and they'll stop feeding on it.
And I'm not saying the SEC hasn't been asleep at the switch, nor the ratings agencies. I don't know why they picked on John Snow. For one thing, his successor bears far more guilt than he does, but of course Paulson, along with Bernanke, is the darling of our socialist government right now. So let's go after their predecessors. The other reason they shouldn't have picked on Snow is that, with a big smile on his face, he called them out, noting that he came before them pleading for curbs on Fannie and Freddie in 2003 and again in 2005, only to have them reject his pleas.
Rep. Frank Mica of Florida correctly pointed out that the blame lies with those who accepted sweetheart loans from Countrywide in favor of blocking regulation and pushing reckless lending, like Senate Banking Committee Chair Christopher Dodd did. Or those who took record amounts of money from Fannie Mae, like Senator Obama did. On that latter point, Mica complained that the final hearing on this matter isn't scheduled until November 20 - after the election.
But Committee Chairman Waxman called Mica's comments "political," and said that now is not the time to get political. Like all of this isn't political to begin with. Sadly, you won't see Mica's comments on the evening recaps. And nobody but my wife and I were probably watching the full hearings.
The same thing happened after the S&L crisis: Congress commissioned a study and grilled everybody in the industry, seeking to know what caused the crisis. I've said this before, but I'd just haul in a big mirror and hold it up in front of 'em.
************
I've said for the better part of a year now that the stock market has been ignoring what the bond market's been telling it. Today, the US stock market is ignoring what the rest of the world is telling it. Asia sold off to the tune of 8-9% overnight. Europe, about 5%, after the UK reported its first GDP contraction in 16 years. US stock futures were halted limit down in overnight trading. The Dow plunged nearly 500 points just after the opening bell.
Right now, it's off a mere 2.15%, and may just rally to a gain on the day.
But is the US market overdone? Hardly. A money manager from Blackrock was on Bubblevision this morning, saying, "The US economy just fell off a cliff in October."
Dude. GDP growth was negative in the fourth quarter of last year. It was only positive in the first quarter of this year due to an inventory build-up. It was only positive in the third due to a) the mailing of tax rebate checks, which were spent on gas, and b) strong exports thanks to a weak US dollar, a trade that has played itself out. This wasn't a sudden "fall off a cliff." It's been a slow, steady slide. You equity guys just never priced it in until now.
Well, next week we'll see third quarter GDP, and it'll be at least as weak as the UK's - maybe worse. Maybe then we'll see the gut-check that is due this market. Oversold? Methinks not, since the multiples don't yet reflect the coming slashed earnings guidance from US companies for 2009 and beyond. And actual earnings will likely miss guidance. (Misguidance - I made a funny!)
The Nikkei is down 56% from its peak, and Japan isn't even in recession yet. Trust me - we have further to fall.
Oh, and about Warren Buffett's recent exhortation to buy stocks, as he proclaimed he was doing? A real patriot, huh? And shouldn't we all throw our money behind an investor as savvy as the Oracle from Omaha?
Folks, understand this: no, Warren's not stupid. He's smart like a fox. And he recently took big stakes in Goldman Sachs and GE. Both of which are since on the bankruptcy bubble. Warren wants you to throw your money in, too, in hopes the momentum will prop the market up and salvage his big bets. In other words, he's joining Bush, Bernanke and Paulson in trying to jawbone stocks higher.
Don't drink the kool-aid.
************
My one-liner of the day: if ratings agencies rated wine, vinegar would be a 98.
************
I read a comment from a guy today who was talking about the priced-in likelihood that the Fed will cut the funds rate by half to three-quarters of a point next week. He said, "Their only option is to inflate our way out of this mess."
Tell me again how that works? I honestly don't know where they find these "experts."
************
I have a new idea for presidential debates. It comes from my undergrad days, when I majored in psychology.
Hook 'em up to an electric shock-delivering device. Every time they go beyond the time limit with an answer, or answer something other than the question that was posed, zap 'em.
Hard.
For every time they do it, increase the voltage.
Ultimate solution: electrocute all the politicians before they can get into office.
************
I leave you with this analogy, inspired by Dr. Greenspan, who referred to the credit crisis as a "tsunami."
It is indeed that. And Paulson, Bernanke, and Congress are standing on the beach, training huge, powerful fire-hoses at the coming mega-wave. They believe throwing all the water possible at the coming tsunami, they can turn it back.
Of course, they will be swamped. But by adding considerably to the water volume, they ensure that the wave will reach much further inland, and do much greater damage, than it otherwise would have.
Friday, October 24, 2008
Thursday, October 23, 2008
Support-Hosed
That's me. That's you. That's us.
Why is the US government - under a Republican administration, no less - throwing so many resources at trying to prop up markets?
President Bush speaks Monday before the market opens. Coincidence? Bernanke speaks later in the day. Paulson's up on Tuesday.
Aren't stock investors supposed to be at risk of losing money?
Same with houses. What goes up too much, must come down. And yet plans still abound to bail out irresponsible people who bought more house than they could afford on terms they couldn't repay. (Yes, yes, along with the poor few who were pushed by realtors and duped by lenders, but trust me, they're the minority. Just as there are no atheists in a foxhole, everyone's a victim in a crisis, especially when the handouts start flowing.)
Yet fresh plans abound to bail out homeowners. Why? "We've got to stop home prices from falling further!" Am I the only one who recognizes the lunacy in that? "We've got to stop rocks from falling after we throw them in the air! We've got to stop fires from burning our forests!" Some things, you can't stop.
Nor should you. If home prices have risen too much, they need to correct. Why? Because if you prop them up, the ultimate correction will be even more painful.
Want a parallel? We had a nice, sustainable long-term growth trend going in stocks in the '80s and early '90s. Then, things got bubble. Alan Greenspan warned of "irrational exuberance."
Then he lost all rationality. He made money dirt-cheap in the middle of that irrational exuberance. Why?
Because a big hedge fund was about to fail. One fund. But the hue and cry from big institutional investors - many of them foreign banks - pressured Mr. Bubble to save the day. So he did. And thereby spawned the dot-com bubble.
That bubble burst in 2000. Mr. Bubble then kept interest rates too low, too long, inflating another asset bubble. Stocks never had a chance to fully retreat to their long-term sustainable growth trend, so we propped 'em up again. Happy times. The Dow hit a new record high of over 14,000 last October.
As Oliver Hardy used to say to Stanley Laurel, "Now look what you've done!"
So they want to do it again. Unbelievable. Those who fail to learn from their past mistakes are doomed to repeat them, as Santayana said.
As for housing, the latest goofy plan comes from FDIC Chair Sheila Bair. Acknowledging that Paulson's Homeowner Hope plan, hatched in July, was "too little, too late," she wants to hatch another one.
Did anybody else get the irony in that? If the plan in July was "too late," isn't it even later now? Or is my calendar off? Do you have to wind calendars for them to work? I'm a bit confounded.
Her plan is based on the "success" the FDIC has had in re-structuring delinquent mortgages on the books of its recent acquisition, IndyMac. Let's examine that success.
Since taking over IndyMac - also in July - the feds have examined its books and found that 60,000 of its mortgages are at least 60 days past due.
That's 60,000 loans, people - at one institution. Just one.
They also found that two-thirds of them qualify for Bair's re-structuring experiment. That's 40,000 loans, unless my calculator's on the fritz along with my calendar.
As an aside, though, that's 20,000 that can't be restructured - at one institution. Just one.
So 40,000 loans can be worked out. So the feds have send more than 15,000 loan modification notices out, and have called "thousands more," offering better terms. And how many of those borrowers have hit the bid?
Three thousand five hundred.
Let's recap this model of success: since July, the FDIC has mailed more than 15,000 letters (you and I bought the stamps, by the way) to deadbeat borrowers. (Again, yes, some of them truly fell on hard times. But the majority just bought more house than they could afford, on terms they couldn't repay, and/or didn't have any savings in the event they lost their job, and/or had too much credit card and auto loan debt, and/or simply didn't want to meet their mortgage obligation anymore if the value of their house wasn't going up by double digits every year.)
But I digress. They mailed these letters, and made "thousands" more phone calls, which should have gotten them to at least half the eligible borrowers. Of that, they've managed to restructure about 17% of those they've communicated with. Or about 5% of the total.
At one institution.
Meanwhile, mortgage foreclosures in the third quarter shot up 71% year-over-year in the third quarter.
So tell me again how efficiently the feds are going to be able to replicate this smashing success nationwide - especially when they've already been trying for the same span of time Ms. Bair's had the keys to IndyMac?
By the end of this year, banks will own a third of all US real estate for sale. REO sales are the only sales taking place these days, because the prices are at bargain-basement levels. That's driving down the price of every home in every neighborhood where there's a bank-owned home for sale. Do you think that additional growth of REO won't drive home prices down more? And do you think bank failures won't continue to mount as the real estate losses tally up?
Of course they will, on both counts. And it's the natural order of things when we've built more homes than people need, and leveraged the system to the hilt, top to bottom.
But they want to prop prices up, on both houses and stocks.
I don't want to be here when the next bubble bursts. No economy can withstand three huge back-to-back asset bubbles in such a short span of time. And I don't want to witness the collapse.
Thankfully, I won't have to. They will fail. Washington can no more stop this thing than you or I could stop a runaway train by standing in front of it.
But they can sure make it worse.
Why is the US government - under a Republican administration, no less - throwing so many resources at trying to prop up markets?
President Bush speaks Monday before the market opens. Coincidence? Bernanke speaks later in the day. Paulson's up on Tuesday.
Aren't stock investors supposed to be at risk of losing money?
Same with houses. What goes up too much, must come down. And yet plans still abound to bail out irresponsible people who bought more house than they could afford on terms they couldn't repay. (Yes, yes, along with the poor few who were pushed by realtors and duped by lenders, but trust me, they're the minority. Just as there are no atheists in a foxhole, everyone's a victim in a crisis, especially when the handouts start flowing.)
Yet fresh plans abound to bail out homeowners. Why? "We've got to stop home prices from falling further!" Am I the only one who recognizes the lunacy in that? "We've got to stop rocks from falling after we throw them in the air! We've got to stop fires from burning our forests!" Some things, you can't stop.
Nor should you. If home prices have risen too much, they need to correct. Why? Because if you prop them up, the ultimate correction will be even more painful.
Want a parallel? We had a nice, sustainable long-term growth trend going in stocks in the '80s and early '90s. Then, things got bubble. Alan Greenspan warned of "irrational exuberance."
Then he lost all rationality. He made money dirt-cheap in the middle of that irrational exuberance. Why?
Because a big hedge fund was about to fail. One fund. But the hue and cry from big institutional investors - many of them foreign banks - pressured Mr. Bubble to save the day. So he did. And thereby spawned the dot-com bubble.
That bubble burst in 2000. Mr. Bubble then kept interest rates too low, too long, inflating another asset bubble. Stocks never had a chance to fully retreat to their long-term sustainable growth trend, so we propped 'em up again. Happy times. The Dow hit a new record high of over 14,000 last October.
As Oliver Hardy used to say to Stanley Laurel, "Now look what you've done!"
So they want to do it again. Unbelievable. Those who fail to learn from their past mistakes are doomed to repeat them, as Santayana said.
As for housing, the latest goofy plan comes from FDIC Chair Sheila Bair. Acknowledging that Paulson's Homeowner Hope plan, hatched in July, was "too little, too late," she wants to hatch another one.
Did anybody else get the irony in that? If the plan in July was "too late," isn't it even later now? Or is my calendar off? Do you have to wind calendars for them to work? I'm a bit confounded.
Her plan is based on the "success" the FDIC has had in re-structuring delinquent mortgages on the books of its recent acquisition, IndyMac. Let's examine that success.
Since taking over IndyMac - also in July - the feds have examined its books and found that 60,000 of its mortgages are at least 60 days past due.
That's 60,000 loans, people - at one institution. Just one.
They also found that two-thirds of them qualify for Bair's re-structuring experiment. That's 40,000 loans, unless my calculator's on the fritz along with my calendar.
As an aside, though, that's 20,000 that can't be restructured - at one institution. Just one.
So 40,000 loans can be worked out. So the feds have send more than 15,000 loan modification notices out, and have called "thousands more," offering better terms. And how many of those borrowers have hit the bid?
Three thousand five hundred.
Let's recap this model of success: since July, the FDIC has mailed more than 15,000 letters (you and I bought the stamps, by the way) to deadbeat borrowers. (Again, yes, some of them truly fell on hard times. But the majority just bought more house than they could afford, on terms they couldn't repay, and/or didn't have any savings in the event they lost their job, and/or had too much credit card and auto loan debt, and/or simply didn't want to meet their mortgage obligation anymore if the value of their house wasn't going up by double digits every year.)
But I digress. They mailed these letters, and made "thousands" more phone calls, which should have gotten them to at least half the eligible borrowers. Of that, they've managed to restructure about 17% of those they've communicated with. Or about 5% of the total.
At one institution.
Meanwhile, mortgage foreclosures in the third quarter shot up 71% year-over-year in the third quarter.
So tell me again how efficiently the feds are going to be able to replicate this smashing success nationwide - especially when they've already been trying for the same span of time Ms. Bair's had the keys to IndyMac?
By the end of this year, banks will own a third of all US real estate for sale. REO sales are the only sales taking place these days, because the prices are at bargain-basement levels. That's driving down the price of every home in every neighborhood where there's a bank-owned home for sale. Do you think that additional growth of REO won't drive home prices down more? And do you think bank failures won't continue to mount as the real estate losses tally up?
Of course they will, on both counts. And it's the natural order of things when we've built more homes than people need, and leveraged the system to the hilt, top to bottom.
But they want to prop prices up, on both houses and stocks.
I don't want to be here when the next bubble bursts. No economy can withstand three huge back-to-back asset bubbles in such a short span of time. And I don't want to witness the collapse.
Thankfully, I won't have to. They will fail. Washington can no more stop this thing than you or I could stop a runaway train by standing in front of it.
But they can sure make it worse.
Wednesday, October 22, 2008
The Truth About the Truth
Where do you get your news? CNN? MSNBC? CNBC? FoxNews? The major networks?
There's a problem if you answered "yes" to any of the above. Of course, we all know what the problem is. MSNBC might as well be called "The Obama Channel," and Fox could be called "The McCain Channel." CNN and the networks fall closer to the MSNBC side of the aisle. The point is, they're all biased.
Watch them all, like I do, and you wind up with the distortions, half-truths and outright lies of both sides, but still no facts. It's entertaining, but not very informative.
Let's talk specifically about the fail-out, as I now like to call it.
If you watched those outlets listed above, you thought it was bound to pass. Paulson, Pelosi, Dodd, Frank, and their ilk made sure they got all the face time with the press, and the media basically ignored the opponents, who were seen as being on the fringe.
Early on, nobody was talking about the ten-to-one constituent opposition to the bailout. They just buried it. (I found out from a Wall Street dealer e-mail that went out to client firms.)
If you wanted to know what was really being said, you could tune in to C-SPAN at ten o'clock at night, when a brave few stalwart lawmakers were fighting the good fight in a near-empty chamber.
But most of us won't watch C-SPAN. We don't want the full context, live, we want the sound bites, spun. So we tune into CNBC or Fox or MSNBC and they tell us what they want us to believe.
I'm going to single out CNBC now, because they report market news, and because I have the most experience with them.
For one thing, I watch them throughout the day, because, like most brokerage firms, my firm has a live CNBC satellite feed to our trading desk.
For another, I know how they get their "experts" and "panelists."
When you see that trader from UBS talking about stocks, or that analyst from Citigroup talking about futures, you might be wondering, "How does a guy like that get picked from among the thousands of traders and analysts out there? Wow - he must be really smart."
I'll tell you how he gets picked: advertising dollars.
UBS and Citi are big advertisers on CNBC. But I'll get back to that later. First, I need to provide proof for my bold claim.
I have personally been invited to appear on several CNBC shows, including Larry Kudlow's. (As an aside, did you know that Larry used to be Bear Stearns' chief economist back in the late '80s and early '90s? Then he started missing meetings with important Bear clients. Turned out he had a nasty little coke habit. Just thought you'd want to "bear" that in mind.)
When I got the first call inviting me on, I was flattered. I could barely contain my enthusiasm when I said, "Sure!"
"Great," I was told. "The minimum package is $15,000, and for that you get ..." Now, this was $15,000 back in about 1999 or so, when I got my first invite. I can only imagine what the price tag is now - I don't know, because I no longer take their calls. I know the drill.
Okay, so why wouldn't I spend the money for that opportunity for my business? And why does UBS?
Simple. My clients generally don't watch CNBC, and my firm doesn't profit from the market conditions that a UBS profits from.
Generally speaking, investment firms make money when people are investing. Remember the dot-com bubble? The day-trading how-to's? Everybody and his brother tuned into CNBC. But during a bear market, we watch other stuff - something that'll cheer us up.
And banks make money when people and companies are borrowing. During a recession, that's not happening.
That's why bank and Wall Street economists are always over-optimistic. And that's why CNBC commentators like the marginally attractive but sadly vapid Erin Burnett look for the silver lining in every cloud.
Oh, a big name can get on CNBC for free. Alan Greenspan, Warren Buffett, Jim Rogers, Mark Cuban - those people are courted constantly by CNBC. But to pick an analyst or a trader to provide today's infomercial - er, insights - they contact investment firms, offer their package, and get a list of names, corresponding to the market or area of the economy in which those individuals have expertise. And they offer them air-time based on the ante.
So now you know how it works. Free speech meets free enterprise. As Russian comic Yakov Smirnoff says, "America - what a country!"
There's a problem if you answered "yes" to any of the above. Of course, we all know what the problem is. MSNBC might as well be called "The Obama Channel," and Fox could be called "The McCain Channel." CNN and the networks fall closer to the MSNBC side of the aisle. The point is, they're all biased.
Watch them all, like I do, and you wind up with the distortions, half-truths and outright lies of both sides, but still no facts. It's entertaining, but not very informative.
Let's talk specifically about the fail-out, as I now like to call it.
If you watched those outlets listed above, you thought it was bound to pass. Paulson, Pelosi, Dodd, Frank, and their ilk made sure they got all the face time with the press, and the media basically ignored the opponents, who were seen as being on the fringe.
Early on, nobody was talking about the ten-to-one constituent opposition to the bailout. They just buried it. (I found out from a Wall Street dealer e-mail that went out to client firms.)
If you wanted to know what was really being said, you could tune in to C-SPAN at ten o'clock at night, when a brave few stalwart lawmakers were fighting the good fight in a near-empty chamber.
But most of us won't watch C-SPAN. We don't want the full context, live, we want the sound bites, spun. So we tune into CNBC or Fox or MSNBC and they tell us what they want us to believe.
I'm going to single out CNBC now, because they report market news, and because I have the most experience with them.
For one thing, I watch them throughout the day, because, like most brokerage firms, my firm has a live CNBC satellite feed to our trading desk.
For another, I know how they get their "experts" and "panelists."
When you see that trader from UBS talking about stocks, or that analyst from Citigroup talking about futures, you might be wondering, "How does a guy like that get picked from among the thousands of traders and analysts out there? Wow - he must be really smart."
I'll tell you how he gets picked: advertising dollars.
UBS and Citi are big advertisers on CNBC. But I'll get back to that later. First, I need to provide proof for my bold claim.
I have personally been invited to appear on several CNBC shows, including Larry Kudlow's. (As an aside, did you know that Larry used to be Bear Stearns' chief economist back in the late '80s and early '90s? Then he started missing meetings with important Bear clients. Turned out he had a nasty little coke habit. Just thought you'd want to "bear" that in mind.)
When I got the first call inviting me on, I was flattered. I could barely contain my enthusiasm when I said, "Sure!"
"Great," I was told. "The minimum package is $15,000, and for that you get ..." Now, this was $15,000 back in about 1999 or so, when I got my first invite. I can only imagine what the price tag is now - I don't know, because I no longer take their calls. I know the drill.
Okay, so why wouldn't I spend the money for that opportunity for my business? And why does UBS?
Simple. My clients generally don't watch CNBC, and my firm doesn't profit from the market conditions that a UBS profits from.
Generally speaking, investment firms make money when people are investing. Remember the dot-com bubble? The day-trading how-to's? Everybody and his brother tuned into CNBC. But during a bear market, we watch other stuff - something that'll cheer us up.
And banks make money when people and companies are borrowing. During a recession, that's not happening.
That's why bank and Wall Street economists are always over-optimistic. And that's why CNBC commentators like the marginally attractive but sadly vapid Erin Burnett look for the silver lining in every cloud.
Oh, a big name can get on CNBC for free. Alan Greenspan, Warren Buffett, Jim Rogers, Mark Cuban - those people are courted constantly by CNBC. But to pick an analyst or a trader to provide today's infomercial - er, insights - they contact investment firms, offer their package, and get a list of names, corresponding to the market or area of the economy in which those individuals have expertise. And they offer them air-time based on the ante.
So now you know how it works. Free speech meets free enterprise. As Russian comic Yakov Smirnoff says, "America - what a country!"
The Scarlet Letter
I wrote my Representative and Senators before the votes on the bailout. My Senators both voted against it, but my Representative voted for it.
He sent me an e-mail reply today, explaining why he voted for it with the standard "sure the people don't like it, but we're smarter than the people and had to save them from themselves" gambit.
He should wear that letter like a badge of shame.
He even cited the fact that Warren Buffett was for it, which was purely self-serving on Buffett's part, just like his recent attempt to jawbone the stock market higher after he bought into GE and Goldman. He quoted Buffett as saying he'd rather be "approximately right" than "precisely wrong," saying that to do nothing would have been "precisely wrong."
And, incredibly, he tried to explain derivatives to me - me, a guy who cut his teeth evaluating risk-controlled arbitrage strategies by thrifts, traded futures, and valued and managed mortgage and interest rate derivatives including captions, swaptions, and residuals.
So, in case anyone's interested, here's my response to him:
"Dear Congressman Moore,
I appreciate your response. However, I fear that in this instance, both you and Mr. Buffett - who, as a professional investor, stands to profit mightily from the stance he's taking, regarding the bailout and his euphoric urging of Americans to buy stocks - are both precisely wrong. (Regarding the stock market, I believe today provided ample evidence of that.)
I am an economist who has been accurately forecasting the current economic crisis for at least 18 months now, and foresaw the perils of excess government intervention in the markets as early as 2001, after the Greenspan-inflated dot-com bubble burst. I have also actively traded and managed many of the complex derivatives you attempt to explain. As such, I am all too aware of the causes for this crisis, which has roots as far back as the New Deal. In fact, most of the causes are legislative in nature - DIDMCA, the Tax Reform Act of 1986, etc. I do not accept your partisan view of the causal factors - your Democratic colleagues, notably Messrs. Frank, Dodd and Schumer, are at least equally complicit in the current state of the US economy. Rep. Frank, in particular, stated in 2004: "I'm willing to roll the dice when it comes to subsidized housing." Given that he - and you - are standing at the craps table with taxpayer money, that attitude is dereliction of duty bordering on the criminal.
Now is not a time for partisan finger-pointing, it is a time for realistic solutions, which you and your colleagues have failed yet again to provide. Rest assured that you will never have my vote as long as I live, because I and my fellow taxpayers will be paying for your reckless, uninformed and irresponsible decision-making for at least that long.
Sincerely,
Brian Hague"
He sent me an e-mail reply today, explaining why he voted for it with the standard "sure the people don't like it, but we're smarter than the people and had to save them from themselves" gambit.
He should wear that letter like a badge of shame.
He even cited the fact that Warren Buffett was for it, which was purely self-serving on Buffett's part, just like his recent attempt to jawbone the stock market higher after he bought into GE and Goldman. He quoted Buffett as saying he'd rather be "approximately right" than "precisely wrong," saying that to do nothing would have been "precisely wrong."
And, incredibly, he tried to explain derivatives to me - me, a guy who cut his teeth evaluating risk-controlled arbitrage strategies by thrifts, traded futures, and valued and managed mortgage and interest rate derivatives including captions, swaptions, and residuals.
So, in case anyone's interested, here's my response to him:
"Dear Congressman Moore,
I appreciate your response. However, I fear that in this instance, both you and Mr. Buffett - who, as a professional investor, stands to profit mightily from the stance he's taking, regarding the bailout and his euphoric urging of Americans to buy stocks - are both precisely wrong. (Regarding the stock market, I believe today provided ample evidence of that.)
I am an economist who has been accurately forecasting the current economic crisis for at least 18 months now, and foresaw the perils of excess government intervention in the markets as early as 2001, after the Greenspan-inflated dot-com bubble burst. I have also actively traded and managed many of the complex derivatives you attempt to explain. As such, I am all too aware of the causes for this crisis, which has roots as far back as the New Deal. In fact, most of the causes are legislative in nature - DIDMCA, the Tax Reform Act of 1986, etc. I do not accept your partisan view of the causal factors - your Democratic colleagues, notably Messrs. Frank, Dodd and Schumer, are at least equally complicit in the current state of the US economy. Rep. Frank, in particular, stated in 2004: "I'm willing to roll the dice when it comes to subsidized housing." Given that he - and you - are standing at the craps table with taxpayer money, that attitude is dereliction of duty bordering on the criminal.
Now is not a time for partisan finger-pointing, it is a time for realistic solutions, which you and your colleagues have failed yet again to provide. Rest assured that you will never have my vote as long as I live, because I and my fellow taxpayers will be paying for your reckless, uninformed and irresponsible decision-making for at least that long.
Sincerely,
Brian Hague"
Thursday, October 16, 2008
Dumb and Dumber
And dumbest.
Dumb: Sen. McCain's economic plan, which is two-pronged.
Prong one: Let people who are 59 or older withdraw from their retirement accounts at a tax rate of 10%, instead of their current tax rate.
Okay, the dis-savings attribute of this is less severe than his rival's plan, and I get the age component: help out those people who are near retirement age, and let them bail in the face of a bear market.
But for one thing, they can "bail" without withdrawing: just rebalance the portfolio. Buy inverse index funds, or bond funds, or bank CDs, or just put it in a money market fund, for crying out loud.
And for another, why tax them at all? Just reduce the withdrawal age to 59, at least temporarily. Lots of people retire in their 50s now anyway. And if you're trying help someone get money out before the market tanks further, why add a 10% hickey on the hit they've already taken?
Prong two: cut the capital gains tax. Hey, I'm all for that, and I understand the increased-investment-stimulates-the-economy logic. But, ah, Senator - not too many portfolios are sporting capital gains these days. Great idea, bad timing, little immediate benefit. I thought your plan was to fix the economy, now?
Dumber: Sen. Obama's plan, also two-pronged.
Prong one: already covered it, yesterday. Worse than McCain's idea.
Prong two: provide a $3,000 tax credit for every job a business creates.
Let's see, average hourly earnings in this country are about $18 (for now). Multiply that by the typical full-time schedule of about 2,000 hours a year, and you're paying $36k. Plus bennies and overhead at about 15% on top of that, plus hiring costs. So all-in, first year, this new position costs you upwards of $45k.
And you want to entice me to add this expense to my business by offering a tax credit worth about 7% of the cost.
Senator, if I need more employees, I'll hire them. If the revenue I can generate with another warm body justifies the expense, you can be assured I'll create a job.
But your generous offer is one of those trades that's hard to make up on volume.
Dumbest? The stock market.
No, I'm not just bitter because I'm short, and had a red-letter day yesterday, and looked set for another one tomorrow, only to give up half of yesterday's gains.
Here was the data slate that hit the market today:
Inflation: the headline reading was down, and the core reading was flat. Neutral signal, basically.
Jobless claims: initial claims were down more than expected, on workers temporarily sidelined by Gustav going back to work. But continuing claims were up unexpectedly, to a new cyclical high. And that's worse because that means once a worker loses his job, he has trouble finding a replacement job. So he's chronically unemployed. Bad news.
Net foreign purchases of US securities: who really cares, for the most part? Not a market-mover.
Industrial Production: the biggest drop since 1974. Ouch. A real recession signal in the year-over-year number. Bad news.
Capacity utilization: down two and a half points, twice as big a drop as forecast, and the first reading below the traditional recession threshold of 78% since the last recession. Bad news.
Philly Fed index: huge drop. It fell three times as much as forecast. Another bad sign for manufacturing.
That was the morning's slate. Also, Citi and Merrill reported yet another quarter of losses, on even more bad bond write-downs.
The market wanted to rally. It tried early on, focusing solely on the inflation number, ignoring that even though the core reading was flat, it's still a half-point above the Fed's comfort zone, and the fact that core producer prices were up for the month, higher core consumer prices are coming, so this is temporary relief at best.
Besides, who gives two hoots about inflation right now? Not Ben Bernanke, I can promise you.
So in the first hour of trading, the Dow was up more than 100 points.
Then reality set in.
The stark reality that, even if the inflation number was spun as a positive, the overwhelming bad news that the manufacturing sector - supported all year by exports, and the last bastion of hope for the US economy - is falling completely out of bed (you heard it here first, by the way), caused a free-fall. by mid-morning, the Dow was down almost 400 points, to 8,200.
Then, it rallied back. We even got another piece of bad news, ugly-bad, at 1:00 EDT, when the National Association of Home Builders reported their builder sentiment index had fallen to a new record low.
Yes, housing's still in the toilet. And getting worse all the time. And what's even worse is the strong correlation (which I've mentioned before) between the NAHB index and the S&P 500 lagged 18 months. So if this new low represents the bottom, that means the bottom for stocks is about another 18 months out.
All these guys looking at every big down day keep talking about whether we're nearing a bottom. This isn't going to happen quick. It's going to look more like the Bataan Death March, with Paulson and Bernanke poking us with their bayonets at every step.
Still, the Dow came storming back to neutral on the day. And it bounced around there from late morning until within about an hour of the close, staying within a range of about 100 points either side of yesterday's close.
And that was telling. Why, you ask?
Because yesterday's close was uncomfortably close to Friday's, which was the low for this bear market to date. And this market wants desperately to avoid setting another low this quickly. Desperately. And a drop of about 125 points would have gotten it there.
So, it took off in the last hour of trading, posting a euphoric, 400-point gain in the face of a slew of bad economic data.
And in the face of all reason and logic.
But I'm not worried. Monday's gain - aided by the closing of the bond market and the banks - was similarly euphoric. And in two days, it pretty much evaporated.
This one won't take any longer, I'll bet. Oh, we may get a Friday rally, since the market loves to end the week positive.
But we may also get a new low. Reality may set in with today's data. Add in the fact that the next shoe to drop - hedge funds - was a hot topic of discussion today, as was the fact that November's ARM resets are going to produce huge jumps in payments due to the spike in LIBOR over the past month, and you have a perfect recipe for panic.
But only if you're logical. The stock market is not.
Tomorrow will also bring the monthly housing starts and building permits numbers. They're already at 17-year lows. You think they'll be up? And the first look at consumer confidence for October. Where do you think that'll come in: higher, or lower?
Today's late rally was attributed to four different causes that I saw. First, the inflation data wasn't as bad as expected - a "hey, at least it didn't go up" reaction. I already debunked that one.
Second, Citi's loss wasn't as bad as expected. Okay. But it was still a loss. And Merrill's was worse than expected.
Third, Yahoo rallied when a Microsoft exec made an off-the-cuff comment that a deal could still happen. Well, Yahoo's CEO didn't say he welcomed it. So it's not likely.
Finally, as stocks sold off, oil dipped below $70 a barrel. Okay, that one could be legit.
But it's around $72 right now.
So, take three false-hope signals, add in a fourth signal that has since reversed direction, and stack it up against five really bad signs. Add in further bank write-downs. Toss in the imminent collapse of half the world's hedge funds, triggering massive sales of securities, driving prices down further. Sprinkle on the specter of a fresh tsunami of foreclosures after ARM payments go up 10-13% in November.
Then throw in what happens in Asian and European markets overnight. I don't think they'll be as irrationally exuberant as ours, to steal a phrase from Mr. Bubble.
Top it all off with the special sauce of a couple more pieces of bad economic news tomorrow.
And the smart money is on a big sell-off.
Oh, it'll be a volatile day, too. Get this: since the beginning of September, 27 of the 33 trading days have seen triple-digit moves in the Dow. The average change (on an absolute value basis)?
295 points. Take out those six double-digit days, and it's well over 300.
So if you're worried about your 401(k), or your job, take heart. It could be worse.
You could be a stock trader.
(Sorry if you are.)
Dumb: Sen. McCain's economic plan, which is two-pronged.
Prong one: Let people who are 59 or older withdraw from their retirement accounts at a tax rate of 10%, instead of their current tax rate.
Okay, the dis-savings attribute of this is less severe than his rival's plan, and I get the age component: help out those people who are near retirement age, and let them bail in the face of a bear market.
But for one thing, they can "bail" without withdrawing: just rebalance the portfolio. Buy inverse index funds, or bond funds, or bank CDs, or just put it in a money market fund, for crying out loud.
And for another, why tax them at all? Just reduce the withdrawal age to 59, at least temporarily. Lots of people retire in their 50s now anyway. And if you're trying help someone get money out before the market tanks further, why add a 10% hickey on the hit they've already taken?
Prong two: cut the capital gains tax. Hey, I'm all for that, and I understand the increased-investment-stimulates-the-economy logic. But, ah, Senator - not too many portfolios are sporting capital gains these days. Great idea, bad timing, little immediate benefit. I thought your plan was to fix the economy, now?
Dumber: Sen. Obama's plan, also two-pronged.
Prong one: already covered it, yesterday. Worse than McCain's idea.
Prong two: provide a $3,000 tax credit for every job a business creates.
Let's see, average hourly earnings in this country are about $18 (for now). Multiply that by the typical full-time schedule of about 2,000 hours a year, and you're paying $36k. Plus bennies and overhead at about 15% on top of that, plus hiring costs. So all-in, first year, this new position costs you upwards of $45k.
And you want to entice me to add this expense to my business by offering a tax credit worth about 7% of the cost.
Senator, if I need more employees, I'll hire them. If the revenue I can generate with another warm body justifies the expense, you can be assured I'll create a job.
But your generous offer is one of those trades that's hard to make up on volume.
Dumbest? The stock market.
No, I'm not just bitter because I'm short, and had a red-letter day yesterday, and looked set for another one tomorrow, only to give up half of yesterday's gains.
Here was the data slate that hit the market today:
Inflation: the headline reading was down, and the core reading was flat. Neutral signal, basically.
Jobless claims: initial claims were down more than expected, on workers temporarily sidelined by Gustav going back to work. But continuing claims were up unexpectedly, to a new cyclical high. And that's worse because that means once a worker loses his job, he has trouble finding a replacement job. So he's chronically unemployed. Bad news.
Net foreign purchases of US securities: who really cares, for the most part? Not a market-mover.
Industrial Production: the biggest drop since 1974. Ouch. A real recession signal in the year-over-year number. Bad news.
Capacity utilization: down two and a half points, twice as big a drop as forecast, and the first reading below the traditional recession threshold of 78% since the last recession. Bad news.
Philly Fed index: huge drop. It fell three times as much as forecast. Another bad sign for manufacturing.
That was the morning's slate. Also, Citi and Merrill reported yet another quarter of losses, on even more bad bond write-downs.
The market wanted to rally. It tried early on, focusing solely on the inflation number, ignoring that even though the core reading was flat, it's still a half-point above the Fed's comfort zone, and the fact that core producer prices were up for the month, higher core consumer prices are coming, so this is temporary relief at best.
Besides, who gives two hoots about inflation right now? Not Ben Bernanke, I can promise you.
So in the first hour of trading, the Dow was up more than 100 points.
Then reality set in.
The stark reality that, even if the inflation number was spun as a positive, the overwhelming bad news that the manufacturing sector - supported all year by exports, and the last bastion of hope for the US economy - is falling completely out of bed (you heard it here first, by the way), caused a free-fall. by mid-morning, the Dow was down almost 400 points, to 8,200.
Then, it rallied back. We even got another piece of bad news, ugly-bad, at 1:00 EDT, when the National Association of Home Builders reported their builder sentiment index had fallen to a new record low.
Yes, housing's still in the toilet. And getting worse all the time. And what's even worse is the strong correlation (which I've mentioned before) between the NAHB index and the S&P 500 lagged 18 months. So if this new low represents the bottom, that means the bottom for stocks is about another 18 months out.
All these guys looking at every big down day keep talking about whether we're nearing a bottom. This isn't going to happen quick. It's going to look more like the Bataan Death March, with Paulson and Bernanke poking us with their bayonets at every step.
Still, the Dow came storming back to neutral on the day. And it bounced around there from late morning until within about an hour of the close, staying within a range of about 100 points either side of yesterday's close.
And that was telling. Why, you ask?
Because yesterday's close was uncomfortably close to Friday's, which was the low for this bear market to date. And this market wants desperately to avoid setting another low this quickly. Desperately. And a drop of about 125 points would have gotten it there.
So, it took off in the last hour of trading, posting a euphoric, 400-point gain in the face of a slew of bad economic data.
And in the face of all reason and logic.
But I'm not worried. Monday's gain - aided by the closing of the bond market and the banks - was similarly euphoric. And in two days, it pretty much evaporated.
This one won't take any longer, I'll bet. Oh, we may get a Friday rally, since the market loves to end the week positive.
But we may also get a new low. Reality may set in with today's data. Add in the fact that the next shoe to drop - hedge funds - was a hot topic of discussion today, as was the fact that November's ARM resets are going to produce huge jumps in payments due to the spike in LIBOR over the past month, and you have a perfect recipe for panic.
But only if you're logical. The stock market is not.
Tomorrow will also bring the monthly housing starts and building permits numbers. They're already at 17-year lows. You think they'll be up? And the first look at consumer confidence for October. Where do you think that'll come in: higher, or lower?
Today's late rally was attributed to four different causes that I saw. First, the inflation data wasn't as bad as expected - a "hey, at least it didn't go up" reaction. I already debunked that one.
Second, Citi's loss wasn't as bad as expected. Okay. But it was still a loss. And Merrill's was worse than expected.
Third, Yahoo rallied when a Microsoft exec made an off-the-cuff comment that a deal could still happen. Well, Yahoo's CEO didn't say he welcomed it. So it's not likely.
Finally, as stocks sold off, oil dipped below $70 a barrel. Okay, that one could be legit.
But it's around $72 right now.
So, take three false-hope signals, add in a fourth signal that has since reversed direction, and stack it up against five really bad signs. Add in further bank write-downs. Toss in the imminent collapse of half the world's hedge funds, triggering massive sales of securities, driving prices down further. Sprinkle on the specter of a fresh tsunami of foreclosures after ARM payments go up 10-13% in November.
Then throw in what happens in Asian and European markets overnight. I don't think they'll be as irrationally exuberant as ours, to steal a phrase from Mr. Bubble.
Top it all off with the special sauce of a couple more pieces of bad economic news tomorrow.
And the smart money is on a big sell-off.
Oh, it'll be a volatile day, too. Get this: since the beginning of September, 27 of the 33 trading days have seen triple-digit moves in the Dow. The average change (on an absolute value basis)?
295 points. Take out those six double-digit days, and it's well over 300.
So if you're worried about your 401(k), or your job, take heart. It could be worse.
You could be a stock trader.
(Sorry if you are.)
Tuesday, October 14, 2008
The Natural Course of Things
Once again, credit my lovely wife for her wisdom.
During last spring's heavy flooding in Iowa and Missouri, we were watching news coverage of residents of river towns frantically putting up sandbags. My wife made the following observation (I'm paraphrasing):
"It's fine, and understandable, that they're doing that. But the river has pretty much gone where it's wanted to go for centuries, and there's really nothing man can do to stop that."
Somebody please tell Hank Paulson and Ben Bernanke. Quick. Before we all drown in a river of debt.
They started out by pretty much ignoring the rising waters.
On July 19 of last year - two days after the Bear Stearns hedge fund collapse - Bernanke told the Senate Banking Committee that losses from the subprime fiasco might total as much as $100 billion.
Today's estimates? According to the IMF, $1.4 trillion. (To be fair, not all of that is directly from subprime. But whether the flooding comes entirely from rainfall directly on the river itself, or whether some of it comes from various tributaries that are also affected by the rain, the guy watching the water level should see the flood coming.)
It's also interesting that less than a month after Bernanke made that bold estimate, his Fed began cutting interest rates, "acknowledging for the first time that an extraordinary policy shift is needed to contain the subprime-mortgage collapse," according to Bloomberg.
So after ignoring the rising waters, Bernanke and Paulson began casually tossing a sandbag here, another there, thinking the raging waters would be "contained." Now, they're throwing everything they've got at it. Come to think of it, since the US is broke and the Fed is insolvent, they're throwing stuff they don't have at it. In the form of money. Mountains of money.
Our money.
But this thing is looking less like a flooded river, and more like one great big honkin' mother of a tsunami.
And by throwing money at it, they're not really throwing sandbags. They're throwing great big buckets of ... water.
See, the river will seek its natural course, and its natural level. As I laid out yesterday, so will markets, whether they be for stocks, real estate, jobs, dollars ... whatever.
And men trying to stop that from happening is as futile as men trying to alter the course of the Mississippi.
Especially when the men are incompetent.
************
Let's get back to that IMF estimate of total losses, because it lies at the heart of part one of the two-part reason Paulson's ever-shifting TARP plan will fail.
Total US bank losses to date have been about $385 billion (for the world, it's $637 billion, or just less than half the IMF forecast). US financials have raised just $338 billion in capital to offset the losses. Now, that doesn't sound too bad - they've raised 88% of what they've lost, so they're only down $50 billion or so.
But they've raised $177 billion of that capital - more than half the total raised - in the third and fourth quarters of this year. And that includes the first round of TARP money - everybody else, from China to Korea to Singapore to Abu Dhabi - is done giving money to Wall Street. And not all of them have yet reported third quarter losses. And none of them have yet reported fourth quarter losses.
It's going to get ugly when they do.
Ultimately, even with the TARP money, the banks will just be back to break-even on their losses to date, if that. So the TARP money will have been wasted. Why?
Because the whole notion behind the shift from buying crappy bonds to injecting capital in the banks has been that the latter will encourage banks to lend. Banking is a leverage game: a dollar of capital can be deployed into a multiple of that dollar in loans. And that primes the economic pump, sending cash from Wall Street to Main Street (oh God, I can't believe I just said that).
Paulson even handed out instructions with his TARP checks, telling the banks to go out and lend, much like his boss told us all after 9/11 to go out and shop. (Remember those ads? "Do your business, all over the country." I used to laugh every time I saw them, since "do your business" is what we tell our dogs when we want them to poop.) Paulson's exact words:
"The needs of our economy require that our financial institutions not take this new capital and hoard it, but to deploy it."
While GMAC isn't a bank and didn't get any TARP money, it is a consumer lender. How is it "deploying" its capital?
It sent a letter to all GM dealers yesterday telling them it would not lend money to any would-be car buyer with a FICO score below 700.
The prime cut-off is 680.
This will really help GM sell cars and avoid bankruptcy.
Other banks aren't going to start lending either. They don't want to go back to the days of making loans to people who can't repay them. And the only way they will is if the government nationalizes them, and does it themselves, using our tax dollars.
Gulp!
(There's a third reason Paulson's plan won't work: Paulson's running it.)
************
Here's a sinister little plot for you. Remember why Fannie and Freddie went belly-up? The two largest mortgage insurers in the world, who between them guaranteed more than $5 trillion in loans at their zenith, were originally chartered to buy only "conforming" loans - those that met stringent underwriting standards, and thus were the highest-quality mortgages in the market. But at one point their combined exposure to subprime loans amounted to 48% of their balance sheets.
So what are they up to now that Uncle is at the helm? From the Credit Union Journal:
"The Treasury Department, which took over Fannie Mae and Freddie Mac last month, is directing the two secondary mortgage giants to start buying $40 billion a month of distressed mortgage securities in order to recreate the failing market. Officials plan to pump new liquidity into the secondary market by having Fannie and Freddie buy up subprime, Alt-A and non-performing prime mortgages."
On whose authority? This is an end-around to the TARP. It allows Treasury to ultimately spend the entire $700 billion of TARP money injecting capital into banks, while spending an unlimited amount of money buying crap assets through Fannie and Freddie.
Which is exactly what caused Fannie and Freddie to fail in the first place.
So they're going to make Fannie and Freddie fail again. Only now, we're the shareholders who will take the hit. Write your Congresspersons. This has got to stop, now!
************
Still in a quandary about who to vote for in just a few weeks? This won't make it any easier.
I reported before on McCain's plan to spend $300 billion of the TARP money buying up bad mortgages.
Bold prediction: if John McCain is elected, we will see the largest one-month spike in mortgage delinquencies on record, covering every home whose market value is below its mortgage balance, and/or whose mortgage interest rate is above 5.25%.
As for Obama, he produced his own brilliant idea yesterday. Remember a week ago, when he and every other politician was crying, "We can't let the value of people's retirement accounts keep going down!"?
Well, he wants to let people withdraw up to $10,000 from their tax-deferred retirement accounts, penalty-free. Won't that make the value of the accounts go down, even if the market doesn't?
Both of these guys have clearly taken leave of their senses. Probably just dizzy from running around in circles, screaming, "The sky is falling!"
Besides encouraging dis-saving, this hare-brained scheme has another shortcoming:
The people that would do this wouldn't spend the money to stimulate the economy anyway. They'd probably stash it in their new wall safe. A local news station reported that a local company that sells in-home wall safes has seen sales skyrocket over the past several months. That's confidence in the banking system.
************
Here's another sign of what's to come: remember the money market mutual fund that "broke the buck" last month, spurring panic in the money markets and leading the feds to basically turn money funds into bank deposits by insuring them (even though the FDIC is about broke)? Well, it had promised to distribute $20 billion to its investors by yesterday.
It can't. Why? It doesn't know what its holdings are. Not what they're worth. But how many shares each investor owns.
Gulp!
************
For the people who still blame mark-to-market accounting for the current mess, besides the rational explanations of what it is, how it works and why it's important that I've already provided, here are a couple of more simple rubrics to help you get it.
There was no mark-to-market accounting in 1929. Or in 1987. And the stock market still crashed.
On a similar note, remember how speculators were blamed for the sharp spike in oil prices? How it couldn't possibly be supply and demand fundamentals driving the price?
Suddenly, oil is dropping like a rock. Where are those voices now? Why aren't they blaming speculators for shorting oil? Why are they suddenly accepting the specter of reduced demand from a global recession as a fundamental price driver?
Back to mark-to-market: there have been, in the past, bank bailouts that worked. They were expensive, averaging about 13% of the respective countries' GDP. But some of them worked.
To put that GDP number in perspective, US GDP is around $14 trillion. So the price tag to bail out our banking system would be about $2 trillion. But that doesn't factor in the impact on US inflation, interest rates and tax rates of adding that to an already-trillion dollar deficit. Which is why, in my humble opinion, bailing out US banks won't succeed.
But another reason is that in the case of every successful banking system bailout, the countries have forced immediate write-downs of bad assets to poo levels (poo is just slightly above zero, in case you didn't know).
We want to do just the opposite, and eliminate price transparency altogether. Crazy.
************
Random thought, from a good friend and fellow cynic: why do we call it "nationalizing the banks" when Britain does it, and "injecting capital into the banking system" when we do it?
************
My t-shirt idea of the week: with Iceland now essentially bankrupt, we can cheer ourselves up with t-shirts that proclaim, "At least we're not Iceland."
On the front. The back would read, "Yet."
************
I'll leave you with this additional gem from my wife. Citing the book of Proverbs (Isaiah needs a rest), she referred to the verse that says, "For everything, there is a season ..."
That's akin to seeking the natural course of things. In the markets, there's a time to prosper, and a time to lose your shirt.
But what Washington is trying to do is make it summer all the time. As the leaves start to turn colors and fall, lawmakers are up the trees with Elmer's glue and green spray paint.
Good luck with that.
During last spring's heavy flooding in Iowa and Missouri, we were watching news coverage of residents of river towns frantically putting up sandbags. My wife made the following observation (I'm paraphrasing):
"It's fine, and understandable, that they're doing that. But the river has pretty much gone where it's wanted to go for centuries, and there's really nothing man can do to stop that."
Somebody please tell Hank Paulson and Ben Bernanke. Quick. Before we all drown in a river of debt.
They started out by pretty much ignoring the rising waters.
On July 19 of last year - two days after the Bear Stearns hedge fund collapse - Bernanke told the Senate Banking Committee that losses from the subprime fiasco might total as much as $100 billion.
Today's estimates? According to the IMF, $1.4 trillion. (To be fair, not all of that is directly from subprime. But whether the flooding comes entirely from rainfall directly on the river itself, or whether some of it comes from various tributaries that are also affected by the rain, the guy watching the water level should see the flood coming.)
It's also interesting that less than a month after Bernanke made that bold estimate, his Fed began cutting interest rates, "acknowledging for the first time that an extraordinary policy shift is needed to contain the subprime-mortgage collapse," according to Bloomberg.
So after ignoring the rising waters, Bernanke and Paulson began casually tossing a sandbag here, another there, thinking the raging waters would be "contained." Now, they're throwing everything they've got at it. Come to think of it, since the US is broke and the Fed is insolvent, they're throwing stuff they don't have at it. In the form of money. Mountains of money.
Our money.
But this thing is looking less like a flooded river, and more like one great big honkin' mother of a tsunami.
And by throwing money at it, they're not really throwing sandbags. They're throwing great big buckets of ... water.
See, the river will seek its natural course, and its natural level. As I laid out yesterday, so will markets, whether they be for stocks, real estate, jobs, dollars ... whatever.
And men trying to stop that from happening is as futile as men trying to alter the course of the Mississippi.
Especially when the men are incompetent.
************
Let's get back to that IMF estimate of total losses, because it lies at the heart of part one of the two-part reason Paulson's ever-shifting TARP plan will fail.
Total US bank losses to date have been about $385 billion (for the world, it's $637 billion, or just less than half the IMF forecast). US financials have raised just $338 billion in capital to offset the losses. Now, that doesn't sound too bad - they've raised 88% of what they've lost, so they're only down $50 billion or so.
But they've raised $177 billion of that capital - more than half the total raised - in the third and fourth quarters of this year. And that includes the first round of TARP money - everybody else, from China to Korea to Singapore to Abu Dhabi - is done giving money to Wall Street. And not all of them have yet reported third quarter losses. And none of them have yet reported fourth quarter losses.
It's going to get ugly when they do.
Ultimately, even with the TARP money, the banks will just be back to break-even on their losses to date, if that. So the TARP money will have been wasted. Why?
Because the whole notion behind the shift from buying crappy bonds to injecting capital in the banks has been that the latter will encourage banks to lend. Banking is a leverage game: a dollar of capital can be deployed into a multiple of that dollar in loans. And that primes the economic pump, sending cash from Wall Street to Main Street (oh God, I can't believe I just said that).
Paulson even handed out instructions with his TARP checks, telling the banks to go out and lend, much like his boss told us all after 9/11 to go out and shop. (Remember those ads? "Do your business, all over the country." I used to laugh every time I saw them, since "do your business" is what we tell our dogs when we want them to poop.) Paulson's exact words:
"The needs of our economy require that our financial institutions not take this new capital and hoard it, but to deploy it."
While GMAC isn't a bank and didn't get any TARP money, it is a consumer lender. How is it "deploying" its capital?
It sent a letter to all GM dealers yesterday telling them it would not lend money to any would-be car buyer with a FICO score below 700.
The prime cut-off is 680.
This will really help GM sell cars and avoid bankruptcy.
Other banks aren't going to start lending either. They don't want to go back to the days of making loans to people who can't repay them. And the only way they will is if the government nationalizes them, and does it themselves, using our tax dollars.
Gulp!
(There's a third reason Paulson's plan won't work: Paulson's running it.)
************
Here's a sinister little plot for you. Remember why Fannie and Freddie went belly-up? The two largest mortgage insurers in the world, who between them guaranteed more than $5 trillion in loans at their zenith, were originally chartered to buy only "conforming" loans - those that met stringent underwriting standards, and thus were the highest-quality mortgages in the market. But at one point their combined exposure to subprime loans amounted to 48% of their balance sheets.
So what are they up to now that Uncle is at the helm? From the Credit Union Journal:
"The Treasury Department, which took over Fannie Mae and Freddie Mac last month, is directing the two secondary mortgage giants to start buying $40 billion a month of distressed mortgage securities in order to recreate the failing market. Officials plan to pump new liquidity into the secondary market by having Fannie and Freddie buy up subprime, Alt-A and non-performing prime mortgages."
On whose authority? This is an end-around to the TARP. It allows Treasury to ultimately spend the entire $700 billion of TARP money injecting capital into banks, while spending an unlimited amount of money buying crap assets through Fannie and Freddie.
Which is exactly what caused Fannie and Freddie to fail in the first place.
So they're going to make Fannie and Freddie fail again. Only now, we're the shareholders who will take the hit. Write your Congresspersons. This has got to stop, now!
************
Still in a quandary about who to vote for in just a few weeks? This won't make it any easier.
I reported before on McCain's plan to spend $300 billion of the TARP money buying up bad mortgages.
Bold prediction: if John McCain is elected, we will see the largest one-month spike in mortgage delinquencies on record, covering every home whose market value is below its mortgage balance, and/or whose mortgage interest rate is above 5.25%.
As for Obama, he produced his own brilliant idea yesterday. Remember a week ago, when he and every other politician was crying, "We can't let the value of people's retirement accounts keep going down!"?
Well, he wants to let people withdraw up to $10,000 from their tax-deferred retirement accounts, penalty-free. Won't that make the value of the accounts go down, even if the market doesn't?
Both of these guys have clearly taken leave of their senses. Probably just dizzy from running around in circles, screaming, "The sky is falling!"
Besides encouraging dis-saving, this hare-brained scheme has another shortcoming:
The people that would do this wouldn't spend the money to stimulate the economy anyway. They'd probably stash it in their new wall safe. A local news station reported that a local company that sells in-home wall safes has seen sales skyrocket over the past several months. That's confidence in the banking system.
************
Here's another sign of what's to come: remember the money market mutual fund that "broke the buck" last month, spurring panic in the money markets and leading the feds to basically turn money funds into bank deposits by insuring them (even though the FDIC is about broke)? Well, it had promised to distribute $20 billion to its investors by yesterday.
It can't. Why? It doesn't know what its holdings are. Not what they're worth. But how many shares each investor owns.
Gulp!
************
For the people who still blame mark-to-market accounting for the current mess, besides the rational explanations of what it is, how it works and why it's important that I've already provided, here are a couple of more simple rubrics to help you get it.
There was no mark-to-market accounting in 1929. Or in 1987. And the stock market still crashed.
On a similar note, remember how speculators were blamed for the sharp spike in oil prices? How it couldn't possibly be supply and demand fundamentals driving the price?
Suddenly, oil is dropping like a rock. Where are those voices now? Why aren't they blaming speculators for shorting oil? Why are they suddenly accepting the specter of reduced demand from a global recession as a fundamental price driver?
Back to mark-to-market: there have been, in the past, bank bailouts that worked. They were expensive, averaging about 13% of the respective countries' GDP. But some of them worked.
To put that GDP number in perspective, US GDP is around $14 trillion. So the price tag to bail out our banking system would be about $2 trillion. But that doesn't factor in the impact on US inflation, interest rates and tax rates of adding that to an already-trillion dollar deficit. Which is why, in my humble opinion, bailing out US banks won't succeed.
But another reason is that in the case of every successful banking system bailout, the countries have forced immediate write-downs of bad assets to poo levels (poo is just slightly above zero, in case you didn't know).
We want to do just the opposite, and eliminate price transparency altogether. Crazy.
************
Random thought, from a good friend and fellow cynic: why do we call it "nationalizing the banks" when Britain does it, and "injecting capital into the banking system" when we do it?
************
My t-shirt idea of the week: with Iceland now essentially bankrupt, we can cheer ourselves up with t-shirts that proclaim, "At least we're not Iceland."
On the front. The back would read, "Yet."
************
I'll leave you with this additional gem from my wife. Citing the book of Proverbs (Isaiah needs a rest), she referred to the verse that says, "For everything, there is a season ..."
That's akin to seeking the natural course of things. In the markets, there's a time to prosper, and a time to lose your shirt.
But what Washington is trying to do is make it summer all the time. As the leaves start to turn colors and fall, lawmakers are up the trees with Elmer's glue and green spray paint.
Good luck with that.
Monday, October 13, 2008
Truth, and Consequences
As I write this, the Dow is up more than 400 points because G7 leaders met ever so briefly to pledge they'd capitalize their respective countries' banks, and because Henry Paulson announced that's what he'll do with the TARP money.
A. We got a similar rally when Congress first began talking about "doing something." Remember what happened since then?
B. Paulson started hinting last week that he'd deploy the TARP money by directly infusing capital into banks. What's new?
C. All this demonstrates is that the guy in charge of righting the ship can't make a sound decision. And this instills confidence in the markets? I guess it also demonstrates that when stock traders want a rally, they'll produce one.
But make no mistake: this is a dead-cat bounce.
True, last week's massive sell-off was, in part, fear-induced. But the fears were well-founded. They were the fear of a recession that is inevitable no matter how many fingers Hank is able to put in the dike, and the fear of what a trillion dollar deficit will do to the US dollar, tax rates and interest rates.
President Bush has been trying to jawbone the fears away, much as FDR did in his inauguration speech in 1933, when he famously said, "We have nothing to fear but fear itself."
I agree. But I have to point out that his words didn't change much. The US economy and the stock market ultimately recovered in 1946.
Okay, let's turn our attention to consequences. I want to hit on several things that the Chicken Littles have been crying for in begging the government to "do something." I'll couch each in terms of paraphrased quotes that represent things we've all been hearing, unless we've kept our TVs and radios off for the last month (in which case, kudos to you).
"We can't let home prices keep falling."
First, I'm sympathetic to the notion of a family losing their home to foreclosure. What a terrible experience that would be. I wouldn't want it to happen to me.
That's why, when I bought a house, I saved a reasonable down payment first, researched the market, got a fixed-rate loan with payments I could afford, and made sure I didn't spend so much money on other stuff that I couldn't make the mortgage payment first and foremost.
That's why, if my home price did decline below my mortgage balance, I'd recognize that it's still my home, and not an investment, and that if I continue paying the mortgage down, the home price will eventually recover, and I'll once again own more than I owe. Because I know that, just as home prices can't go up forever, they can't go down forever either.
And that's why, if I did lose my job, I'd sell everything else I had, work two or three jobs if I had to, to be able to continue making my mortgage payment on time.
I recognize that not everyone is in my situation. And I also believe that the expansion of homeownership is a worthwhile goal, both economically and socially. But here's a simple fact: about 65% of Americans can actually afford to be homeowners. The only way we can expand homeownership above that number is by some kind of financial artifice.
That's exactly what happened in the subprime fiasco: a perfect storm of regulatory pressure, credit scoring, financial "innovation," Wall Street risk-parsing, and dubious marketing.
And, in the end, we did no favors shoe-horning a renter into a home he or she could not afford, letting them live in it for a few years, then taking it away from them.
(It kind of reminds me of how the S&L regulators enticed healthy thrifts to take over sick ones by letting them book "goodwill" as capital, then, after a few years, they took away the "goodwill," declared them insolvent, and shut them down, too.)
Here's how markets work: they go up, and they go down. Why? Because the sometimes go up at a pace above their long-term sustainable rate of growth. In housing, that should be roughly akin to the rate of inflation, discounting extreme supply and demand factors in certain markets like Manhattan. And that rate is about 3-4%.
Well, home prices went up by double digits for several years due to the subprime frenzy and the speculative excess it spawned. Everywhere. Not just in places like Manhattan, but in places where there's plenty of buildable land.
That is a classic example of a bubble. And every bubble demands a correction.
Here's a little exercise for you. Look at the S&P/Case-Shiller Home Price Index for each of the 20 metro markets it covers. Go back to before the housing bubble began, and plot the trendline at the long-term sustainable growth rate for that particular market, whatever it happens to be. Trace it all the way out to the end of 2008.
And you'll find that home prices still have not fallen to where they should be.
"Stop home prices from falling further?" Go ahead and try. Home prices have to fall further, to reach market equilibrium. How is Washington going to stop that from happening? Fix home prices? Say, "You have to buy a house this year, and you have to pay no less than X?"
The day they start doing that, color me gone.
It is both a truth and a consequence that home prices are going to fall further.
"People are losing money in their 401(k)s - we have to do something about that."
I find this almost comical. It was Washington, influenced by businesses, that led the grand exodus from defined benefit to defined contribution retirement plans to begin with. In doing so, they placed the risk directly on the shoulders of the employees.
We took that risk. We make money in the good times, and, unless we successfully rebalance, we lose money in the bad times.
On paper.
Look, if you were planning to retire next year, and now can't, I truly sympathize. I'm sorry you continued to expose yourself to too much risk for your age and life situation, and that you now face the consequences.
But I've had at least two retirees call me to ask if they should move their money. When I asked them what they were invested in, they said they were in a balanced lifestyle fund targeted to their age, invested mostly in bonds, and that it was returning around 4.75% year-to-date.
I told them if they were making money in this environment, they were fine.
But what about the guy who's 30, and fully allocated to equities?
Well, by the time he retires, he'll likely earn the long-term, sustainable historical average that stocks have returned, of about 11%. If he's diversified somewhat into bonds, maybe 8%.
That's more than twice the inflation rate. That should allow any diligent saver to retire comfortably. Only greed could make us expect higher returns than that.
Oh, but we do, because we are indeed greedy. We see those bubbly 25% returns for a couple of years, and it gets good to us. We think it'll go on forever.
See, this is the same story as housing. Only here, the long-term sustainable growth rate is, as I said, about 11%. So let's try the same exercise we tried above.
Go back to before the dot-com bubble, which was inflated by easy money beginning in late 1998, when Greenspan bailed out the Long-Term Capital Management hedge fund (important lesson: bailouts inflate bubbles, and bubbles burst, creating severe corrections). Plot the long-term sustainable growth rate of stock prices - pick any index - from about 1982, when the long-term bull market began, through year-end 2008.
You'll find that when the dot-com bubble began, stocks appreciated at a rate well above what could be sustained. Then it corrected from 2000 to 2002 - hard. But it didn't get all the way down to where it needed to be. Why?
Government intervention. A bailout, again in the form of too-easy money, again courtesy of Alan Greenspan, and again igniting a fresh bubble. This time, in housing.
You'll also find that, even with last week's carnage, the stock market still has not corrected to where its long-term sustainable growth rate would peg it. That level is around 7-8,000 on the Dow, or about 700 on the S&P, or about 1,400 on the NASDAQ.
So we're fairly close. The bad news is, the way corrections work, the market may fall below that mark, then rebound to it.
In the case of stock prices, it is theoretically easier for the government to intervene in a way that props them up, than it is for house prices.
They can simply keep pumping federal money into the economy until growth resumes, and stock prices go up on the prospects for that growth.
But for one thing, that only creates a new bubble. And three massive bubbles in a row, within a relatively short time frame, would totally destroy the US economy, and take the rest of the world with it.
And for another, the theory doesn't work when you're facing a trillion dollar deficit, and when your national debt is approaching 100% of GDP.
You then become a net-debtor nation, and in order to finance all that spending, you have to a) raise taxes by a massive amount, which further depresses spending and investment and causes further economic decline, as happened when Hoover raised taxes in 1932, and b) pay much higher interest rates on government debt you issue, in order to entice foreign investors, who hold the bulk of it, to buy more.
Folks, that is already happening. The ten-year Treasury yield has been rising since the last rate cut. Why? The ten-year note, since it matures in ten years, anticipates future events. A ten-year note trades like a strip of ten one-year bills. And if investors think that bill yields will go higher over the next ten years, they demand higher rates on the ten-year note.
What happens when those rates go up? Well, for one thing, 30-year fixed-rate mortgages are priced off the ten-year. So mortgage rates will go up, even if the Fed cuts the funds target to zero. That won't help solve the housing-led crisis we're in.
Another consequence is that the government has to print even more money, because it's now paying even more in interest - money it doesn't have, because it's still deficit spending. So the deficit gets wider, and that drives rates higher, in a never-ending inflationary spiral.
And they might as well buy every man, woman and child in the country a wheelbarrow in which to take their worthless US dollars to the grocery store.
So here's another truth, and another consequence: when you've enjoyed well-above-trend returns on your 401(k) for several years, you have to expect well-below-trend returns - and probably losses - for a while to get you back on trend. You should plan on the trend, take the good times with a grain of salt, and not worry through the bad times. And, as you near retirement, get out of the risky stuff to an increasing degree.
"We have to keep people from losing their homes."
This is closely related to the home price issue, and I've addressed it before, so I won't belabor it. But here's one important point.
Let's say we're going to pursue the McCain solution of refinancing all the "bad" mortgages into 30-year, fixed rate mortgages at 5.25%. Besides the near-impossible task of finding who now owns all those mortgages, piecing the tranches back together into whole loans, and buying them up - and besides the fact that most of those mortgagors won't be able to make the payments even at 5.25% now - here's the fundamental flaw:
Who will hold the mortgages? Banks won't. They're currently getting more than 5.25% on the mortgages they make. And they're through with making loans to people with impaired credit, who probably won't pay them back.
Investors won't either, for the same reasons. Their risk appetite has waned considerably. And they're back to pricing risk appropriately. So they won't pay par for a 5.25% mortgage-backed bond with a ton of credit risk.
That leaves Uncle Sam - you and me. And that's just what's being proposed. They say we'll ultimately make money on this.
So we're going to accept a 5.25% return on mortgages in a 6%-plus market, with rates sure to rise even further. And suffer eventual default rates that are about what they currently are on the subprime ARMs we're replacing.
Tell me again how we make money on that trade?
Fact is, we don't. We lose on the subsidized yield, we lose even more in a rising rate environment, and we suffer principal losses when they default - which, by the way leads to another glut of foreclosed homes on the market, which creates another overall housing slump.
And the ultimate direct cost to the taxpayer alone will be much, much more than $300 billion.
So, once more, it is both a truth and a consequence that more people are going to lose their homes.
"If we don't do something, people are going to lose their jobs."
Guess what? They already are. And that happens in every recession. Is the government proposing to guarantee that everyone has a job? (Perhaps - the trial balloon of resurrecting the WPA has already been floated .)
Furthermore, about 800,000 people have already lost their jobs since January. If the government spends a ton of money ensuring, somehow, that no one will lose their job going forward, how do they explain the timing of their actions to the guy or gal that got canned in January?
Truth and consequence: more people are going to lose their jobs.
"If we don't act now, more banks will fail."
How many new banks and bank branches have cropped up on every street corner over the past ten years? Can't we live with a few less banks?
Look, bank growth exploded during the housing bubble, because everybody wanted to get into the hyper-profitable lend-and-sell loan game. So it is only a natural consequence that the number of banks will contract when the demand for credit drops sharply.
During the S&L crisis, 747 institutions failed. Thus far in this debacle, 15 have gone down.
The truth is, we have a long, long way to go before we get back to equilibrium.
"We have to un-freeze the credit markets so people will start borrowing again."
Why are so many people whose ARM rates, and thus their mortgage payments, risen, defaulting on the loans?
Because they can't afford the higher mortgage payments when they already have two six-year car loans on brand-new luxury cars they bought with no money down, and several maxed-out credit cards, which combined eat up all of their take-home pay.
As with the banks, we need less credit right now. It is a natural and healthy cleansing of a system that got bloated with greed and excess, which was unnatural and unhealthy. So let's purge it.
More borrowing is not the answer. It's like a glutton who becomes obscenely obese, to the point that he becomes diabetic and has a heart attack.
So the doctors put him in the hospital and work to regulate his blood sugar and do a triple bypass. But they say, "Why, he's become so accustomed to his three milkshakes a day and his quart of ice cream at bedtime - we can't deprive him of that!" So they continue to gorge him. What eventually happens?
Again, I am totally sympathetic to the notion of people losing their jobs, their homes, and a portion of their retirement savings. A big part of the problem, though, is that we focus on those things, and place our faith in dollar-denominated things.
We have survived recessions before. Some of us have lived in poverty. Some of us have survived even worse: the Holocaust, ethnic cleansing in Eastern Europe or Africa, etc.
The key word is "survive." Many who have made it through bad experiences unscathed have been able to do so by placing our faith in the only One that can ultimately sustain us.
But in a nation that increasingly attempts to separate itself from the Creator it acknowledged at its birth, we're becoming increasingly reliant on government - man - to fix things.
And they can't.
The more they try, the worse it gets. So please, Washington, get the message: go home. Visit your constituents. Listen to them, not to your pals on Wall Street. Pay attention when they tell you, "Enough, already!" Then go on a nice junket or whatever you do on your lengthy recesses.
Because the more you spend, the worse it ultimately gets.
The fundamental message is, "We do not have faith in you."
A. We got a similar rally when Congress first began talking about "doing something." Remember what happened since then?
B. Paulson started hinting last week that he'd deploy the TARP money by directly infusing capital into banks. What's new?
C. All this demonstrates is that the guy in charge of righting the ship can't make a sound decision. And this instills confidence in the markets? I guess it also demonstrates that when stock traders want a rally, they'll produce one.
But make no mistake: this is a dead-cat bounce.
True, last week's massive sell-off was, in part, fear-induced. But the fears were well-founded. They were the fear of a recession that is inevitable no matter how many fingers Hank is able to put in the dike, and the fear of what a trillion dollar deficit will do to the US dollar, tax rates and interest rates.
President Bush has been trying to jawbone the fears away, much as FDR did in his inauguration speech in 1933, when he famously said, "We have nothing to fear but fear itself."
I agree. But I have to point out that his words didn't change much. The US economy and the stock market ultimately recovered in 1946.
Okay, let's turn our attention to consequences. I want to hit on several things that the Chicken Littles have been crying for in begging the government to "do something." I'll couch each in terms of paraphrased quotes that represent things we've all been hearing, unless we've kept our TVs and radios off for the last month (in which case, kudos to you).
"We can't let home prices keep falling."
First, I'm sympathetic to the notion of a family losing their home to foreclosure. What a terrible experience that would be. I wouldn't want it to happen to me.
That's why, when I bought a house, I saved a reasonable down payment first, researched the market, got a fixed-rate loan with payments I could afford, and made sure I didn't spend so much money on other stuff that I couldn't make the mortgage payment first and foremost.
That's why, if my home price did decline below my mortgage balance, I'd recognize that it's still my home, and not an investment, and that if I continue paying the mortgage down, the home price will eventually recover, and I'll once again own more than I owe. Because I know that, just as home prices can't go up forever, they can't go down forever either.
And that's why, if I did lose my job, I'd sell everything else I had, work two or three jobs if I had to, to be able to continue making my mortgage payment on time.
I recognize that not everyone is in my situation. And I also believe that the expansion of homeownership is a worthwhile goal, both economically and socially. But here's a simple fact: about 65% of Americans can actually afford to be homeowners. The only way we can expand homeownership above that number is by some kind of financial artifice.
That's exactly what happened in the subprime fiasco: a perfect storm of regulatory pressure, credit scoring, financial "innovation," Wall Street risk-parsing, and dubious marketing.
And, in the end, we did no favors shoe-horning a renter into a home he or she could not afford, letting them live in it for a few years, then taking it away from them.
(It kind of reminds me of how the S&L regulators enticed healthy thrifts to take over sick ones by letting them book "goodwill" as capital, then, after a few years, they took away the "goodwill," declared them insolvent, and shut them down, too.)
Here's how markets work: they go up, and they go down. Why? Because the sometimes go up at a pace above their long-term sustainable rate of growth. In housing, that should be roughly akin to the rate of inflation, discounting extreme supply and demand factors in certain markets like Manhattan. And that rate is about 3-4%.
Well, home prices went up by double digits for several years due to the subprime frenzy and the speculative excess it spawned. Everywhere. Not just in places like Manhattan, but in places where there's plenty of buildable land.
That is a classic example of a bubble. And every bubble demands a correction.
Here's a little exercise for you. Look at the S&P/Case-Shiller Home Price Index for each of the 20 metro markets it covers. Go back to before the housing bubble began, and plot the trendline at the long-term sustainable growth rate for that particular market, whatever it happens to be. Trace it all the way out to the end of 2008.
And you'll find that home prices still have not fallen to where they should be.
"Stop home prices from falling further?" Go ahead and try. Home prices have to fall further, to reach market equilibrium. How is Washington going to stop that from happening? Fix home prices? Say, "You have to buy a house this year, and you have to pay no less than X?"
The day they start doing that, color me gone.
It is both a truth and a consequence that home prices are going to fall further.
"People are losing money in their 401(k)s - we have to do something about that."
I find this almost comical. It was Washington, influenced by businesses, that led the grand exodus from defined benefit to defined contribution retirement plans to begin with. In doing so, they placed the risk directly on the shoulders of the employees.
We took that risk. We make money in the good times, and, unless we successfully rebalance, we lose money in the bad times.
On paper.
Look, if you were planning to retire next year, and now can't, I truly sympathize. I'm sorry you continued to expose yourself to too much risk for your age and life situation, and that you now face the consequences.
But I've had at least two retirees call me to ask if they should move their money. When I asked them what they were invested in, they said they were in a balanced lifestyle fund targeted to their age, invested mostly in bonds, and that it was returning around 4.75% year-to-date.
I told them if they were making money in this environment, they were fine.
But what about the guy who's 30, and fully allocated to equities?
Well, by the time he retires, he'll likely earn the long-term, sustainable historical average that stocks have returned, of about 11%. If he's diversified somewhat into bonds, maybe 8%.
That's more than twice the inflation rate. That should allow any diligent saver to retire comfortably. Only greed could make us expect higher returns than that.
Oh, but we do, because we are indeed greedy. We see those bubbly 25% returns for a couple of years, and it gets good to us. We think it'll go on forever.
See, this is the same story as housing. Only here, the long-term sustainable growth rate is, as I said, about 11%. So let's try the same exercise we tried above.
Go back to before the dot-com bubble, which was inflated by easy money beginning in late 1998, when Greenspan bailed out the Long-Term Capital Management hedge fund (important lesson: bailouts inflate bubbles, and bubbles burst, creating severe corrections). Plot the long-term sustainable growth rate of stock prices - pick any index - from about 1982, when the long-term bull market began, through year-end 2008.
You'll find that when the dot-com bubble began, stocks appreciated at a rate well above what could be sustained. Then it corrected from 2000 to 2002 - hard. But it didn't get all the way down to where it needed to be. Why?
Government intervention. A bailout, again in the form of too-easy money, again courtesy of Alan Greenspan, and again igniting a fresh bubble. This time, in housing.
You'll also find that, even with last week's carnage, the stock market still has not corrected to where its long-term sustainable growth rate would peg it. That level is around 7-8,000 on the Dow, or about 700 on the S&P, or about 1,400 on the NASDAQ.
So we're fairly close. The bad news is, the way corrections work, the market may fall below that mark, then rebound to it.
In the case of stock prices, it is theoretically easier for the government to intervene in a way that props them up, than it is for house prices.
They can simply keep pumping federal money into the economy until growth resumes, and stock prices go up on the prospects for that growth.
But for one thing, that only creates a new bubble. And three massive bubbles in a row, within a relatively short time frame, would totally destroy the US economy, and take the rest of the world with it.
And for another, the theory doesn't work when you're facing a trillion dollar deficit, and when your national debt is approaching 100% of GDP.
You then become a net-debtor nation, and in order to finance all that spending, you have to a) raise taxes by a massive amount, which further depresses spending and investment and causes further economic decline, as happened when Hoover raised taxes in 1932, and b) pay much higher interest rates on government debt you issue, in order to entice foreign investors, who hold the bulk of it, to buy more.
Folks, that is already happening. The ten-year Treasury yield has been rising since the last rate cut. Why? The ten-year note, since it matures in ten years, anticipates future events. A ten-year note trades like a strip of ten one-year bills. And if investors think that bill yields will go higher over the next ten years, they demand higher rates on the ten-year note.
What happens when those rates go up? Well, for one thing, 30-year fixed-rate mortgages are priced off the ten-year. So mortgage rates will go up, even if the Fed cuts the funds target to zero. That won't help solve the housing-led crisis we're in.
Another consequence is that the government has to print even more money, because it's now paying even more in interest - money it doesn't have, because it's still deficit spending. So the deficit gets wider, and that drives rates higher, in a never-ending inflationary spiral.
And they might as well buy every man, woman and child in the country a wheelbarrow in which to take their worthless US dollars to the grocery store.
So here's another truth, and another consequence: when you've enjoyed well-above-trend returns on your 401(k) for several years, you have to expect well-below-trend returns - and probably losses - for a while to get you back on trend. You should plan on the trend, take the good times with a grain of salt, and not worry through the bad times. And, as you near retirement, get out of the risky stuff to an increasing degree.
"We have to keep people from losing their homes."
This is closely related to the home price issue, and I've addressed it before, so I won't belabor it. But here's one important point.
Let's say we're going to pursue the McCain solution of refinancing all the "bad" mortgages into 30-year, fixed rate mortgages at 5.25%. Besides the near-impossible task of finding who now owns all those mortgages, piecing the tranches back together into whole loans, and buying them up - and besides the fact that most of those mortgagors won't be able to make the payments even at 5.25% now - here's the fundamental flaw:
Who will hold the mortgages? Banks won't. They're currently getting more than 5.25% on the mortgages they make. And they're through with making loans to people with impaired credit, who probably won't pay them back.
Investors won't either, for the same reasons. Their risk appetite has waned considerably. And they're back to pricing risk appropriately. So they won't pay par for a 5.25% mortgage-backed bond with a ton of credit risk.
That leaves Uncle Sam - you and me. And that's just what's being proposed. They say we'll ultimately make money on this.
So we're going to accept a 5.25% return on mortgages in a 6%-plus market, with rates sure to rise even further. And suffer eventual default rates that are about what they currently are on the subprime ARMs we're replacing.
Tell me again how we make money on that trade?
Fact is, we don't. We lose on the subsidized yield, we lose even more in a rising rate environment, and we suffer principal losses when they default - which, by the way leads to another glut of foreclosed homes on the market, which creates another overall housing slump.
And the ultimate direct cost to the taxpayer alone will be much, much more than $300 billion.
So, once more, it is both a truth and a consequence that more people are going to lose their homes.
"If we don't do something, people are going to lose their jobs."
Guess what? They already are. And that happens in every recession. Is the government proposing to guarantee that everyone has a job? (Perhaps - the trial balloon of resurrecting the WPA has already been floated .)
Furthermore, about 800,000 people have already lost their jobs since January. If the government spends a ton of money ensuring, somehow, that no one will lose their job going forward, how do they explain the timing of their actions to the guy or gal that got canned in January?
Truth and consequence: more people are going to lose their jobs.
"If we don't act now, more banks will fail."
How many new banks and bank branches have cropped up on every street corner over the past ten years? Can't we live with a few less banks?
Look, bank growth exploded during the housing bubble, because everybody wanted to get into the hyper-profitable lend-and-sell loan game. So it is only a natural consequence that the number of banks will contract when the demand for credit drops sharply.
During the S&L crisis, 747 institutions failed. Thus far in this debacle, 15 have gone down.
The truth is, we have a long, long way to go before we get back to equilibrium.
"We have to un-freeze the credit markets so people will start borrowing again."
Why are so many people whose ARM rates, and thus their mortgage payments, risen, defaulting on the loans?
Because they can't afford the higher mortgage payments when they already have two six-year car loans on brand-new luxury cars they bought with no money down, and several maxed-out credit cards, which combined eat up all of their take-home pay.
As with the banks, we need less credit right now. It is a natural and healthy cleansing of a system that got bloated with greed and excess, which was unnatural and unhealthy. So let's purge it.
More borrowing is not the answer. It's like a glutton who becomes obscenely obese, to the point that he becomes diabetic and has a heart attack.
So the doctors put him in the hospital and work to regulate his blood sugar and do a triple bypass. But they say, "Why, he's become so accustomed to his three milkshakes a day and his quart of ice cream at bedtime - we can't deprive him of that!" So they continue to gorge him. What eventually happens?
Again, I am totally sympathetic to the notion of people losing their jobs, their homes, and a portion of their retirement savings. A big part of the problem, though, is that we focus on those things, and place our faith in dollar-denominated things.
We have survived recessions before. Some of us have lived in poverty. Some of us have survived even worse: the Holocaust, ethnic cleansing in Eastern Europe or Africa, etc.
The key word is "survive." Many who have made it through bad experiences unscathed have been able to do so by placing our faith in the only One that can ultimately sustain us.
But in a nation that increasingly attempts to separate itself from the Creator it acknowledged at its birth, we're becoming increasingly reliant on government - man - to fix things.
And they can't.
The more they try, the worse it gets. So please, Washington, get the message: go home. Visit your constituents. Listen to them, not to your pals on Wall Street. Pay attention when they tell you, "Enough, already!" Then go on a nice junket or whatever you do on your lengthy recesses.
Because the more you spend, the worse it ultimately gets.
The fundamental message is, "We do not have faith in you."
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