Open Hatch

Archive for the ‘Money’ Category

That statement is mine, and it’s a conclusion I draw (again), after reading this, from an article entitled “Reckless Myopia”:

We face two possible states of the world. One is a world in which our economic problems are largely solved, profits are on the mend, and things will soon be back to normal, except for a lot of unemployed people whose fate is, let’s face it, of no concern to Wall Street. The other is a world that has enjoyed a brief intermission prior to a terrific second act in which an even larger share of credit losses will be taken, and in which the range of policy choices will be more restricted because we’ve already issued more government liabilities than a banana republic, and will steeply debase our currency if we do it again. It is not at all clear that the recent data have removed any uncertainty as to which world we are in..

Andrew Smithers, one of the few other analysts who foresaw the credit implosion and remains a credible voice now, concurred last week in an interview with my friend Kate Welling.. “The good news so far is that the stock market got down to pretty much fair value or even, possibly, a tickle below it, at its March bottom. But now it has gone up… we probably have a market which is, roughly, 40% overpriced. In order to assess value, it is necessary [to speak financial Vulcan about two different stock market valuation methodologies].. The validity of both of these approaches can be tested and is robust under testing – and they produce results that agree. Currently, both q and CAPE are saying that the U.S. stock market is about 40% overvalued.”..

One of the fascinating aspects of the past few months is the lack of equilibrium thinking with respect to what happened to the trillions of dollars in government money that has been spent to defend the bondholders of mismanaged financial companies. Almost by definition, money given to corporations will show up most quickly as improvements in corporate earnings, and then slightly later, as executive compensation. A few pieces came across my desk last week, hailing the ability of the corporate sector to bounce back from the recent economic downturn even though revenues have continued to suffer and employment has been steeply cut. Why is this a surprise? Where else could the money have gone? Labor compensation? It is truly mind-numbing that a moment after a temporary surge of trillions of dollars, borrowed and tossed out of a helicopter (though to specific corporations and private beneficiaries), analysts would hail a subsequent improvement in corporate results as evidence of “resilience.”

Since early 2008, beginning with the provision of non-recourse funding in the Bear Stearns debacle, the Federal Reserve and the Treasury have repeatedly allocated or implicitly obligated public funds to defend the bondholders of mismanaged financial companies. This has included the outright and non-recourse purchase of nearly a trillion dollars in mortgage securities that have no explicit guarantee by the U.S. government. By purchasing these securities outright (rather than through a well-defined repurchase agreement), the Fed is effectively obligating the U.S. government to either guarantee them or to absorb any future losses.

Aside from the fraction of bailout funding that was specifically allocated by Congress through legislation, these actions represent an unconstitutional breach into enumerated spending powers that are the domain of the elected members of Congress alone. The issue here is not whether the Fed should be independent from political influence. The issue is the constitutionality of the Fed’s actions. The discretion that it has exerted over the past two years crosses the line into prerogatives reserved for Congress. That line needs to be clarified sooner rather than later.

Emphatically, the trillions of dollars spent over the past year were not in the interest of protecting bank depositors or the general public. They went to protect bank bondholders. Instead of taking appropriate losses on those bonds (which financed reckless mortgage lending), those bonds are happily priced near their face value, for the benefit of private individuals, thanks to an equivalent issuance of U.S. Treasury debt. But that’s not enough. Outside of a very narrow set of institutions that are subject to compensation limits, just watch how much of the public’s money – which benefitted several major investment banks following a very direct route – gets allocated to Wall Street bonuses in the next few weeks.

I find this simply scary.

The past few days, the Philadelphia Bank Index (which allegedly “leads” the markets) has been dramatically declining in comparison to the S&P 500 stock index, which has been making defiant yet pathetic attempts at remaining bullish. At the same time, volume is declining sharply – big money is selling out of large positions (and buying up hedges, and loading up on option puts, which profit from declines). Banks decline, prices expand, volume contracts – the whole picture is undecided – or maybe decidedly tearing apart in several directions. Something has to give – and today the S&P finally started to drop fairly quickly at closing.

I have speculations in the market turning down (even sharply). And I still think it will. Watch the TZA ticker, which goes the opposite of the S&P, times 3 (meaning UP three times as much, I’m hoping). I’m banking on it taking an upswing or spiking, to above 13.35, by Dec 19th.