The Bottom Approaches

As you probably know I think that 95% of the difficulties experienced recently in the markets is hokum based on the psychology of panic.

The recent panic among the ill educated but greed consumed trader class started with well intentioned mandates which directed the US banks to make mortgages to "red lined" populations.  That might have been harmless in a tightly regulated banking and investment system of systems, but the Bush Administration and their committed anti-regulation friends (in both parties) dumped the regulatory ballast over the side and freed the traders of any restraint.  The result was an orgy of speculative and trading excess in mortgages and mortgage derivatives that rode on a myriad of mortgages in the hands of many who could not possibly pay them off or even pay them at all for very long.

The bubble, like all bubbles, eventually burst, wiping out trillions in paper profits and some peoples' real money.  Confidence in the value of the banks declined following the realization of the potential worthlessness of the paper they were sitting on.  The contraction in credit between banks followed.

The panic in the trader class has been impressive.  It has been pumped up a lot by the trader fringe group employed by the financial media. 

But,  I think the bottom of the panicky slide is approaching.  A fire only burns so long as there is fuel.  The hedge fund managers and other such riff-raff have been busy de-leveraging themselves.  That means that they have been divesting assets in order to acquire cash with which to stabilize the companies that they run.  After all, the life style that enables them to stand at the bar in Ben Benson's and bellow boorishly to each other depends on money in the till.

We are nearing the bottom of the pile of fuel available.  The governments have done everything they could for the restoration of trading confidence.  The stage is set for the moment when investors and traders look around and see that huge, confidence devouring swings in the markets have eased.  At that moment it will be noticed that money is to be made at these prices and the game will resume.  pl

http://www.forbes.com/feeds/ap/2008/10/09/ap5530706.html

Comments

[Shrike58]

One would hope. I'm still waiting for at least one more freaky move from out of left field. Maybe Iceland declaring bankruptcy.

[Lawyer Smith]

The red line loans you speak of only comprise app. 3% of the pile of bad mortgages and debts - (that's assuming every such loan under this mandate failed, as that was how many Fannie and Freddie handed out compared to the rest of their loans). 97% are the flipper class who took ARMs, borrowed on equity they presumed would be there when they sold the house in a few years. The few years then flip crowd, an economy based on raising market value beyond reason was the "bubble" that burst. ABC News has been profiling people who defaulted and they are yet to produce anyone scammed into this problem. Every person has been middle to upper middle class house flippers who got caught with an ARM raise they knew they could never afford when they entered the deal. Accuracy is important.

[William R. Cumming]

Respectfully disagree. Domestically within US markets yes, but foreign markets have plenty of fuel left to burn which in turn may heavily impact domestic markets. If regulation domestically is almost unknowable as to its management and secondary and tertiary impacts, imagine that even more so with respect to foreign governments and entities.

[Patrick Lang]

Lawyer Smith

Ok. A lot of yups piled on.

[Fred]

The new myth is that this was a Freddie/Fannie created crisis. They are neither the sole nor the major cause. The hedge funds and multiple financial derivatives are far more complicit in this than Freddie/Fannie.

On a humoursous note, you could see the handwriting on the wall 3 weeks ago:

http://208.7.160.123/money/2008/09/17/2008-09-17_hard_economic_times_hits_the_high_end_gi.html

[Cold War Zoomie]

My prediction for the DOW was 9,000 a few days ago.

A little more to go.

But I think the stock market will basically bounce around for a year while the housing bubble finally deflates completely and Wall Street toxins are flushed out of the system.

My WAGROM (Wild Ass Guess Rough Order of Magnitude) is DOW bouncing between 8500 and 10500 for all of 2010.

You all heard it here first. Invest accordingly!

[Dave of Maryland]

95% of it hasn't got here yet.

[charlottemom]

I agree that panic is being spoon fed to the public from Cramer screaming "sell stocks now" on tevee to frozen LIBor rates scrolled on CNBC non-stop, Paulson/Bernanke at the helm making ad hoc decisions regarding markets, etc. Now the G20 to meet over the weekend (currency crises?).

You rightly point out that insolvent banks indeed got into trouble because of greedy leverage during the speculative bubble. But our citizenry also displayed greedy overleveraged behavior as did the old U.S. of A. (compounding on our natl debt is staggering)

We in Charlotte are seeing Wachovia carved up and Bank of America-Countrywide-MerrillLynch in trouble. It does mean lost jobs, falling real estate, loss of tax revenue etc. for those outside the banking industry, so it's not just the yuppies hurting.

I see many federal schemes to inject more and more credit into the system - loan rates dropping and attempts to revive credit markets. "They" seem desperate to keep this credit bubble going while countries, consumers, etc. are choking on peak debt. Is the solution to the cash starved, over-leveraged more debt? Is it in the interests of Main Street to work to prevent a bottom in various asset groups -- equities, housing? I don't know, but without a true housing bottom, will there be a real recovery? So I believe at best we get a short-term bottom.

With regard to the game resuming, what game that will be is the question? Many I know in banking and hedge funds are moving to private equity companies -- they've got cash and they're hiring. I know, no one crying for the yuppies, but many in finance are repositioning themselves for a different economic landscape than we currently have - will it be better or worse? Our current global economic system is changing -- maybe helped along through a bit of economic creative destruction. Yes, eventually, things will normalize, but what will this new "normal" be. I do agree that those (companies, countries, individuals, whatever) with cash will set the terms.

[John Hammer]

Dave of Maryland,

"95% of it hasn't got here yet."

Does that mean the Dow will go below zero?

[Nicholas Weaver]

My thought: The general market is irrational.

But smaller markets with primarily intelligent players are far more rational. The key I believe (as do many others) is the TED spread: the rate at which banks will lend to each other for a 3 month term, minus the 3 month treasury rate.

I've been ignoring the panic on the stock market. But the panic AMONGST the banks is palpable: NO bank trusts any other bank. And as long as that remains, the credit market will remain troubled.

[b]

Disagree with you Colonel.

This is far from over.

With the real economy now tanking profits and profit expectations will be cut. The result is lower fair value which is not yet reflected in the stock markets.

In the unregulated "shadow" financial markets there are still trillions of "insurances" CDS that need to be solved (declared null and void by the authorities) or will explode.

The bond market is under extreme stress and could dislocate pushing interest rates significant higher (the treasury yesterday had a bad auction paying 0.4% more than was thought).

Higher interest rates would again put any more homeowners into foreclosure.

There are so many things now that can go wrong that some will go wrong.

This is far from over.

[zanzibar]

"Red lining" based on the CRA was really a tiny portion of the total mortgages issued. When one looks at the relative sizes - sub-prime of which CRA loans were again a very low percentage was much less than Alt-A which was less then near prime and Jumbo. Additionally delinquency rates of CRA loans are much less than the rest of the pile. CRA had nothing to do with Fannie/Freddie buying private label MBS & CDOs in the market and ballooning their balance sheet post the dotcom equity bubble unwind. Personally I think CRA is a convenient political excuse that some are using to justify the why financial institutions were "forced" to make such economically misguided loans.

IMO, the root of the problem was the easy money policies of the Greenspan Fed along with a Pavlovian conditioning that the Fed will always bailout market participants with the "Greenspan Put" as well as the elimination of the capital adequacy rules for Wall St pushed by the likes of Hank Paulson and acquiesced to by the SEC in 2004. This then needs to be put in the context of the prevailing Wall St culture of earnings growth beating quarterly expectations and executive compensation that focused on the goosing of stock prices in the short term. Wall St transformed itself from being an intermediary of capital to a "profit machine" on the back of securitization and the proprietary trading of securities all based on increasing leverage. In many ways the train left the station in the Reagan 80s. But it was in the 90s and the Clinton era with Bob Rubin & Greenspan tag teaming for the administration and Phil Gramm, Barney Frank and other Wall St water-carriers on both sides of the aisle in Congress that we really set the stage for the bubbles. The corporate media is finally getting to the edges of the story IMO.

Simplistically speaking, Wall St took $1 of a mortgage written on the basis of lax lending standards (meaning broke every common sense rule) packaged several of them into a MBS, then levered it up 20 times and made a CDO, then packaged several of these CDOs and levered that up 20 times into a CDO Squared, packaged several of these together and levered that up another 20 times into a CDO Cubed. Each of these securities were then traded back and forth with even more leverage by hedge funds on the basis of securities credit from the very same Wall St firms. The ratings agencies were "bought" into this so that pension funds and insurance companies could buy into these leveraged securities. And then add to all this leverage Wall St came up with insurance called CDS that would pay out in the event any of thse securities defaulted. Folks like AIG happily wrote plenty of it with no capital reserved. And why did they call it a swap not insurance because then it could be traded unregulated (meaning no capital adequacy rules) over the counter. None of this had anything to do with CRA. This was pure speculation and a gigantic Ponzi scheme aided and abetted by politicians from both parties and the regulators. The winners were Wall St executives who paid themselves hundreds of billions in bonuses each year and hedge fund managers who became billionaires by the boatload. Today middle class Americans are holding the bag. Yet there are no calls for grand jury investigations, clawbacks from these guys and how was our political and regulatory system corrupted.

This bubble was the most well publicized financial bubble in recent memory and the nature of the current debacle was also predicted by many. No one should be surprised.

No doubt this will also pass. But if we don't any learn any lessons as we have not over the past 30 years then we will continually get even worse outcomes. We will now have to face the outcome of the unwind of the credit bubble that will include the loss of confidence in the US central role in global finance and the pain that middle class America will feel. Tragic!

[Curious]

http://www.nakedcapitalism.com/2008/10/money-markets-still-frozen-dollar-libor.html

Money Markets Still Frozen, Dollar Libor Reaches New High

Over the last two weeks, we have said that central bank liquidity measures had become counterproductive. Throwing more liqiudity at banks made it more viable for them to depend on monetary authorities and not rely on private sources for funding, and in turn extend credit to them.

The cost of borrowing in dollars for three months in London soared to the highest level this year as coordinated interest-rate reductions worldwide failed to revive lending among banks for any longer than a day.

The London interbank offered rate, or Libor, for three-month loans rose 23 basis points to 4.75 percent today, the British Bankers' Association said. That's the highest level since Dec. 28. The Libor-OIS spread, a measure of cash scarcity, widened to a record 350 basis points. The overnight rate fell 29 basis points to 5.09 percent. That's still 359 basis points more than the Federal Reserve's target rate of 1.5 percent.

(Must listen radio show. basically explaining current crash)

http://audio.thisamericanlife.org/player/CPRadio_player.php?podcast=http://www.thisamericanlife.org/xmlfeeds/365.xml&proxyloc=http://audio.thisamericanlife.org/player/customproxy.php

[m savoca]

Colonel Lang

in my opinion the panic in the markets is NOT 95% hokum

rather the sell-off reflects the termite ridden underpinnings of an economy that has increasing become divorced from necessity.

the vast majority of Americans do not save...and quite the opposite more than half of all wage earners have a negative net worth

corporations that used to be the bulwark of the us economic system have insufficient cash flow to manage payrolls and inventory without floating short term paper (debt) the in CP and repo market.

on average in the last 7 years the federal government has spent nearly half a trillion, dollars per year more than it takes in from taxes / revenues

our balance of trade is entirely out of wack, we buy more than half a trillion dollars more goods and services from the rest of the world than we sell them, and nearly half of that is energy.

finaly most of the highest paid, richest people in America, hedge fund managers and Investment Bank top management don't produce anything of value, they play numbers games with financial paper, creating SIVs (structured investment vehicles) that spread sub investment grade debt mixed in with triple A ,infecting the financial markets.

These same people have created a derivatives market, essentially a casino, (pozi scheme built upon the toxic securities), which has a notional value of 750 trillion dollars, more than 10 times the worlds GDP.

we are in serious serious financial and economic crisis, and it is likely that we will see 10s of millions of Americans loose their jobs and their houses in the next few years.

the vast sum of observations and opinion you present on your blog are very incitefull and i have learned much from you, i am in your debt.

on this matter Colonel Lang you are wrong.

you can prove to yourself that subprime has little to do with the crisis...how? the 700 billion bailout is enough money to buy all the foreclosed subprime houses outright lock stock and barrel leaving half a trillion dollars left over !!!

a strong economy and financial system could and should handle a problem like this with barely a whimper

the real problem is the cascading default of the casino derivative bets like credit default swaps the investment banks created and bet on, to make outrageous paper profits...and now loses.

[zanzibar]

If this and this becomes a trend then the marginal buyer of Treasuries may not lift a bid. The unintended consequence of this deleveraging could be the toppling of the TBond edifice.

[Frank]

Over the past twelve months or so we've gotten news that shakes the underpinnings of ones life.
We learned that cholesterol has less, if anything, to do with heart problems than we'd thought. So a lifetime of avoiding fatty foods was built on a lie. We also learned that the myth of drinking eight glasses of water a day was founded on nothing and that put the lie to the 1990's utterance that “the important thing is to stay hydrated” . And so it went. One by one the pillars of life have fallen.

Some other events that have shaken the philosophical foundation of some lives were this pair regarding the Communists party in the USA:
“Two international events of 1956 brought new chaos to the Party: the Soviet suppression of the Hungarian Revolution and revelations of Stalin’s misdeeds at the Twentieth Soviet Congress. Individuals long faithful to the Party now felt betrayed and wondered privately and openly if their political lives had been built upon self-delusion.”
http://www.marxists.org/history/usa/parties/cpusa/encyclopedia-american-left.htm

And now the underpinnings of many Republicans, deregulation and the free market system have been exposed via the current market situation and subsequent credit freeze.
So just as it has been hard for me to begin eating fatty foods because I just can't believe that a lifetime of self denial has been for naught I imagine that Old Commies found some sort of rationalization to help cope with such a devastating revelation.

I'm not surprised that the free market/deregulation true believers have come up with something to blame for the apparent failure of their core beliefs. I believe that you are referring to the Community Reinvestment Act when you mention redlined areas and that argument is being thrashed out now.

I've read several postings by Barry Ritholtz of “The Big Picture” such as this one ( http://bigpicture.typepad.com/comments/2008/10/federal-reserve.html ) and it seems pretty hard to build a case for that assertion.
I may be incorrect that you refer to the CRA and if so apologize in advance.

[Curious]

These are the logical things that needs to be done. But it means massive haircut in part of the bankers. (ie. not going to happen)

Therefore: market will keep selling and continue the credit collapse.

http://www.forbes.com/home/2008/10/08/recession-depression-keynes-oped-cx_nr_1009roubini.html

Policy rate cuts will have a limited effect as they don’t resolve the fundamental problem in markets--massive counter-party risk--that is keeping money-market spreads relative to safe rates so high. Yesterday’s plan to support the commercial paper market is a step in the right direction, but other, more radical policy actions are also needed now. Here are four suggestions for such additional policy action.

--To reduce the counter-party risk in the money markets, a triage between insolvent banks that need to be shut down and a recapitalization of solvent banks is necessary, together with massive injections of liquidity in non-banks and the corporate sector. Direct lending by the government to small businesses--via the Small Business Administration--is also necessary to avoid the implosion of smaller businesses.

--A generalized temporary blanket guarantee of all deposits is now necessary, both in the U.S. and in Europe, followed by a triage between insolvent banks to be closed rapidly and illiquid-but-solvent banks that deserve to be rescued to avoid the moral hazard of such blanket guarantee.

--The flawed $700 billion Troubled Asset Relief Program (TARP) legislation will have to be modified in three ways to: a) allow for direct government injection of public capital in banks in the form of preferred shares, matched by private capital contributions by current shareholders (via suspension of all dividend payments and matching Tier 1 capital provided by private shareholders); b) implement a clear plan to reduce the face value of mortgages for distressed homeowners and avoid a tsunami of foreclosures; c) do a rapid and radical triage between solvent banks and insolvent banks that need to be rapidly closed.

--Given the collapse of private aggregate demand--consumption, residential investment and non-residential investment in structures are falling, and capital expenditure by the corporate sector was falling already before the latest financial and confidence shock and will now be plunging at an even faster rate. You need to give a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade-long stagnation.

[Cieran]

Colonel:

I must protest your use of a picture of a Longhorn as the lead image in this post.

Given the importance to the college football world of the Oklahoma-Texas game in Dallas this weekend, it would seem that your neutrality in this matter has been compromised via this ostentatious display of Bevo, the UT/Austin mascot.

Or is this your subliminal manner of making yet-another prognostication? Are you engaging in some form of speculation yourself regarding the outcome of the Red River Shootout?

I predict the Sooners win this by 14, that oil continues its downward price slide, and that the stock market has not yet reached its true bottom.

But I'll settle for just getting the first prediction right...

[Frank]

Over the past twelve months or so we've gotten news that shakes the underpinnings of ones life.
We learned that cholesterol has less, if anything, to do with heart problems than we'd thought. So a lifetime of avoiding fatty foods was built on a lie. We also learned that the myth of drinking eight glasses of water a day was founded on nothing and that put the lie to the 1990's utterance that “the important thing is to stay hydrated” . And so it went. One by one the pillars of life have fallen.

Some other events that have shaken the philosophical foundation of some lives were this pair regarding the Communists party in the USA:
“Two international events of 1956 brought new chaos to the Party: the Soviet suppression of the Hungarian Revolution and revelations of Stalin’s misdeeds at the Twentieth Soviet Congress. Individuals long faithful to the Party now felt betrayed and wondered privately and openly if their political lives had been built upon self-delusion.”
http://www.marxists.org/history/usa/parties/cpusa/encyclopedia-american-left.htm

And now the underpinnings of many Republicans, deregulation and the free market system have been exposed via the current market situation and subsequent credit freeze.
So just as it has been hard for me to begin eating fatty foods because I just can't believe that a lifetime of self denial has been for naught I imagine that Old Commies found some sort of rationalization to help cope with such a devastating revelation.

I'm not surprised that the free market/deregulation true believers have come up with something to blame for the apparent failure of their core beliefs. I believe that you are referring to the Community Reinvestment Act when you mention redlined areas and that argument is being thrashed out now.

I've read several postings by Barry Ritholtz of “The Big Picture” such as this one ( http://bigpicture.typepad.com/comments/2008/10/federal-reserve.html ) and it seems pretty hard to build a case for that assertion.
I may be incorrect that you refer to the CRA and if so apologize in advance.

[Paul]

A friend of mine allowed his company to be controlled by a venture capitalist who had taken a majority position on the promise of the company’s underlying technology. The technology did not pan out so after a couple of years, the VC put the company up for grabs. When my friend had the opportunity to buy back his former company, he asked me to have a look at the purchase agreement. That agreement was a three page document that treated the sale of the company, the underlying technology, and the entire purchase in terms equivalent to the sale of a carload of potatoes. No due diligence, no intellectual property (and rights) questions, no NOTHING. The simplicity and irrelevance of the proposed sales agreement astounded me. It came from a Wall Street investment bank, and the guy handling the transaction could not and would respond to any question nor would he provide any information beyond that within the four corers of the document. He was just the “processor”!

That experience foretells – at least for me – what is in store.

IMHO, the bottom of the credit crunch and the Wall Street mess will not soon pass. It is 10 to 15 years away from resolution. The laws and regulations of every state distinguish between the sale of chattels (stuff) and real property. Though Wall Street sold these basic instruments and the “swaps” harmonics as commodities, unwinding and reselling individual mortgages (and real property) will be complicated, time consuming and expensive. An army of bankers, lawyers, escrow agents, appraisers, lenders, loan processors and bill collectors will make fortunes, and none of them will be inclined to speed things up. Kiss the $700 Billion goodbye!

[Mad Dog]

Want my advice?

You might buy carrots instead of carats.

[Strudel & Shotguns]

Bottom? DJIA closed down 678 points today. You also wrote in this space that Hillary would be the next president and that you'd be glad to see the adults in charge again. Building castles in the sky, are we?

[Patrick Lang]

S&S

Come on!! You know better than that. The bigger the final fall the better. There probably will be some more big falls.

Now, don'y jump. It isn't that bad. pl

[Patrick Lang]

S&S

I don't think I ever predicted that HC would be president. What I said was that I wanted her to be president. I still do.

You still don't get the difference between wanting and predicting? pl

[eakens]

you are right PL. The key is to buy up companies with little to no debt and a mountain of cash.

That's the play.

As for stuff out of left field -- GM will cease to exist in its current form. they have $20B in cash and losing $1B/Month and have $40B of debt and in this market nobody is going to loan them anymore.