The American financial system's problem . . . in a nutshell, is not merely 'liquidity' as often debated or trumpeted (whether you listen to bearish or bullish arguments on the subject, because leveraged derivatives open superficial basics to real debate with limited understanding that 'real liquidity and reserves status' varies vastly within some cases; even within various sectors such as brokers, banks, integrated financial firms, or other institutions; with hedge funds not to be overlooked; much less insurers etc). It's rather a more direct evaluation: solvency of mortgage loans or securitized debts.
Efforts to stabilize the banking system are not extraordinary; they are essential and in that regard are the primary mandate of systemic functionality that's engaged the Fed. Federal Reserve liquidity injections are normal (some are actually seasonally notable; like around the holidays); but they do little or nothing to eliminate the problems many are appropriately worried about as relate to the housing situation or recession risks.
Hence; there are really no extraordinary measures to 'bailout' anyone (on either side, by the way of the lending/borrowing ledger); while the Treasury's plan for resetting or avoiding the foreclosure tsunami we warned of for many months; may be too little too late; or too convoluted and open to interpretation to mitigate the overall economic risk for the Nation (which generally is already slowing; while some argue Wall Street's just talking the Country into a needless recession; which is nonsense since all the tighter, and sober, lending policies which negate availability of 'easy money' have nothing to do with Wall Streeter's cajoling for the downside so as to enhance their short position holdings). Au countraire; the majority on the Street desire the opposite, and pressed a reluctant Government to interfere in areas they'd normally prefer 'gaming' avoided.
Not to challenge any of those arguing Wall Street creating non-existent pressure, but the reality is that these typically are the same pundits who felt subprime was a small and irrelevant area that couldn't have spillover effects into the general economy. We tended to think they were myopic then, and they remain unenlightened about extents or impacts of slow housing and (ripple effect) ancillary business environments now.
At the same time, we suspect (given the contraction of manufacturing prowess and a slew of outsourcing trends that were unmitigated for too many years), that the Fed as well as Treasury already know there is no viable alternative to reflating once more, as there is little else to be done, over the short run. However even if we liberate all those who plundered the necessary reflation of a 2001-2002 'crisis' beyond common sense; there will be a period of time for the next go-round (more in our audio remarks) to just take hold. That lead time will enable banks to re-liquefy, and essentially hand them at least a pile of profits (in 2009-'10 particularly; but the trend will commence next year it seems to me) that they may not deserve but will obtain. Reform will concurrently be a footnote to all this; though some of it will make it tough to endorse rampant borrowing or lending. One of the real keys will be whether they reform 'leverage' within banking, and related fields, themselves. That's a topic that's hardly heard by financial reports. I suggest that the financial media broach this subject more candidly (it seems like they address everything important; but rest assured they're trivializing or skipping over the heart of the matter as relates to 'why' the banking losses are as colossal as they are).
The heart of reform may lie in this area, which if not overused, would have avoided -it seems to this observer- the waivers of Fed reg's that some major institutions needed (so as to shore-up their net capital or reserve requirements; again, little reported on). Ultimately, there is a very litigious situation shaping-up; separate from reform issues. The credibility of rating agencies and 'packaged' investment products might resemble a common perception about the integrity or ethics of some gov'ment officials, even. It does not argue well for an unbridled free-reign on investment structuring, leverage or even other aspects for years; much less globalist extremists playing citizens for fools (ie: free fair trade fine; we're not protectionist: but free trade needn't mean no policy).
Daily action . . . thus derides courteously those continuing to minimize the impact on economic contraction of the 'grinding' mortgage mess and housing stagnancy called-for commencing well before this year, but with the overt societal impact commencing in this year, as mortgage resets became a problem. All along we've indicated that the 'cresting' of just the 2006 loans resetting, wouldn't occur until Feb/Mar of 2008; so we felt continuously there was no reason for debates as to whether the worst was ahead.
So that of course is why Treasury and others are trying to cobble-together something, after the fact for the most part (though the cresting is ahead; the time to intervene for sure was when I argued it months ago during which point even state & local officials, to some extent, could have been more helpful if they 'got it' then rather than waiting. I think that is doubly so for Federal officials, because this wasn't a hurricane you can't truly address until it hits. This was one that showed up on the 'economic radar' years, really, in advance, so thus there was no excuse for the abuses; the investment grade ratings absurdity; or even the deferral until now for figuring out what to do about all of the pending defaults. What we hear (this week) leaves it open for debate with respect to becoming a political football, and even a litigious issue, given that the methodology isn't across-the-board, but tries to be arbitrary (discriminatory?) towards certain loans where 'ability to pay' is or isn't an issue. That means re-approval essentially; and that is a non-starter ('code' term?) for almost all speculators (non-owner-occupied), and at least a segment of hard-working regular families who would argue there's no logic for them to sacrifice more than their neighbors in terms of sustaining upside-down loans.
Weighing-in on the 'scare tactics' alleged by some columnists by Wall Street: really it is the opposite that is the case. Most have been minimizing the risk to the economy in various ways; typically by suggesting all this happens in isolation to general activity (it is especially the case where one old sage wrote thusly in the New York Times, after a few months in which Mr. Stein meant well, but misjudged the impact on the economy overall). What we heard from Sec'y. Paulson was not systematic enough to work fast enough; given the proximity of the tsunami. We hope they can; but remain skeptical.
Our view's been that the Fed's actions primarily were addressed at systemic liquidity, not housing resurrection. The Reg 12 waivers were dubious; and prolonged the issue of course (though at risk to other aspects of the banking system). You now have what I described as a threatened 'run' of sorts on managed pension assets in some states such as Florida, which we forewarned of in-particular (the highest levels of authority knew directly our views). Sec'y. Paulson admitted just in this week's remarks, if your ears perked-up, that the overall situation's bigger than at this point what Government can deal with readily, and that they're still trying to come up with the approach (hours after his formal statement). Both points concur with what we've been saying. 'Rolls to play', is not the same as knowing a script or seeing how the performance is reviewed. It was somewhat a multifaceted 'tap-dance' talk. Also believe it won't even rescue the needy; seems more like a invitation for arbitrary and discriminatory debate, as it culls-out those who qualify or don't; and leaves unanswered who even owns the loan now.
The Oil of this economy is of course oil; but when it becomes housing; it's the banks. It is a (structure and prospect reserved for ingerletter.com members) for a reasonable probability of success. It's the real estate equivalent of catching (more for members). After all, in housing more so than in stocks, there is little risk of inventory evaporating instantly. Continue to suspect we have to unwind more (the extent is projected here).
Finally; we won't get into comparisons with Northern Rock; or Countrywide's survival. And we won't get into the brilliance of Glass Steagall, even though others bemoan it. But we still expect more builder defaults and bankruptcies, if not even some banks, in the course of completing this bearish financial de-structuring. And by the way in 1929 bank debacles some say began in England, not here; but spread. There were varying versions of a 'credit bubble' that popped, with a strong rebound then disaster. I think the Fed (and Treasury) actions mitigated some worst-case outcomes, but I also think that freezing some rates; cutting other rates; maintaining the system; might avoid the worst-case outcome, but will not amount to an instant oil and refueling pit-stop as yet.
To wit; financials and banks are the service stations to empower housing vehicles but that capital flow will be impeded (timeframe projected) as argued consistently. I'm not concerned about 'sunset provisions' on subprime quotas while focused more than the financial press on how this has little to do with the real dearth of new money available to grease the gears of a housing revitalization. So, all you're hearing about may help some people stay in their homes; but won't engineer a bottom for housing prices; and that's essential before the machine's re-empowered. I believe it happens, but slowly at first, and maybe [reserved for members] years from now aggressively. (Of course it could be sooner or later; but won't be immediate just as rates come down or some families are saved from the perils of unsavory mortgages.)
Summary: again emphasize that without credit expansion underpinning at least some of the SIV's from further leaks (and accordingly some of the lenders just a bit); it's little more than a non-starter for economic recovery. Yes, a stepping-stone as at least the necessary direction; but doesn't address 'structured to fail' deals; marketed incredibly irresponsibly; as well as retained by some banks and brokerages for their 'house' accounts as well. This is the part of the issue we honed-into tonight as well.
It was symptomatic of greed, and the culmination of the projected multiyear reflation we outlined as coming starting in mid-2002; and also kept us robustly bullish until late 2006. It is the question of where this projected 'Chinese Water Torture' from July's high takes us over time. that is a question; as I don't expect sustainable improvement on a dime. Keep these things in mind irrespective of (absolutely helpful to those right in the middle of the perfect storm) ruminated plans to 'freeze' subprime loans from an imminent indexing to levels that would displace many folks given truly realistic equity levels, in the wake of the forecast 'ripple effects' (which are ongoing) from housing:
· Low or no growth in the economy is feasible for much of 2008; in any event pulling already-ludicrous arguments (we've said that since July) for multiple expansion (it should be noted you do get a higher multiple when earnings diminish but price lags in terms of catching-down with reality) entirely;
· there is a mosaic which enhances the core problem liquidity; but doesn't replenish issues more than what we've alluded to;
· comparisons with other historical (even hysterical) periods of headwinds, economically, where interest rate cuts had a 'lag' before truly reversing the slide (that many don't acknowledge but ongoing in key parts of the Nation);
· job losses are a continuing 'given' for the near-term; media does disservice tying robust shopping season with U.S. prosperity; as a healthy saving's season may be a better prescription for domestic consumption addiction;
· ripple effects and concerns are not related to 'fighting the Fed', but rather to realization the debt-bubble (overall) is gargantuan, thus doesn't lend itself to simplistic solutions such as some pundits and economists suggest, so;
· lots more has to be done in terms of coordinated efforts beyond mere rate cuts. We favor going easy on Funds cuts; while opening-up the Discount Window further; similar to what I correctly forecast before the first cuts;
· don't overlook eventual significance of China's policy shift outlined last week; they are probably posturing against Taiwan's sub-NATO affiliation;
· just because we noted lower hedge shorts 10 days ago and prospects for rebound efforts, that doesn't mean the overall challenging period of duress won't evolve over time. Yes; in time anticipate (price levels for members).
Again; the battle is not about rates (that's noise really because they weren't high); but structures of inverted yield curves that contributes to credit freezing unless addressed which the Fed is actively engaged in doing. However, while defrosting the freeze, that is not going to be a panacea. As we've opined for many months; everything the Fed's doing is aimed as maintaining liquidity in the banking system and ameliorating 'panic'; not restoring an insane 'fix' to consumer desires to support consumer addictions, that largely occurred on-the-backs of credit availability (or credit lines) as are evaporated.
For sure; savings won't revitalize everything immediately; but it will help America for down-the-road solutions a good bit; which simple rate cuts to spur consumption don't. Risks disaster, as with much of consumption based on the (historical) anomaly of the 'housing and credit bubble'; it's disingenuous for media, government, or municipalities encouraging people going into debt, because it's hard enough migrating tough times.
Summary: Are we position short this market? Index-wise yes; practically no some days as outlined (but making the position guideline point to represent concern beyond prior logical rebounds); common stock wise, no. Holding an S&P guideline short from S&P 1585. Were and are candidly suspicious of recent forecast thrusts higher beyond general levels outlined in audio-video 'chart' comments for now.
Bottom line: signs as we interpret them, included the (slightly updated tonight) following bullet points:
· Fed's Janet Yellen affirms our concern about economic risk remaining particularly high now;
· England's MI5 issues warning to firms in GB about Chinese state-sponsored web espionage;
· Rumors of high-risk terrorist penetration across U.S. border per BOLO's to law enforcement;
· Continued and unusual (fuel etc.) resupply to US Navy facilities in the Persian Gulf region;
· This accelerated after the White House knew about the latest 'intelligence' summary on Iran;
· By the way Iran 'halting nuclear work' was from spurious source; may not reflect reality;
· Do not forget the risks to reinsurers; pensions; even municipalities; as this is a bit colossal;
· Add concern about Commercial Paper holdings or even money funds not in Gov'ments;
· Dollar likely bottomed (starting) as forecast (prior weeks); at least temporarily;
· Debt issues are not resolved; massaging of every aspect being attempted as 'they' best can;
· Subprime bubble forecast to burst was a microcosm of bigger issues clearly not resolved;
· Institutional debt issue; housing; commercial property bubble bursting; are all 'acts in motion';
· Does this coincide with problems related to commercial property, generally yet to implode;
MarketCast (intraday analysis & embedded Daily Briefing audio-video). . . remarks continue our guideline position-short from 1585; as intraday guidelines primarily on long side; though anticipating moving back to short-side into semi-blowoff strength. It is an honor to have predicted virtually all this (particularly subprime as microcosms of bigger issues; not the sole issue itself, which was massive 'junk debt'). (More.)
Key credit or derivative issues are not ameliorated, as projected Fed actions were, though 'structuring' does move toward improvement, essentially 'pushing on a string'. That's a different issue then just stemming a tide. The Fed is treading maturely, and doing the right thing. We are hardly yet out of the woods with respect to housing; or debt or war issues. Important: a Fed 'staying ahead of a situation', isn't preventing it. At this point; as argued for months; it would not help if rates were at 1% if loans aren't available to the masses; as they are not. Consumer credit and plastic are likely next.
Bits & Bytes . . . provide investors ideas in a few stocks, often special-situations, but also covers an assortment of technology issues (needed for assessment of general factors in tech overall, or as compelling developments call for) that are key movers in the NDX, SOX or S&P, plus ideas ingerletter.com thinks might merit further reflection.
--
Slow growth has likely descended into recession; of course that fear prompted what the Fed did, inline with expectations (and a tad more), albeit with a bigger reaction to it. Our 2007 view has been that we're in an ill-defined recession; likely recognized if at all, only later. As to whether it descends into something like post-railroad debacles of the 1880's; well in-part it's what the Fed worries about. Regression to the mean and traditional affordability 'rules' will be hallmarks of lending guidelines for a while.
McClellan Oscillator finds NYSE 'Mac' fluctuating via intervening bull-bear shuffles on the NYSE and NASDAQ. Reflex rallies allowed 'risk off-loading' tactics; many of the 'Street' debt holdings aren't investment grade. Multi-month efforts are evolving. In this regard, we suspect that strategy is fluctuating with the markets; trying to salvage attractiveness of structured-to-fail creative financial paper. So many of the analysts are 'volunteering' what bargains financial firms now are; makes it dubious even as of course they rebound; much of which is based on speculation about consolidation(s).
Issues continue including oil, terror; China, Pakistan (possibly the key to survival for a number of aspects of the 'war on Terror'); certainly all the Middle East, Russia and yes, a hangover of funny money NY economics. Includes international dependency.
Fears are rising in the credit markets that the turbulence could last for months as big US & European banks come under pressure due to losses in US mortgage securities. The 'cover' of strong economic activity masks the greatest credit bubble ripple effect risk since the 1907 Panic, if not the 1930's. The similarity is somewhat like I recall in the 1880's when the 'railroad' bond debt fiasco took the Nation into a situation taking years to recover from; more so than the 1990 banking mess that led to mergers and a rebounding stock market (though there are similarities, and this isn't going to yield easily). Frankly, though trading opportunities expected; folks will pay for real growth; it will often be smaller domestic stocks, nominally big-cap multinationals or financials.
As this evolves, we forecast the market might become more volatile, rather than less so, and it has (almost bipolar in a way). Believe the Fed has their head(s) screwed on right (truly believe they do); if so they might not take the Street 'bait' entirely; and cut Discount more than Funds rates next. Not at all sure that this forecast snapback isn't an A-B-C rally prior to something fairly nasty evolving anew. However; it's extremely sensitive. Hence internal erosion interspersed by rebounds (as outlined to members).
Enjoy the evening,
Gene
Gene Inger,
Publisher
~Gene Inger’s Daily Briefing™ (The Inger Letter daily analysis on www.ingerletter.com)
~Gene Inger’s MarketCast™ (Intraday audio updates emphasizing S&P futures and market action)
