Vigilant Investor

I had a chance to listen to and then briefly question J.P. Morgan’s global equity strategist, Abhijit Chakrabortti on Wednesday. I was surprised by how concerned he was about earnings growth and the economy as a whole. Frankly, I was reminded of Stephen Roach over at Morgan Stanley, who, the day before the Great Plunge, had posted a quite  sobering dispatch about Wall Street and global complacency titled The World Drops Its Guard — a quality read if you are among the masses scratching their heads wondering what exactly happened yesterday. Actually, even if you aren’t, its good perspective to have.

Why did The Great Plunge happen? Chakrabortti understood this much: China was the catalyst, but something much deeper has to be going on. A drop of 540 points reveals the existence of a hair trigger amid the amazing amount of complacency in the markets. China tripped the switch, but a 540 drop out of the blue, said Charabortti, could have as easily been triggered by any number of other rogue wave incidents.

The drop was a punch in the consensus’ jaw, amid record or near-record bullish sentiment, depending on which figures you reviewed. Clearly a systematic or fundamental button was pressed yesterday to expose something much bigger than just a little market complacency.

Loudmouth analyst Jim Cramer, blamed “the system” for failing investors. Wrote Cramer in his RealMoney.com column at 4:15 EST,

“You didn’t even have time to panic. The system failed us, breaking down too fast for you to panic. We totally collapsed between 2 p.m. and 3 p.m. ET, dropping 200 points. All the circuit breakers and all of the rules that were put into place years ago after 1987 just utterly failed.”

Certainly, many will be looking for scapegoats like Cramer. Perhaps “the system” failed, but that’s missing the deeper point.

On the other hand, our belief is that the crowd just smelled the sudden odor of smoke, but few are even close to understanding that the roof is on fire. It has happened in the midst of a pretty darned good party where folks have been so drunk on good times that they’ve been too busy to bother to acknowledge that a the increasing number of people staggering and throwing up might be a sign that things are too carried away. Nobody wanted to listen to sober party-poopers repeatedly reminding everyone that playing with fire is dangerous, and that inevitably someone is bound to get hurt.

But now the cat is out of the bag, and it will be interesting to see how many people start to rethink their reality. Obviously there was something big going on, and they had no idea. The scramble is on, although I expect that, given the extreme bullishness we’ve seen, too few will heed the warning without a few more smacks in the jaw. For better or worse, that’s just human nature.

So what was behind the tension released today? While the plunge caught so many off-guard today, the current excuse is what we’ve noted for many months now: there is far too much complacency.

However, regular readers know we think its much deeper than that. The complacency issue means too few are acknowledging the serious structural problems we discuss day after day, week after week.

Today’s headlines seem to be breaking through the denial. Will people listen?

Consider the other headlines today:

• Orders for Durable Goods in U.S. Fall 7.8 Percent, More Than EstimatedFor Manufacturing, a Recession Has Arrived
• Freddie Mac to Tighten Subprime Mortgage Standards
• Global Bond Risk Soars on U.S. Mortgage Defaults
• US mortgage default fears grow
• Worst risk to market? Subprime mortgages
• Subprime Game’s Reckoning Day
• Derivative risk threatens private equity
• Home prices fall most in 14 years
• Central banks cutting holdings of U.S. dollar
• Global markets get taste of risk appetite reversal
• Fannie Mae delays 2006 financial report

In case your missed it live…. Nothing like watching hundreds of points fall off the Dow Jones Industrial average in about of 120 seconds.

We’ve warned tirelessly over the last few months about far too much complacency. Hence, it came as no surprise to us that Wall Street was completely caught off guard.

“File this under strange but true: Insurance encourages risk-taking behavior, and ultimately, it increases the size of a disaster when it finally strikes. That is bad news, really bad news, for the debt markets. So bad, in fact, that if you’re worried about a financial-market meltdown, you should be watching the debt markets and not the stock market.”

Those words could have been ours, but they are those of Jim Jubak over at MSN Money, in an article bluntly titled “Debt-market bomb could hurt us all.” If your among the Goldilocks crowd who believes the economy is immune from anything problematic thanks to all the smart folks on Wall Street and at The Fed, perhaps you ought to give Jim’s article a read. It is an excellent short primer on the risk credit derivatives play in the market, and ties them into the emerging problems in the sub-prime mortgage market. Recall, derivatives are what Warren Buffet referred to as financial weapons of mass destruction a few years back.

On the other hand, you can go on trusting the wisdom of those who are now saying this problem is totally self contained, and that the housing bubble is already at bottom and ready to kick in the next upward leg. Of course, those were the same people who denied the housing bubble existed in the first place, and then denied it would cause any problems in the new era of highly robust debt markets.

Go ahead and pick your horse.

Stay Vigilant!

UPDATED: 9:20 a.m. ET 02-26-2007

It is nice to see Carolyn Baum’s comments in Bloomberg on the forgotten subject of money supply. Actually, it was even nicer to see Baum point out the charade played month after month by the Fed and Ben Bernanke (and his predecessor, Sir Al), as well as the financial media as a whole, in that inflation is almost always described as some sort of exogenous force from the great beyond that our trusty knights at the Federal Reserve must ride into battle against each and every day. (“Thank GOD for the Federal Reserve!”, you can hear through a collective gasp when folks write about the economy.)

Says Baum:

” The Zimbabwe government recently outlawed inflation, arresting a number of senior executives in recent months for breaking the law: raising the price of flour and bread without the express approval of the Ministry of Industry and International Trade.

Venezuelan President Hugo Chavez adopted the same inflation- fighting tactic, threatening jail sentences and even nationalization if grocery store owners defy price controls.

The 1,331 word New York Times article on Zimbabwe’s economy never mentions money. Rarely does the Fed refer to money — in its public statements and apparently in its internal discussions. There are no mandated targets for the monetary aggregates, fewer aggregates (reporting on M3 was discontinued last year much to the chagrin of conspiracy theorists), no agreement on how to define money and no good way to measure it, we’re told.

But excess money creation is the cause of inflation, and it would be better if the Fed could make the public understand that the rise in the price level is not a result of higher commodity prices, aggressive labor union demands for wage increases or greedy businessmen trying to milk the public.

It may not sell in Zimbabwe, where anyone trying to explain the roots of inflation might be arrested on the spot. But in the U.S., with inflation running at about 2.5 percent, the public can handle the truth. “

Yet the Fed just plays along as if rising prices are the natural state and it would appear that most folks are none the wiser… and could care less. (Itis quite a racket to be able to print money out of thin air to loan into circulation for a profit, or use for highly leveraged dealmaking! That’s called getting something for nothing! You certainly won’t hear complaints coming out of Wall Street.)

Still, it is good to see a mainstream rag finger the real culprit for most all the inflation we experience: those who print money from nothing and exercise claims to others’ hard work, savings, and production without contributing anything of value to the economy to gain that purchasing power in the first place. Perhaps that is why counterfeitting is illegal. Perhaps we should question why the near exact behavior has been legalized for those in the banking system.

With all the rhetoric about capitalists crooks ruining government with all their campaign contributions, we found it interesting to learn that many of the biggest contributors were not the usual pilloried organizations — e.g. Big Oil, and the likes striving for “unfair profits”, and so forth. Of course, following the money in government is very important. When you’re talking millions of dollars of contributions, you have to question what exactly is that money buying?

We can thank groups like the folks over at OpenSecrets.org for organizing the raw electronic data the government is making available. In this case, OpenSecrets has a nice page laying out who (or what) is making the largest contributions to Congress, and has the data tracked back to 1989! Not terribly surprisingly, many of the largest contributors, overall, are organized labor groups. It was not surprising to see that government workers — a sector where free market competition is forbidden by design and purpose, and the taxpayer is viewed as the bottomless resource for funding — lead the list at number one, followed closely at #4 by the National Education Association, the misleading name for the largest government school teachers’ union in the nation. The American Federation of Teachers is #15, which means, combined, government teachers carry more clout than any other group.

Should we be surprised that those workers quite literally have taxpayers over the barrel, receiving far more generous wages and benefits than are available to their non-government brothers in struggle, and dramatically more than non union workers who don’t use legislation to extract their advantage at the expense of the rest of the economy??

All said, money talks, and unions represent 13 of the top 30 political contributors. As an organized philosophy of collectivist and socialist ideology, unions combined are the single most influential driver of politics. We encourage our readers to click over to Vedran Vuk’s piece on the implications to the United States given so much power is in the hands of those who would see America’s trademark liberty and freedom be replaced with organized socialism.

The main groups behind these activities are labor unions. The trap is set perfectly. Make everyone hate business. Talk about lobbyists and special interest groups. Scream “Corporation! Corporation! Corporation!” while secretly influencing politics more than the blatant poster boys of campaign financing. The American people willingly fall into this snare every time.

Should it be any wonder how far we’ve already come??

Surprisingly, big oil is fairly low on the list, with Chevron at #67, Exxon Mobil at #73, and BP at #100. Halliburton, the super whipping boy of many critics, is not even among the top 100, although that may reflect that Halliburton is so connected, it does not have to bother.

Meanwhile, what should not be ignored are the major banking and financial institutions, and other associations of workers in those fields.  Certainly those who profit from an inflating money supply ought to be watched, as should those who benefit by the ever increasing complexity of financial planning.  If the organized labor is at the trough grabbing what they can, so too are many of these other groups.  The losers are those who are average Americans too busy to play such games.

Feel free to check out the list yourself to make your own conclusions about who is buying what favors.

The New York Times is covering the unfortunate rip-currents as the high tide recedes in the Housing Bubble in South Florida, where “everybody thought that they were going to be a real estate mogul.”

And as the saying goes, you don’t know who’s swimming naked until the tide goes out.

So here we are saying again that this should not have been a surprise: there is no free lunch from an expanding money-supply-induced bubble. Eventually the chickens come home to roost. Housing bubbles are no exception.

How?

Why?

Well, you’ve come to the right place. Why not subscribe? It is free!

The Washington Post has a nice article that points out that Goldilocks may not be so mild as thought. As the economy slows, prices are staying high — Too cold and too hot at the same time????

With the terrible news in housing earlier this week and the melting down of the sub-prime mortgage lending industry, well… Gold is at $670 (up $20 in one day alone…) Oil over $60 again… higher prices are not what the Fed wants to hear. Good luck at explaining to Henry Waxman why wages are growing too fast!

Our thoughts?

Uh Oh! Looks like the bears might be returning home!

That may well be in the form of an inflationary recession dead ahead. It would not surprise us one bit given the insane monetary policy of the last decade, not to mention the ever more restrictive business killing environment we’ve created domestically.

Ron Paul is a gem, and thankfully he is the ranking member of the committee that gets to grill Ben Bernanke each month on the shadowy (literally) doings of the secretive Federal Reserve. It seems so many politicians are either so far down the socialist path, they think confiscation of wealth through Fed inflation is a good thing, or they are simply too economically illiterate to understand the real implications. Too bad Congressman Paul is only allowed 5 minutes. It would be interesting to see him spar with the Fed Chief publicly.

To accompany our post earlier today, we thought these observations from Bill Fleckenstein were worth a read:

• The housing ATM rot is just the beginning

We agree that end of “the home as an ATM” is a broader theme being missed by most among the overwhelming majority who believe the housing deceleration will bottom out in Goldilocks fashion. With that spigot cut off in the face of stagnating or declining prices, tighter lending standards, and increasing mortgage rates, it’ll be interesting to see where the next round of personal consumption originates.

With New Century and HSBC’s lousy news recently, and the Mortgage Implode-O-Meter now up to 23, keep your eye on the sub-prime as the leading edge of a crack up.

Vigilant folks ought to be seriously questioning if this is just the tip of the housing iceberg. That’s the direction we’re leaning.

Many in the media (from Jim “El Capitan” Cramer to Sir Larry Kudlow to Bob Pisani) have opined that the bears “don’t understand the conditions under which real estate markets collapse, and these conditions (suggestive of a broadening credit problem) are not present.” And, in a series of perfunctory conference calls over the last week, the leading brokerages have supported their case that there will not be a credit contagion emanating from subprime lending and that the brokerage exposure will be contained and limited, even though none of the banks disclosed their involvement in the subprime market (as agents and as principals).

It appears that the principal reason these observers are ignoring the subprime problem and its ramifications is that the equity markets are ignoring them. Ergo, it must not be a problem. This is the definition of a Goldilocks mindset (see no evil, hear no evil), not a Goldilocks scenario.

Read the rest of Doug Kass’s observations [Subprime Fungus Will Spread] at TheStreet.com.

Occasionally we depart from the finance theme of Vigilant Investor when we find something that meaningfully encourages vigilance on other levels.

Today’s departure: the national sport of ridiculing those who are arguably suffering serious problems.

With the recent crash and burn of Anna Nicole Smith, and today’s confirmation that Britney Spears has entered rehab – yes, her regrettable behavior was the meltdown many of us suspected – perhaps society ought to look in the mirror a touch and question just why so many of us delight so much in ridiculing others when common sense tells us they are desperate and/or falling apart. Why must we be so voyeuristic to demand every detail about others when it is very likely that, with such ripping scrutiny and paparazzi documentation of every second of our lives, we’d be crushed, ourselves? What does it say about the void of compassion an lack of empathy among so many media consumers who make such “sport” a hundred million dollar industry? How thin is the veneer between our culture and that of the Roman Coliseum and bread and circus?

Here’s a link to the sobering and very prescient comments made by CBS’s Late Late Show host, Craig Ferguson, on Monday night. Kudos to Craig for saying what so many observers think.

Please hear Craig out, and then pass it along as if Britney and Anna Nicole are your daughters or sisters.

Boy, the headlines are flying.. Let us help you connect the dots to dveloping problems!

Merrill sounds alarm on global liquidity

Merrill Lynch has warned of a global credit crunch as central banks in Europe and Asia tighten monetary policy, advising clients to shun risk and switch to safer assets over the forthcoming months.

Merrill Loaded for Bear in Mortgage Market That Humiliated HSBC

Merrill already has bankrolled two home lenders that subsequently failed and purchased a third, First Franklin Financial Corp., for $1.3 billion, just before HSBC Holdings Plc disclosed that its bad-loan provisions increased 20 percent because of the unraveling U.S. subprime market.

Sacramento: The pressure’s on sellers to lower their prices

Here’s an alarming fact about Sacramento’s housing market: About one of every five existing homes on the market is a “short sale.” That means the home is worth less than the value of the mortgage, and the lender is willing to accept less than full repayment of the loan to avoid foreclosure, says Tracey Saizan, president of the Sacramento Association of Realtors.

Zero-down lenders folding: High-risk loans go bad; subprime firms go under

Brian and Selah Davenport were two days away from closing on a townhouse in Parker when their mortgage broker called on Valentine’s Day. Their lender, Las Vegas-based Silver State Financial Services, one of the country’s bigger subprime lenders, had ceased operations. That forced the couple, who were looking for a zero- down loan, to scramble to find another lender and save the purchase.

After Subprime: Lax Lending Lurks Elsewhere

Investors who dabbled in subprime mortgages have learned that risk is a four-letter word. The lesson might need to be applied elsewhere before too long. The shakeout in the subprime-mortgage industry — which caters to high-risk borrowers — claimed more victims last week. ResMAE Mortgage, a Brea, Calif., lender, said it was filing for bankruptcy protection and selling assets. Accredited Home Lenders Holding reported a fourth-quarter loss of $37.8 million, in part because it was forced to buy back nonperforming loans it had sold

Investors in mortgage-backed securities fail to react to market plunge

It’s amazing how long it can take investors to see that the wheels are coming off a prized investment vehicle. Denial, after all, is a powerful thing. But when an imperiled favorite happens to be a pool of asset-backed securities — especially those involving home mortgages — denial can be compounded by outright blindness to the real risks of that investment.

• Risks Still Cloud U.S. Economic Outlook
• Central Banks Face Rising Pressure From Politicians

This is an excellent expression of the history of the Mid East and conquest. It would be interesting to see something similar, but more detailed, covering that last 200 years. Click the image for one heck of a ride!

A new study reaffirms the Peak Oil theory. Peak oil is often dismissed as a quack theory that says oil is running out.

No such thing. In reality, it merely points to the hard science that shows the cheapest sources of oil — the lowest hanging fruit that is most easily refined — is declining at a decent clip in the face of rising demand. No major finds have been discovered in over 30 years and new discoveries are comparatively minuscule.

Certainly the earth is filled with lots more petro-energy, but getting at it will require more and more investment input, meaning the dollar input to energy output ratio will decline. That translates into higher petro related prices going forward.

Is that a guarantee? No. But certainly folks need to open their eyes to the possible global macro and geo political implications and plan accordingly. It puts the Mid East region in a different light, and it explains the recent maneuvers of China and Russia with Iran, which appear designed to ward off U.S. hegemony.

For more details on the subject of Peak Oil, we’d recommend Twilight in the Desert.