It began last summer with the implosion of two subprime oriented hedge funds, one leveraged 15 times, the other 10 times. In the end, investors of the 10x fund received about 9 cents on the dollar, while the 15x was wiped-out altogether. Today it comes as no surprise that the rumors were true: Bear Stearns was on the brink of collapse, and never mind that CEO Alan Schwartz asserted the rumors themselves caused the collapse. The once venerable institution was doomed. The seeds were sown, just as they are for many other institutions as the Great Credit Bubble — and the false paradigm sloppy thinking it engendered in so many players — continues to unwind.
As such, the Fed — having been, since its founding, in the “game of bailout” in order to preserve the obscene profits made by member firms on the back of many prior credit and monetary inflations — will bail out Bear Stearns, along with the sham front of JP Morgan Chase & Co., whose risk will once again be backed up by the Fed’s ability to print money out of thin air. The buying price — About $2.00 a share, which was the only alternative to going bust - is almost criminal, and harks back to a day when banking cartels would collude to create booms and busts by expanding and then rapidly contracting money supply to buy for pennies on the dollar overextended business projects that were lured into action by the sharply curtailed inflation. Indeed, it is like we’re watching history all over again. Reports the WSJ:
To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns’s less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn’t describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.
Once again the secrecy prevails on what’s being functionally financed out of all dollar holder’s pockets. Truly, everyone in the United States should be up in arms with what the Fed has unilaterally done with their own purchasing power, yet the silence is nearly deafening. What a great game to be in if you have few scruples about profiting from what in any sense of the word is nothing more than legalized counterfeiting.
But foreigners are not so indifferently stupid. Reports the Telegraph in Britain, “Foreign investors veto Fed rescue“, where Business Editor, Abrose Evans-Pritchard, comments:
” Asian, Mid East and European investors stood aside at last week’s auction of 10-year US Treasury notes. “It was a disaster,” said Ray Attrill from 4castweb. “We may be close to the point where the uglier consequences of benign neglect towards the currency are revealed.”
The share of foreign buyers (”indirect bidders”) plummeted to 5.8pc, from an average 25pc over the last eight weeks. On the Richter Scale of unfolding dramas, this matches the death of Bear Stearns.
Rightly or wrongly, a view has taken hold that Washington is cynically debasing the coinage, hoping to export its day of reckoning through beggar-thy-neighbour policies.”
So the Fed’s response has been to further cut rates by .25% to 3.25%, meaning they’re working on greasing the liquidity skids: Hello more money and cheap credit out of thin air! Not surprisingly the dollar is in a tailspin vs. hard assets such as oil and gold.
But what’s amazing is that so many still fail to fully comprehend the calamity at hand. Consider this headline from Reuters:
Despite Fed action? The article at that Reuters headline has since disappered, but the message tells volume: What should folks be expecting for the d
Meanwhile, the Great Bubbler himself, Alan Greenspan, continues to inject his opinions into the mix as if his own policies were not the seeds that grew into this current crisis. We’ll comment on that blather in another post.
Readers should not forget that right now reality and “official stamps of approval” — such as ratings from the major agencies like S&P and Moody’s are not one and the same, and the market knows this all to well, hence the lockups experienced in the Muni Bond market and the multiple examples of BS being called on the entire mortgage financing market, which is now bleeding heavily in the credit default swap (CDS) derivatives market.
Shoes still to drop:
- Credit Default Swaps: In fact the entire mega $ trillion derivatives market is in danger from cascading defaults as corporate debt default rates will, in our opinion, undoubtedly rise far more than most contemporary finance “experts.”
As an aside, we’ve been criticized for using quotes around “experts” in the past, so let me explain why we’ve been doing this for years: This “expert” crowd has exhibited a constant expertise at being 1) absolutely blindsided by events since the initial (and largely ignored) shot across the bow at the end of February 2007, and these same “experts” 2) failed miserably at interpreting what they were experiencing. After all, how many times over the last 12 months do you have to hear “this will blow over” / “remain contained” / “the worst has past us already,” or “financial stocks are irrationally bargain priced — we can’t buy enough,” before you came to the conclusion these “experts” have absolutely no idea what’s caused this problem?”
But I digress: For the same sloppy thinking reasons that mortgage backed securities have been the epicenter of this calamity, similar risk indifference and risk taking permeated the corporate debt market. Much of that risk is insured with CDS instruments. CDSs are the equivalent of you or me buying life (or any other type of insurance) from an insurance company with zero cash reserves required to be set aside to back up their insured risk obligations. In other words, CDS investors better hope their bets are not so correct that their CDS counterparties cannot afford to come up with the required payment to cover the insured loss! Unfortunately, risk was so mispriced over the last few years, we can’t fathom any way that CDS risks will not take a terrible toll as guarantors default on their obligations, and the loss-related consequences cascade throughout the marketplace.
- Commercial and Retail Real Estate: We’ve written about this a lot over the last year. There’s little doubt in our mind that the easy credit conditions created a oversupply of both retail and commercial real estate, with ever more space designed to accommodate an economy basking in the temporary, artificially induced glow of easy credit and expanding money supply. Now that the tide is receding, the consumer is being exposed as woefully over indebted with many to the point of insolvency. More money supply will not solve this problem, it’ll only make it worse. Expect assets backing these projects to suffer badly and play into the CDS mess noted above.
- Foreigners will finally lose all taste for financing U.S. profligacy and abuse of the dollar.
Hold on to your hats, people. As we’ve been saying, this is only just starting to get interesting. Hurricane Credit Bubble Bust has just started to hit our shores with the early wisps of wind and rain. Much worse lies ahead, and don’t be faked out by the eye of the storm that’ll induce many into the calm. That eye will be the byproduct of the majority still buying into the false paradigm that is collapsing around them. When it comes to the economy, it is in many ways a democracy and if enough players buy into the belief that Liquidity and expanding credit can actually solve the problem, that collective belief in action can actually provide some temporary ballast to an economy. But economic gravity will rule the day and catch up with the free lunch policy crowd. After all, its not really that complicated:
- You can’t get rich by overly-indebting yourself, especially with unproductive debt that hangs like an anchor around the economy’s neck as we all struggle to stay above water. The legacy of that debt is what’s catching up with us.
- You can’t spend you way to riches, never mind what the sloppy thinking big-wigs of contemporary finance say. Consumption — the holy grail of policy makers economic thinking — is a one way ticket to putting the cart before the horse.
- You’ll have a harder and harder time funding your deficits by pledging as collateral overpriced assets (thanks to all that inflation) whose values foreigners are growing increasingly skeptical about.
Such simple truths criticizing the conventional free lunch mentality may seem like common sense to you if you’re here reading this, but common sense never got in the way of academicians like Ben Bernanke and his meddling predecessors who love testing their Ivory Tower theories in our real time economy, or in the way of those who feed from the highly profitable trough created by policy actions inherent to what such central planning theory supports. The naturally productive economy is very tolerant, and can stay afloat a very long time riding on the the good reputation of U.S. strength. But that’s about to be blown out of the water as the 37 year experiment of unbacked fiat currency comes to a calamitous end.
Stay vigilant and make sure to Think it Through!
