Noland this week perfectly encapsulates the mess we're in. While indicting Greenie he says it's clear the Fed is no longer in control and the world is now much less dependent on the US.
prudentbear.com
Indictments:
The market today decided that the subprime meltdown matters – at least a little. The Bank index, after reaching a record high earlier in the week, dropped almost 1%. The Broker/Dealers were hit for about 2%. Stocks concentrated in the so-called “prime” mortgage business – including Fannie, Freddie, Countrywide, and MGIC all traded lower. Even Credit insurers MBIA and Ambac declined better than 1%. Meanwhile, Treasury prices rallied sharply, generally pushing narrow spreads somewhat wider. The dollar index dropped back below 84, and gold shot briefly above $688.
The bulls would retort, “Don’t get carried away; the S&P500 declined only 0.36% and NASDAQ 0.39%. The broader market was up strongly on the week.” And, curiously, the Morgan Stanley Cyclical index closed the day higher (up 8.7% y-t-d), with only small declines for the Morgan Stanley Retail Index (up 8.6% y-t-d) and the S&P Supercomposite Restaurants Index (up 2.5% y-t-d). Financials may have been a worry, but the consumer was not. And technology stocks were generally unchanged to higher, with today’s small advance in the Credit-sensitive NASDAQ Telecommunications index pushing y-t-d gains above 6%.
The market is not yet inclined to connect the dots of subprime woes spreading to the prime mortgage market, in the process creating a meaningful tightening of Credit conditions for the consumer economy as a whole. That would be expecting too much from an over-liquefied market undoubting of Goldilocks, the power of contemporary finance, and the capabilities of the Fed. After all, with the exception of subprime, U.S. and global Credit systems remain firing away on all cylinders. Worries about the general economic impact of mortgage problems are assuaged by lower market yields and the prospect of a more generous Fed.
Yet the market now has good reason to ponder subprime’s financial contagion effects. This week’s news from NovaStar confirmed that profitability has vanished across the board for the mono-line subprime originators. An ensuing industry liquidity crisis is feeding a self-reinforcing markdown of distressed loans and originator retained portfolios, with negative ramifications for subprime ABS and securitizations. At the minimum, the specter of rapidly tightening subprime Credit conditions is beginning to foment heightened uncertainty throughout the mortgage finance super industry. The derivatives market for hedging subprime exposure has badly dislocated, with agonizing pressure to acquire protection (or reinsure/unwind “insurance” previously written) but few willing providers (think panic buying of flood insurance during torrential rains and rapidly rising waters).
It may take some time before mortgage tumult expands to the point of significantly impacting the general economy. However, recognition that the unfolding subprime debacle is an Indictment of Contemporary Wall Street Finance should be more immediate. The almighty Wall Street securitization and distribution machines were directly responsible for millions borrowing more than they could reasonably be expected to ever repay. The issue was never that it didn’t make sense for an individual borrower to bury himself in debt to participate in an obvious Bubble. Instead, it was all about whether scores of such loans could be pooled together and structured in a fashion that ensured that holders made above-market returns for awhile – and, later, with the eventual blow-up, that risks had been spread sufficiently so that nobody suffered too big a hit. We’ll wait to see how effectively risk was dispersed and how well related Credit “insurance” markets function. And let’s see to what extent Wall Street can simply pack up its gear and move it on over to the next nascent Bubble.
As for the Fed, they were happy to take a hands-off approach as long as most subprime risk was seen to be dis-intermediated outside the banking system. The subprime debacle is certainly an Indictment of Federal Reserve policy. The Greenspan Fed knowingly fueled the mortgage finance Bubble (post-tech Bubble "mop-up" reflation). Worse yet, I am convinced that Mr. Greenspan promoted variable-rate mortgages to the masses as part of a strategy to extricate potentially catastrophic interest-rate risk associated with normalizing rates after an extended period of ultra-accommodation (especially for the highly-exposed GSEs and derivatives markets!). The sophisticated were certainly forewarned and well positioned to profit immensely from Fed (telegraphed) policies, while so many less fortunate destroyed themselves financially at the grimy hands of housing Bubbles and “teaser-rate”, “option-ARM”, negative amortization and zero-down mortgages.
The flaw in Greenspan/Bernanke Inflationism has always been that it further empowers the flourishing booms in Wall Street “structured finance,” leveraged speculation and asset inflation, generally. The Federal Reserve and their apologists couched the “debate” in terms of some dire risk of “deflation.” We were instructed that expansionary policies were required to elevate the general price level to a much less risky 2% or so – as if once it got there they would - or could - turn down the inflationary spigots. The amount of Credit, leveraged speculation, general financial excess and economic distortion associated with this so-called “price stability” was a moot issue. And the ballooning Current Account Deficit was the consequence of our economy’s “excess of investment over savings” – a blessing of “globalization” that works to boost our standard of living while at the same time containing inflationary pressures.
The principal consequence – the actual inflation fostered by inflationist monetary policies – has been massive Credit and speculative excess, along with resulting dependency. Deluding conventional analysts, the impact on the so-called “general” price level has been token. But the effect on the financial and economic structure – what really matters and is conspicuously indicated by our disastrous Current Account Deficits - has been momentous. Subprime mortgage finance today provides an instructive microcosm of the degree to which securitization-based finance, derivatives, and leveraged speculation foster egregious Credit excesses that contort price signals in both the Financial and Economic Spheres. The boom was fun and games while it lasted, but the bust will be an utter mess.
Prior to today’s rally, the bond market’s concern for the week had been the 2.7% y-o-y rise in January core-CPI. Confidence that the worst inflation data was in the rear view mirror is now being supplanted by justified concern for a problematic ratcheting up in price pressures. Gold prices have shot higher, while crude prices have jumped back above $60. The global backdrop is strongly inflationary. Knock-on affects from higher energy prices (i.e. corn, soybeans, meats, foodstuffs, etc.) are garnering more attention. And from the minutes of the 1/31 FOMC meeting: “Many participants observed that labor markets remained relatively taut, with significant wage pressures being reported in some occupations. In addition to the continuing shortages of skilled workers in technical and professional fields, recent reports suggested a scarcity of less skilled and unskilled workers in some areas of the country.”
I’ll take Fed officials at their word that they harbor inflation concerns, and I found interesting Dallas Fed President Richard Fisher’s comment today that “globalization is helping less in inflation fighting.” His comments were, however, followed a few hours later by dovish San Francisco Fed President Janet Yellen stating the Fed “should not take” the risk of raising rates. The markets will likely rubberneck at subprime carnage and take Yellen’s comments as indicative of the true sentiments harbored by many on the FOMC – including its chairman. The prevailing analysis will be that the Fed talks tough on inflation but can be expected to quickly rationalize away inflation risks at the first whiff of systemic stress.
It’s tempting this evening to suggest that we witnessed this week a meaningful step toward the scenario of the markets perceiving that mortgage-related financial fragility has finally hamstrung the Fed. For some time the markets have presumed that the Fed would not actually ratchet rates to the point of tightening financial conditions. This was a safe bet, recognizing the predominant role encompassing asset inflation, leveraged speculation, and Ponzi-like finance had come to play in sustaining our financial and economic booms. The Fed had become hostage to the markets and the powerful leveraged speculating community, and would be forced to back off come the first sign of trouble. We might be close.
It is a defining characteristic of the current U.S. financial and economic booms that they are dependent upon enormous and uninterrupted Credit and speculative excess. Wall Street and the U.S. financial sector create (through inbridled Credit expansion) and disseminate the requisite liquidity/purchasing power – not the Fed. The Fed does retain the power to impose its will on the Financial Sphere – enticing expansion with the carrot of financial profits or by exacting restraint with its blunt instrument of threatening financial loss. As we have witnessed, telegraphed baby (carrot) steps have been perfectly in accord with ballooning Financial Sphere profits. At this point, the Fed doesn’t even dare remove the vegetable platter (modern-day version of the “punch bowl”).
As I’m writing, I see the headline cross the tape that KKR is bidding for TXU Energy. While Credit conditions tighten in subprime, they couldn’t be looser throughout corporate finance. Indeed, the M&A boom, and the corporate debt Bubble generally, could additionally benefit from lower rates (or at least no Fed tightening) and the marginal flow of speculative finance from mortgages to corporates. And here we see the Fed’s dilemma: Not only is there no general price level to manipulate, the heart of the (Wall Street-dictated) Credit system is locked in aggressively financing one asset Bubble after another.
The upshot is Monetary Disorder and resulting price instability that seem to worsen by the week. A New York Times article this week highlighted the recent resurgence in the local housing market. Meanwhile, condo markets in Miami, Las Vegas, Washington DC and elsewhere appear nothing short of unfolding debacles. Following in the footsteps of energy properties, farm prices are shooting higher. At the same time, homebuilders are cancelling options on and liquidating billions worth of land held for residential development. Most housing markets are posting moderate price declines, while Sam Zell speaks of upper single-digit and perhaps even double-digit residential rent increases nationally this year. The residential construction goes bust, yet this provides only greater firepower for the non-residential (echo) boom; same dysfunctional financial infrastructure – just a new target. Meanwhile, some key labor markets are demonstrating acute wage pressures, as workers in many industries don’t even keep up with the rising cost of living.
The Fed is not in control of any “general price level” and they certainly aren’t in command of Credit Bubble and speculative asset market boom and bust dynamics. There is no interest rate that could today rectify the Bubble Dilemma. Contrast the old banking system where Fed tightening would reduce industry loan portfolio profitability, thereby inducing a general system tightening - to that of the current securities and speculation-based system where waning financial profits in one asset class simply induces greater lending, securitizing and speculating elsewhere (one boom and bust leads naturally to the next). And I’ll further hypothesize that the more protracted the global Credit boom, the less reliant the world becomes to the U.S. economy and Credit excess. This has important implications for prospective U.S. and global inflation, dynamics increasingly outside the purview of our policymakers.
I wouldn’t go rambling on about the Fed’s lack of control if grossly inflated asset markets weren’t so convinced of the polar opposite. Perhaps the greatest Indictment should be reserved for highly over-liquefied and speculative marketplaces. |
