Bear markets generally have long periods of moderate decline, interrupted with explosive rallies.
Bull markets generally have long periods of slow advance, interrupted by shocking drops.
I think what the FED is doing is large enough and specific enough that we will see stocks advance for most of Thursday, and be only a little off Friday and Monday.
The core problem -
There is about 500-750 billion in bad mortgages. Let's call that the primary problem. Maybe they are worth 30-60 cents on the dollar. These were created from mortgages from 2003, 2004, 2005, 2006 and 2007. There is another 1200 billion ARM mortgages that will reset in the next two years, about 400 billion may be at risk. With lower rates the amount of loans at risk has declined from about 700 billion.
As a result, about 2 Trillion in various mortgage backed assets are now illiquid - secondary effect, partially the result of not knowing the contents of the assets, and partially because of the higher risk now assigned to mortgage anything. Many of these were created before 2003, had some lending standards, and the loan value does not exceed the property value, and they have a history of payment, and to some degree, the early defaults have already occurred. Because of poor record keeping etc. Mark to market accounting intensifies this problem. These will be the assets Warren Buffet and others will try to get for 30 cents on the dollar - they are really worth from 80 cents to $1.05 for some with slightly high interest rates and good payment history. Right now, there is little market for these.
Maybe another 7 billion in other assets are illiquid because they do not have bids, because the the banks can't loan or play because of capital limitations. The central banks, notably the FED, have provide money for additional reserves to the banks.
Fourth order effect is everything else in the world.
The central banks have been trying solve this problem from the big end, printing money, and it has not worked for many reasons. The idea was to provide liquidity, but not bail out the bad loans.
Now, they are moving closer to fixing the core problem - bailing out the bad loans. What the FED has done today is allow the bad loans to be used as collateral. This may partial alleviate the secondary problem, since a bank can borrow money against a loan, even if there is no market.
However, the bank still has an obligation to make good on the loans used as collateral by the FED, so while this helps with good loans, it does not relieve enough capital adequacy pressure on banks with bad loans.
The second step will be having the taxpayers buy the bad loans from the FED.
Trying to fix the liquidity problem from the big end could destroy the US Dollar, or at least kill 2/3 of it's value. It would, however, let the banks with bad loans pay the price.
Trying to fix the big end - to refloat everything - could send gold to $2000 - $3000.
Fixing the small end of the problem - meaning the taxpayer takes over the bad loans, like the S&L crisis - doesn't just have a moral hazard, it is pretty bad policy. However, that need not destroy the US Dollar. This means gold may peak at $1200 to $1500 or so.
After the bad loans are put on the taxpayers back, and Warren Buffet and the other value investors have grabbed the good loans cheap, the rest of the mortgages will slowly return to about 90 cent of the dollar, and become tradeable and liquid. Most banks will then have lots of capital , and want to lend.
I expect this will take 4 months to 1 year.
Then the FED will need to remove some of the excess liquidity in the system, that may take two years.
The financial stocks, and most of the market except for resources, may still decline until the banks get bailed out of the bad loans by the taxpayer. Being able to use the bad loans as collateral is only step one. How will the taxpayers find the money ? Iraq war activity will be reduced, and inflation will push up Federal Government income tax revenues.
So maybe one more good run for SKF, and then maybe, a chance to buy gold at a little lower price.
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There is considerable criticism of Bernancke that he did not understand the specific mortgage credit / fraud problem, and applied academic, general monetary solutions to a problem needing specific action in one area.
>>>About 2 years from now, we will see that about 1.1 Trillion in poor quality loans in a 14 trillion dollar economy, when problems are amplified by FED action, can result in a drop in the value of the US Dollar of almost 50% in about 5 years<<< |
