Recession? Yeah. 'Tis OpEx Friday
Yesterday afternoon The Bulls were feeling their oats. Two days, nearly 500 points straight up in The Dow, with commensurate rises in the S&P 500 and Nasdaq.
Then Google, Merrill, Capitol One and Microsoft happened. Oh, and IBM came along and crushed the ball, but nobody cared - they sold it anyway.
Why?
Well, as I've noted for a while now, Google has a "little" problem. You can see it on Tickerforum - in the last month or so there have been a lot of "placeholder" advertisements, selling.... Google Adwords.
Why? Well is this hard to figure out? People can't keep their advertising budgets up. They cut back, the system finds nothing to display in the slot, and....
Merrill? What's there to say here? The bad news in Merrill isn't that they lost nearly $5/share - a horrific result. Its how they lost $5/share.
A big part of that is credit provisions for the monoline insurers.
COF? Consumer credit cards? What do you think?
Today features OpEx games, and Citibank didn't announce they were going bankrupt at 4:01, losing only $2.2 billion (this is good news?), so the market is going to open higher.
But let's focus on what JPM said yesterday - prime mortgages are in trouble.
Prime.
Now is "prime" really prime? That's an open question. Exactly what sort of "prime" are they talking about? I don't know and that's a problem up front, but let's not assume that "prime" means really, honestly, 80/20 loans with 36% maximum back-end ratios, because if those loans are in trouble we're headed for a Depression.
Really.
My "best guess", however, is that JPM's definition of "prime" is kinda like Freddie's and Fannie's - that is anything that was sold to a "prime" borrower, or someone with a high credit score who got called "A" paper.
This might not include OptionARMs but it most certainly does include 100% loans on property in bubble areas, those with computer-based (or no) appraisals, and those with only a signature to back up claimed levels of income.
Well yes, those loans are in trouble.
They should be in trouble as they're not really "A" paper at all! They violated virtually every standard of safe underwriting and nobody should be surprised that they're going bad.
But this, really, is the 900lb Gorilla in the china shop, and the market totally ignored it - and will, for a little while longer.
Maybe for another month or two.
But eventually, the truth is going to come out, and when it does, things are going to get extremely ugly.
See, this problem can't be fixed. Fannie and Freddie can't be bailed out from this mess and neither can anyone else. This so-called "A" paper isn't, but it was both sold off to investors worldwide as "Grade A" debt and retained by these organizations, including banks and the GSEs, when in fact it is more like a credit card receivable in terms of its credit quality.
That is, in a slowing economic environment it should be treated as threatened because in a recession only the security behind the paper really matters; people lose jobs and walk off from things that are upside down.
It would be nice if this had been recognized by the banks and regulators several years ago and fixed, but it wasn't. It would have been nice if Bernanke and Paulson, along with the OTS and OCC would have come along last year when I and others pointed out the crap that was going on with "capitalized interest" and investigated, finding that this paper really isn't safe and sound, forcing capital raising and selling of this paper into the market for whatever could be fetched.
See, in a declining value environment he who sells first gets the most, not the other way around.
But that didn't happen either.
Now we're seeing the "meat" of the slowdown in the economy and it is going to get significantly worse. As it gets worse this "so-called A Paper" will have to be recognized as the trash it is and written back to its underlying credit quality.
That, in turn, is going to constrain the ability to lend and drive up the cost of money, which in turn feeds into economic contraction, which....
That's the "nightmare scenario."
Now the "hyperinflationists" think that Ben will just print up money and drop it from helicopters, whether literally or otherwise.
Well, you've already seen what injecting $250 billion in "excess liquidity" has done to the dollar, to oil, to the price of food.
Now consider this - the losses involved here that have to be "papered over" are, as I've said repeatedly, somewhere between $2.5 and $3 trillion dollars.
Or more importantly, 10x what's already been injected.
Would you like your gasoline to be $15/gallon? It could easily be, if they were to try to paper over this in that fashion.
Forget it. Its not going to happen. Among other things Congress is waking up to the reality of what's going on, and who's responsible. That path won't be taken, because if it is, government borrowing costs go to the moon and if there is one thing that Congress loves to do, its spend money.
But you can only spend what you can either collect via taxes or borrow from the bond market.
Destroy the bond market via a hyperinflationary bout and the ability to spend disappears.
No, what's coming is deflation folks.
It is unavoidable.
Now there are many who will cite Bernanke's "seminal paper" in which he says that "The Fed has this device via a printing press with which it can make as many dollars as it wants; ergo, it can always halt a deflation."
That's true as far as the statement goes but misleading, and that this managed to get through Bernanke's Thesis Challenge is an indictment of the committee that performed it.
Bluntly, they are all mindless boobs who are incapable of thinking in four dimensions. Yet in fact you must always think in four dimensions, not three, because the fourth dimension is time and time is omnipresent.
The Fed can halt deflation only in the instant case, and in the four dimensions that actually govern reality that fourth dimension, time, derails attempted printing every time.
Why?
Because The Fed cannot control what people will demand in order to loan out their capital. It can set a target rate and then defend it by either injecting or withdrawing liquidity, but if it tries to set the rate too far under the actual trading rate (that is, the true cost of borrowing is higher than what the fed funds target is set to) the amount of money necessary to defend that too-low rate rises to infinity!
Once The Fed prints the perception is that they will do so again. As such interest rates in the market rise to the actual monetary inflation rate plus a margin for the risk of The Fed doing it a second time.
See the problem?
The margin is always positive, otherwise nobody would lend at all!
Let's do the math.
We start with $100,000 in "total money and credit" in the system, of which some percentage cannot be repaid. Let's just say all of it can't. The original market interest rate, in a "stable" (no monetary inflation) regime, is 5%.
The Fed injects $10,000, inflating by 10%.
The market responds by charging 10% plus its margin, or 5%. That is, the market charges 15.5% (remember, the margin is on the entire amount, including the monetary inflation!)
Well that's actually a net negative, isn't it? The actual burden to the people in debt increased by a half-percent! So the bank, not having solved anything, inflates by 20% more!
Ok, the market responds by increasing its interest rate by 20% + its margin on the entire mess, and suddenly you have an interest rate of (15% + 20%), or 36.5%. Notice that one and one half extra points appeared on the rate because the 5% margin will be charged on the inflated money supply.
See what happens? You can't get out of the hole - you inflated the money supply by 35% but borrowing costs went up by 36.5%, so in fact the problem got worse, not better!
As such any attempted "printing" increases borrowing costs by more than the printing "lubricates" the system - you create a positive feedback loop - that is, borrowing costs always must increase by more than the stimulative effect of the "printing".
In other words, you're an idiot if you think you can print out of this. You can't - and if you try it the spiral tightens inexorably until you destroy yourself. This is the fundamental principle of compound interest and it applies to every interest-bearing transaction!
Since Bernanke is in fact a banker and he understands compound interest, why would you write such a piece of fiction in the first place? One has to wonder if he was practicing the fine art of "the jawbone" even while working on his PhD dissertation!
So what does this leave us with as the necessary outcome of a credit bubble?
The bad paper will have to be defaulted, and those who are stuck with it will eat the losses. Congress (or others) can try to change who eats the loss, but not whether the loss is going to happen.
The mad dash to find dollars to pay off what can be covered will accelerate.
The dollar? Well, its relative value will depend on how bad everyone else gets nailed by this. But its absolute value, if you're pricing it in terms of houses, has already appreciated by more than 10% in the last year nationally, and if you're in California or Florida, its more than a 30% appreciation.
In a crunch like this cash is king and hard assets become very cheap in relative terms.
If you're in debt?
You're screwed.
market-ticker.denninger.net |
