We are a year into the financial pain and virtually no systemic problem has been solved. Markets have entered into a new unsustainable cycle. The new dance is a two-step. Home prices slide, delinquencies rise, defaults rise. This puts additional pressure on housing going forward. Financial firms announce greater write-offs. Retailers slump and contagion goes global. Selling grips the markets, the good and the bad are sold off indiscriminately. Commodities rise, fear escalates and reaches a crescendo as at least one major institution nears or reaches insolvency. Forecasts of impossible return to the good old days are debated and rebound timetables are pushed back. In the depths of the swoon, the Fed opens the discount window to some new and previously barred set of institutions. Bail-outs are readied, Treasury checks are cut and we rebound off the lows. Bad news becomes good, commodities sell-off and financials soar.
We are at least three episodes deep. Discount window borrowing is open to anyone not convicted of a federal crime. Interest rates are under half the official rate of inflation. House prices keep falling, delinquencies keep rising and losses keep mounting. Mountains of dubious debt have and will be parked on the Government’s books. Bad mortgages, mortgage bundles and sundry cycle on and off Fed books as the Treasury writes checks to the public, maybe JPMorgan Chase (JPM) and likely Fannie Mae (FNM) and Freddie Mac (FRE). The dollar rallies when folks ignore that the Greenback is ever more backed by home mortgages. Interest-rate jawboning replaces inflation management and traders adapt to buying policy driven rallies and shorting on rising fear and fading intervention. Fear returns, babies are tossed with bath-water, commodities rally and short attacks batter firms based on rumor and trend.
Each round sees lower lows and greater intervention. Early on, reassurances and rate cuts rallied the believers. When that failed, new regulation and credit action were added. When that failed, Treasury assisted liquidation, greater assurance and rebate checks were put into motion. As that failed, direct mortgage aid, tightened regulation and enforcement of short position mixed with explicit assurance of implicit guarantees. New housing assistance is now forthcoming and another round of rebate checks appears increasingly likely. Now that we know this cycle is not working to solve any systemic or structural problem, we will do more. How much bad debt can Uncle Sam paper over or eat? How much household and financial pain can be pushed onto government books? How much more will the Fed, Treasury, SEC and Congress have to do to reverse the next leg down? Are we flirting with disaster? With a loss of confidence in state intervention to slow or reverse the slide?
There are distinct patterns emerging. Slides are lasting longer and falling to new lows. More dramatic and extensive interventions are required to generate shorter rebounds. These factors do not augur well. Fed and Treasury actions stall downslide and nibble at the edges of larger problems. Nothing like an actual solution is in the offing. Time buying and slide soothing will have to continue long enough for an organic turn around to take effect.
Otherwise, we will ride this unsustainable wave into the rocks. Rates are below comfort levels. Consumer, producer and import price inflation are well above stated target levels and recent historic norms. Deficit spending is rising fast. There are few candidates left for discount window action that have not already been invited. Recent slides in oil and commodity prices are creating some rotation back into equities and financials in particular. There is no meaningful improvement in fundamentals – yet.
The weakness of US and EU demand has put downward pressure on oil futures prices. This is combining with housing policy, Fannie Mae and Freddy Mac assistance to breathe new life. Folks are buying on oil and commodity declines. There has been some dollar strength as US economic weakness pressures oil and commodity prices. Does that sound sustainable? The dollar has done some strengthening – further pressuring oil and commodities – as Congress and candidates get down to promising spending and tax cuts that can not possible be paid for out of tax revenues? Oil is down on declining demand from economic pain. Federal Deficit spending is spiking on bail-outs, bail-ins and rebate checks. This is good news for American equities and the macroeconomic outlook?
If this bounce is like those leading into it, I expect a real show as it reverses and greater drama is called for form the Fed, the Treasury and traders. Who will get creative temporary assistance next? Who will be attacked suddenly by a rabid short crowd on 3 month old news? What further guarantees are forthcoming? What will they say when the discount window gets a “billions served” sign a la the golden arches?
July 24, 2008
Source: Seeking Alpha