 Bank
Bust & Sea Change: 3 Views
Jim Willie
CB
Jim Willie CB is the editor of the "Hat Trick
Letter"
Mar 15, 2007
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A preface is in order, to honor
Sir Alan Greenspan. The housing bust and the mortgage finance
debacle have his signature on them. So far he is still revered,
for some odd reason, probably basic ignorance. Some called Clinton
the "Teflon Man" which more deservedly belongs to Greenspan.
Heck, they both earned the title; they can wear it with the ignominy
it so justly is associated with.
GREENSPAN SIGNATURE
The current mess of
mortgage defaults and foreclosures testifies to the venerable
and highly acclaimed serial bubble inflation engineer Greenspan's
leadership and counsel as destructive in high order. Alan must
be shuddering and cringing at the extreme damage to banking balance
sheets, the spate of lending institution collapses, and the contagion
within banks. He urged millions of US homeowners to rush into
adjustable rate mortgages, so as to reduce their monthly costs.
Here is an actual quote from Greenspan, extolling the virtues
(vultures) of innovative mortgages. IT IS A SHOCKER, from a modern
day John Law, who assisted in the transformation of the USEconomy
into a giant hedge fund. Its foundation sits atop bubbles. Remember
the two concepts Alan loves the most. That "innovation"
is just another misleading term for broadened leverage to ramp
a particular market. That "productivity" refers to
more computing power for program stock & bond & derivatives
trading (to earn fees), to displace workers (ending employer
labor costs & fringe benefits) in the age of the great financial
engineering miracle. Or is it a miraculous destruction? Would
Sir Alan recall his words? Would he be proud of them? Methinks
no and no. Why was he knighted by the Queen? Could it be because
he helped bring down the US challenger to Old Europe? The lost
US manufacturing base is a direct consequence of chronic inflation
topped off by Greenspan policies. The housing bubble is one of
Greenspan's more direct accomplishments. Decide for yourself.
"Innovation has brought
about a multitude of new products, such as subprime loans and
niche credit programs for immigrants... With these advances in
technology, lenders have taken advantage of credit scoring models
and other techniques for efficiently extending credit to a broader
spectrum of consumers... Where once more marginal applicants
would simply have been denied credit, lenders are now able to
quite efficiently judge the risk posed by individual applicants
and to price that risk appropriately. These improvements have
led to rapid growth in subprime mortgage lending... fostering
constructive innovation that is both responsive to market demand
and beneficial to consumers."
-- Alan Greenspan,
April 2005
The reality is that innovation
efficiently grew a dangerous reckless housing bubble, using the
bizarre financial engineering alchemist tools to corruptly leverage
the inflated (crowbar cranked as in amphetamines) construction
into a monster which is now exploding, taking down everything
tied to it. Credit scoring models were uniformly abused to grant
loans to unqualified buyers who now are losing their homes and
invested equity. Risk was systemically improperly priced. It
fostered destructive innovation to cater to market demand in
predatory fashion, to the detriment of consumers. What resulted
was a temporary bailout from the 2000 stock bust with a Greenspan
signature, followed by a greater housing bubble & bust with
added Greenspan fingerprints, and a highly mysterious continued
ongoing unjustified adulation admiration and worship of a knighted
serial bubble engineer!!! He is celebrated much like the village
drug dealer, only to escape criticism when the addict is down
& out.
The current housing bubble
& bust serves as vivid testimony of the failure and inability
for free people to manage money and a monetary system, without
the discipline and rigorous enforcement of a gold standard. When
we run out of new available bubbles to puff, we will earn a new
system, which is most likely to be less friendly and less gentle
with liberties and freedom. Like now!
Greenspan was responsible for
creating the mess, now he leads interference for reactive policy
change. He has talked about a recession likelihood, but continues
to deny a spillover of the housing debacle into the real economy.
More accurately, he awaits the spillover. One should regard
the Greenspan role as carefully orchestrated, not by any means
accidental. He has created the psychological backdrop perfectly
for Bernanke to cut official interest rates. Ben needed a
shock to stocks, a change in sentiment and outlook. He got it.
GLIMPSE OF REALITY FROM SHADOW STATISTICS
The shocking developments
are at work now, a clear testimony to a failed self-regulated
inflation management scheme abusing a fiat currency, just as
Von Mises warned:
- MONEY SUPPLY GROWTH IS AT
10% (according to USGovt statistics)
- PRICE INFLATION IS AT 10%
(disregard USGovt statistics)
- ECONOMIC GROWTH IS AT MINUS
1.4% (disregard USGovt statistics)
- THE HOUSING MARKET IS IN REVERSE
- ITS COLLATERALIZED MORTGAGE
BONDS ARE IN FREE FALL
The Shadow Government Statistics
folks do great work. Here is their view of reality, after removing
what they call a steady stream of gimmicks in USGovt official
economic statistics. They eliminate the garbage methods known
as substitution, quality improvements, geometric averages, double
counting, cockeyed weights, and more. We are in the midst
of a queer mixture of severe monetary inflation, damaging high
price inflation, yet an economic recession, weighed down severely
by a housing bust and a mortgage finance crisis. Yet, the
USGovt & Dept of Treasury & US Federal Reserve tag team
are pumping money from the printing press like there is no tomorrow,
in utter futility. They had better push harder on the accelerator,
since the crises and shocks have only begun. We are in for a
wild ride. See their website at ( www.shadowstats.com
).
The actual price inflation
for the USEconomy is near 10% and rising in trend, having surpassed
11% in the last two years. One must add over 7% added to the
official CPI to enter the world of reality. These two distortions
have been regular themes of my Hat Trick Letter, which
celebrates its three-year anniversary this spring. The Shadow
Guys articulate and quantify the distortion better than any agency
or institution in existence.
The actual growth for the USEconomy
is near minus 1.4%, a recession, having entered positive ground
only briefly in the last six years. One must subtract over 4%
from the official GDP to enter the world of reality.
BOND IMPLICATIONS TO RECENT SHOCKS
One highly significant
topic barely touched upon is the shock wave to the credit spreads
and the direct linkage to USTBonds. Long-term interest rates
will be falling (NOT RISING) even though price inflation abounds.
The unwind of domestic credit market spread trades ensures the
buyback of anchored long-term USTreasurys securities, in particular
the 10-year TNote. The typical spread trade purchases a higher
yield bond and sells the lower USTNote yielding bond. They invest
in one of (riskier corporate bond, riskier mortgage bond, riskier
junk bond, even credit default swaps) and shorted the anchoring
USTNote. The entire trade benefited from the difference in risky
yield from base USTreasury yield becoming smaller. As spreads
widen, the spread trade loses money, and investors in them have
sold quickly. The domestic unwind of the spread trades entails
resetting the risk pricing. This will result in higher yields
for the riskier bonds and lower prevailing long-term interest
rates linked to the USTreasury long-term bonds. This is NOT the
carry trade, which is the international currency spread trades,
like buying a currency with higher yield and selling the currency
(yen or euro typically) with lower yield. The bond yield differential
trades are what can be called the "domestic spread"
trade.
This all means US long-term
yields could come down toward the 4.0% mark previously cited
here as a target. Some
cavalierly and with shallow understanding claim simply that the
markets are moving in a "flight to quality" or "flight
to safety" which misses the point. No, that is the propaganda
to divert attention away from the bond speculation dominance
within the markets. Risk spreads are unwinding, and the anchor
trade USTBond is seeing a massive short covering. Long-term interest
rates will fall as the domestic spread trades unwind, and risk
is more properly reset. The rub is that the unwind process, the
short covering process, REMOVES money from the investment arena.
Gold will continue to compete with USTreasury Bonds, a constant
nemesis.
However important the mortgage
bond situation is, its impact on banks, and the effect on changes
to bond yield spreads, the US stock market in the last couple
weeks is trading with a 90% correlation to the Japanese yen currency.
The Yen Carry Trade is the key here and now. This lends credence
to the claim that some cheap Japanese money was used to speculate
in the US domestic spread trades.
SEA CHANGE (IN THE YOKE)
Since the year 2003,
commodity & energy contracts (their stocks also) have been
tightly yoked to the mainstream stock market, as in the S&P500
index. We are about to see that yoked effect be broken. We are
about to see a reversion back to the traditional lack of correlation,
one which made great sense. As the cost of metals, energy, materials,
and foodstuffs rises, the inherent "tax" on the economy
is felt, endured, and overcome. Thus higher costs should reflect
in a suppression of corporate profits. For four years, all stocks
have been the beneficiary of historically unprecedented liquidity,
which fits my definition of modern day Weimar inflation. Sadly,
the great majority of the investment community has no idea what
inflation is anymore, the tragic effect of bad information, poor
teaching, and outright indoctrination. It is the growth rate
of the money supply, the monetary base or aggregate.
A shift is coming. The first
ratio to observe is the CRB commodity index divided by the S&P500
stock index. It suffered a decline during the energy downslide
engineered by Goldman Sachs last late summer, with political
motivation for election steering. Since winter, a reversal
is in progress in this ratio. From this point onward, commodity
prices should outperform mainstream stocks.
A shift is coming. The second
ratio to observe is the HUI gold & silver unhedged stock
index divided by the S&P500 stock index. Despite some steady
pressure in the last several weeks, the ratio has maintained
its footing, and has found support from the 50-week moving average.
Support appears strong. From this point onward, precious
metal stock prices should outperform mainstream stocks.
A shift coming. The third ratio
to observe is the S&P large-cap XLE energy stock index divided
by the S&P500 stock index. Its behavior in the last several
weeks closely resembles that for the HUI precious metals ratio.
Despite some steady pressure in the last several weeks, the ratio
has maintained its footing, and has found support from the 50-week
moving average. Support appears strong. From this point
onward, energy stock prices should outperform mainstream stocks.
CONCLUSION
We are in for a wild
ride. Until the USFed awakens to the reality of the current horror
show, all stocks (equities) will remain under pressure. The metal
and energy stocks should fare better than the mainstream stocks,
as the correlated yoke is slowly removed. Tumult is sure to come.
After the USFed takes the necessary medicine, or delivers it,
namely interest rate cuts, the sea change will be complete. The
migration to tangible assets will proceed, as ordinary stocks
and debt instruments will be shunned until the damage is fully
measured. Given all the domestic spread trades to be unwound,
don't expect any upward move in long-term USTreasury bond yields.
The long-term prevailing rate reflect bond speculation, not
inflation expectorations. They anchor too many (in)securities
and will benefit from the unwind process, just like in summer
2005 when the General Motors bonds cratered. Some mistakenly
call it a "flight to quality" when there is no inherent
quality to USTreasurys, PERIOD. The process is mere unwinding,
with buybacks of the anchoring USTBonds in some form or another.
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Mar 15, 2007
Jim Willie CB
 Jim Willie CB is the editor of the "HAT
TRICK LETTER"
email: jimwilliecb@aol.com
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Jackass
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Trick Letter
Jim Willie CB
is a statistical analyst in marketing research and retail forecasting.
He holds a PhD in Statistics. His career has stretched over 26
years. He aspires to thrive in the financial editor world, unencumbered
by the limitations of economic credentials. Visit his website
at www.GoldenJackass.com. For personal questions
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