The Market Ticker

Ok, folks, here's another "Come To Jesus" Ticker.

Last night we saw the mother and father of all implosions - and attempted "sticksaves" and "power grabs", all at once.

First, the implosions.

Lehman Brothers has gone down and Bank America has forcibly swallowed Merrill Lynch.  Forced by The Fed, one assumes - they surmised (correctly) that come Monday shorts would attack Merrill immediately and in force, thrusting them to the bottom of the pool if they did not first insure that they couldn't be attacked.  So a deal was brokered, and now we have gone from five investment banks to two, with the count decreasing by fifty percent in one day.

That's right - Morgan Stanley and Goldman Sachs are all that's left, and they won't last long.  Say good-bye to the last pieces of the Depression-era legislation that prohibited the co-mingling of investment and commercial banking, the hard way. 

ALL investment and commercial banking is now in the hands of a very small number of institutions, with the key players being JP Morgan and Bank of America.

This is not a good thing folks.  Not at all.  At the same time The Fed orchestrated this they also announced that the "23A Exemptions" that limit to 10% the "passthrough" financing to affiliates was being "temporarily suspended" on a blanket basis.

In addition, The Fed has announced that it will take equities as collateral for loans.  "Equities" is a fancy name for stocks.

That's right - for the first time in history, now banks can take stocks to the discount window.  Maybe even their own stocks. 

The Fed has gone from taking only the highest-quality securities - "AAA" rated debt instruments - to taking everything up to and including the most dangerous (common stock) all at once!

Now I may be blind but I've read The Federal Reserve Act multiple times and nowhere do I see where equities can be taken to the window (or anywhere else for that matter) for Fed Credit.

If they intend to actually do this, its quite clear they don't care what the law says.  They're going to do it anyway, and their precedent is that you sat back and allowed them to take equity when they bailed out Bear Stearns, and said nothing!  They will do anything they want by citing "exigent circumstances" and claim blanket authority.

What's worse, this effectively makes The Fed a margin lender on the equity markets!  You think they don't have a reason to interfere in the market eh?  Oh boy, now they have billions of reasons, all of them sitting on their balance sheet!  Fair and open markets?  Bah!

Note carefully folks - this effectively makes The Fed LONG (that is, a "buyer") of STOCKS.

What's even better is that they don't eat their own losses if there are any - they're yours! 

That's because The Federal Reserve Act says that the profits (or losses) from The Fed flow through to the Treasury (after operating expenses) which means that now, suddenly The Federal Government is potentially directly exposed to losses in the stock market!

Now it has always been true that The Government "loses" when the market goes to hell as it gets less in the way of tax receipts.  But that's different than suffering an actual capital loss - and that is now possible.

You think you've seen "intervention" in the stock market in the past?  Bah!  You've seen nothing yet; now we have The Fed going entirely outside of the boundaries of The Federal Reserve Act and literally making things up as they go along.

Over the last 20 years you have been repeatedly lied to, bamboozled and scammed by those "in power", including the members of both political parties, The Fed, and Treasury.

Who has eaten the harm to your standard of living as your cost of food and fuel has doubled over the last couple of years?  You have.

Who has taken the hit as our job base has gone overseas, so China can buy a trillion dollars worth of our debt to artificially suppress their currency, thereby making it uneconomic to manufacture DVD players and Cell Phones here, and costing us millions of high-paying jobs?  You have.

Who took the damage when you were conned into buying houses with Option ARMs, with Alan Greenspan himself telling people that Adjustable Rate mortgages were the "best option" for many people - with rates at the bottom?  You did.

Who took the hit from the credit bubble when Alan Greenspan intentionally blew liquidity into the system and held it there for an extended period of time, keeping interest rates at 1%, thereby igniting the housing and credit bubble and leading directly to this mess?  You did.

Who has found that its nearly impossible to have a single-earner household with children nowdays, where one parent stays home with the kids while the other is a breadwinner, as a direct consequence of rapidly-rising costs for food, energy and housing?  You have.

Who has seen medical and educational costs skyrocket at 3x the rate of inflation, fueled by an intentionally-blown credit bubble such that your son or daughter will graduate with $100,000 of debt, and you can't buy a medical procedure at a reasonable cost nor afford individual insurance?  You have.

Who, all-in, has seen their standard of living stagnate and even reverse over the last few years, as all of these elements together conspire to destroy your earnings capacity and wealth?  You have.

Was any of this a mistake, an accident, or "unexpected consequences"?

No - absolutely every bit of it was an intentional act by people in power in The United States - Representatives, Senators, Treasury officials and The Fed.

All of it.

The credit bubble was not a mistake folks.  It was an intentional act undertaken for the explicit purpose of getting you to buy things you cannot afford at prices that are radically jacked up from where they should be.  It has been a raw attempt to appeal to your "desire for more", without regard to whether you can actually afford any of it.  It was intended to and did operate as a monstrous transfer of wealth from you to a handful of bankers in New York!

You have been led around by the nose to think your kid needs an Ipod, you need a cruise vacation, one Lexus isn't enough (you must have two) and you "deserve" a boat, an RV and a vacation home in the Hamptons - no matter how far in debt you must go to get it.

You have been told repeatedly by bankers and lenders that "you can afford it" when nothing of the sort is in fact true.  Being naive and uneducated, you have believed these people -and been repeatedly shorn like sheep.

For over a year I have blogged in an impassioned tone, asking, even pleading for America to wake up, smell the coffee (or in this case the rancid stench of bad debt) and raise hell with their elected representatives.  To tell them that this crap is unacceptable and must stop.  To demand that these elected officials represent us, not greedy investment and commercial bankers, not to mention turning a blind eye to blatant usurpations of power by The Fed that extend beyond the clearly-documented powers in The Federal Reserve Act.

What has America - both the population and our elected representatives - done? 

In the case of our elected representatives, nothing. 

In the case of the population, we've managed to muster forty protesters.

Yeah.

Forty.

Folks, you are literally having everything we have worked for and defended over the last 230 years destroyed before your eyes.

Our free market.

Our banking system.

Our representative government.

It is all being destroyed piece-by-piece.

Your ability to earn a living has come under attack, your savings have been systematically robbed and your home's equity has been stripped off and handed to a bunch of greedy bankers who have bought yachts and vacation homes in The Hamptons.  You can no longer buy health care on the open market with your free cash flow and your kid can't afford to go to college. 

You have sat back and let all this happen over the last 20 years; this is all - every bit of it - happening because every single day you give your explicit consent!

Follks, we continue to cross more and more lines on a daily basis - lines that were supposed to not be possible to cross.  Federal Agencies like The Federal Reserve have been allowed to intentionally blow huge credit bubbles in our economy, effectively destroying your ability to accumulate savings and leading the population to take on more and more debt.  At the same time these credit bubbles have led to insane price inflation in essential goods and services such as housing, food, energy, medicine and education.

Now we have The Fed intentionally interfering in the stock market by making margin loans against stocks while able to shove off any losses they take on you!

This morning, as I write this, the DOW futures are down over 300 points. 

Are you going to allow these same bankers, appointed officials and elected representatives to destroy your 401k, 403b and/or IRA as well?

How far does this have to go before you say "enough!" and put a stop to it?  How long before you show up with a few hundred - or thousand - of your friends and neighbors, angry letters and demands in hand?

We have an election coming in November.  Has this usurpation been the focus of either candidate?

No, and it won't be, until and unless you force it upon them.

That opportunity exists here and now - but if we, the people, refuse to take it, I don't want to hear complaints one, two, three or four years from now.

The clear opportunity - and perhaps the last opportunity - to stop the destruction of our way of life not only for ourselves but for our children and grandchildren is right under your nose, with just a few weeks before you go to the polls.

Wake up America. 

THIS IS, QUITE POSSIBLY, YOUR LAST CHANCE.

So this weekend everyone who is a "who's who" huddled in New York at The Fed to figure out what to do with Lehman Brothers.

The market sat on pins and needles, and in fact ramped by nearly 10 full handles (close to 1%) in the last 10 minutes before the futures locked up for the weekend, in the vain belief that there will be some "resolution."

I'm here to tell you that there is no resolution, no fix, and we now face a stark choice between most of American Finance being sucked into the vortex, and everything, including you, being sucked into the vortex.

Yes, those are some stark - and harsh - words.

They're also true.

Let's begin with what we were told wouldn't happen after Bear Stearns.  We were told that Bear was an "extraordinarily" event, and that it was a "liquidity run" that doomed them; absent that, they were "fine."

This was a lie.

In truth what doomed them is the same thing that dooms all of these other institutions - credit risk.  The truth is that all of these firms have written paper imprudently across the spectrum - "subprime" loans, ALT-A loans, Commercial Real Estate loans and leveraged buyout loans, for starters.

Lehman, allegedly, has some $80 billion of this trash on its balance sheet.  Who knows what its worth.  A good part of it is probably worth 40 cents on the dollar - or less.

This charade has been promulgated and maintained by the ratings agencies, who were more than happy to assign "AAA" ratings to securities that had thin capital backing and assumptions about loss rates that required that the price of whatever asset was behind them would always and forever go higher.

This, of course, is an impossibility, but nobody in Congress bothered them with that minor little fact - even though Congress authorized them to play this game in the first place via their "NRSRO" designation.

The Truth is that Merrill, Morgan Stanley, and even Goldman are all in the same boat.  The Fed and Treasury actions have given them roughly six months to "cut that crap out", but they didn't.  They didn't sell off their portfolios of junk, but what they did do was take the liquidity they were given and speculate in the commodity markets, earning a nice profit and allowing them to report better-then-disaster "earnings" while hiding the trash in "Level 3" buckets on their balance sheets.

The entire game was predicated on the idea that the market for housing and commercial real estate would turn within six months to a year from last summer. 

We now know, of course, that this is total garbage; housing and commercial real estate are long-cycle businesses that average fifteen to eighteen years from cycle top to cycle top, and there is absolutely nothing you can do to change that.

As a consequence every one of these firms that has tried to "hide the sausage" is ultimately going to die.  They have made the critical mistake of trying to play games instead of selling off their portfolio of trash last summer when it was still possible, and now are going to have to eat it - with disastrous results.  It is highly probable that three years from now none of these firms will have survived in their present form.

Speaking of hiding the sausage, let's talk about AIG and WaMu. 

In AIG's case they were writing credit default swaps like candy over the last few years.   As I have repeatedly pointed out these instruments are nuclear devices and all of them tick at inception, but the timer's window has duct tape over it.  There has been zero margin supervision on these as they're all "over the counter"; that is, no centralized reporting, no central clearing, no central control and no supervision - by anyone.  Now AIG is in the uncharitable position of having nearly $500 billion of exposure to corporate loans and CDOs, with nearly all of it written to banks - the very institutions that are now in trouble! 

WaMu, for its part, still has some $50-80 billion (getting an EXACT amount out of their 10Q is an exercise in high frustration) worth of ALT-A "liar loans" on its books, most of them the worst sort - "Pay Option" ARMs on which negative amortization builds into the loan balance.  This caught my eye last April and as I've repeatedly noted should have caught the eye of regulators as well, with the OTS and FDIC stomping on their neck instantly when they reported 1Q 2007 "earnings" and were paying their dividend out of capitalized interest!  But that didn't happen and now we have a huge thrift trading at $2 and change.  Why is the stock price $2? I'll bet that if they were to mark all of their retained exposure to the current market price of those homes they'd be instantaneously insolvent. 

Of course none of these banks or other institutions are taking their marks - including WaMu - but the market is quickly figuring out that home prices are not going to reverse and head higher - they are instead continuing lower, as they must, as until affordability returns there is no other possible path forward. 

In markets like California where the median family income is $64,000 (as of 2006); this means the median home price must be about $192,000.

As of August it was $350,000, or still a bit over 40% overvalued!

Every bank with retained exposure to California of any material extent is in serious trouble and most of them with fail outright. 

This is simple mathematics. 

The regulators had to know this was going to happen years ago as the median price reached nearly nine times median income in 2005 and 2006. 

They willfully looked the other way.

Then we have Fannie and Freddie, who were the architects of the housing credit bubble.  A story you need to read detailing this - in the mainstream media (now, after the explosion of course) is found on MSNBC today:

"The Clinton administration wanted to expand the share of Americans who owned homes, which had stagnated below 65 percent throughout the 1980s. Encouraging the growth of the two companies was a key part of that plan.

....

"They have always done everything in their power to massage Congress," Leach said.

And when they couldn't massage, they intimidated. In 2003, Richard H. Baker (R-La.), chairman of the House Financial Services subcommittee with oversight over Fannie Mae and Freddie Mac, got information from OFHEO on the salaries paid to executives at both companies. Fannie Mae threatened to sue Baker if he released it, he recalled. Fearing the expense of a court battle, he kept the data secret for a year.

....

An employee at one of the companies said it was already a constant discussion around the office in 2004: When would the regulators notice?

"It didn't take a lot of sophistication to notice what was happening to the quality of the loans. Anybody could have seen it," the staffer said. "But nobody on the outside was even questioning us about it."

President Bush had pledged to create an "ownership society," and the companies were helping the administration achieve its goal of putting more than 10 million Americans into their first homes.

And there you have it.  Fannie and Freddie effectively (if legally) bribed and blackmailed their way through Congress - just like the Investment Banks, just like Treasury, and just like The Fed.

Note carefully that both Clinton and Bush administrations are implicated in the above-cited article.  Those who try to make this a partisan issue are simply wrong - this is a leach-fu** issue, in that America, as a whole has come to believe that the government can make everything ok and can provide for us.

Health care, retirement, housing, automobiles, gasoline, heating oil, electricity, hurricane and other disaster relief, jobs and so on.

All the government's responsibility.

On 9/11 Hank Paulson tried to calm down jittery GSE paper holders with this pithy little comment regarding the Fannie and Freddie Fiasco:

"The stock purchase agreement is designed to discourage Congress from trying to change the terms of the agreement, the Treasury said. If Congress did try to change the law, it would open itself up to legal challenge, the fact sheet said.

``As with any contract, the parties to the agreement may modify the covenants by mutual agreement only,'' the Treasury said. "

Of course Hank. 

What's left unsaid is that (1) you can't sue Congress successfully unless it allows itself to be sued (there's this little thing called "sovereign immunity" that gets in the way) and (2) Congress appropriates the money in this nation under the Constitution and could - and should - refuse to fund your mess. 

Good luck with "performance" on that contract if you don't have the cash!

Paulson, like the rest of these fools, thinks he can bludgeon people into holding this GSE paper.  In truth anyone who is not unwinding it at this point and running away is a five-alarm idiot, as I've previously noted, because the entire Treasury department changes hands along with the rest of the Executive branch of government in four months time.

We keep hearing that "its all ok, and the government is here to help and solve the problems we face as a nation."

The Truth: Its all a house of cards.

EVEN THE FDIC:

"We were wrong. As a former FDIC chairman, Bill Isaac, points out here, the FDIC Insurance Fund is an accounting fiction. It takes in premiums from banks, then turns those premiums over to the Treasury, which adds the money to the government's general coffers for "spending . . . on missiles, school lunches, water projects, and the like."

The insurance premiums aren't really premiums at all, therefore. They're a tax by another name."

Betcha you didn't know that. 

That's right folks - there is no FDIC insurance fund. 

Just like there is no Social Security insurance fund, or Medicare insurance fund. 

They are all accounting FICTIONS that our Congress has created and allowed because we keep demanding that they spend more than they have. 

To keep us, and foreign bond investors (who must pony up $2 billion per day to keep this charade alive) from freaking out and saying "no mas!" they rob and steal every nickel from every nook and cranny they can so their "budget deficit" looks much smaller than it actually is.

Clinton never ran a budget surplus if you simply add back in the FICA receipts he stole to "balance his budget."  Bush of course never even claimed to run a surplus.  Every administration since the 1970s has played this game to one degree or another, and we, Idiot Nation, sit back and let it happen.

Now the check is on the table and the waiter is tapping his foot.

So America, what are you going to choose to do about this?  Sit on your hands?  Tap your foot?  Drink another beer?  Turn on the NFL?

Its your money they're spending in DC, you know.  You've been lied to repeatedly by the clowns inhabiting Washington.  Democrat, Republican, elected, appointed, its all a piece of the same mess.

Here, once again, is The Truth for those of you who wish to hear it:

• Homes cannot sell, on average, for more than three times average incomes.  Period.  Short-term distortions can and do occur, but over longer periods of time (decades) house prices cannot advance faster than wages.
• We will not see the bottom of the mess in housing or the economy generally until houses sell for that three times income.  Those who say we will are simply wrong.  Attempts to delay or reverse this adjustment will make the total economic impact far worse and in fact can easily lead us to an economic depression.
• Those firms who made bad investments must be forced to eat them.  If this results in their insolvency then it does.  We cannot clear our credit and economic systems until we know who is bankrupt and who is not.
• We as individuals and our nation as a whole must stop spending more than we make.  This is not negotiable.  We as a nation are beholden to foreign interests at present to the tune of $2 billion per day in external funding requirements.  If that funding is interrupted for any reason - such as a loss of confidence - we are instantaneously plunged into DEPRESSION. 
• The market is vastly overvalued with essentially the entirety of its "future earnings appreciation" predicated on a resumption of the "FIRE" (Finance, insurance and real estate) economic boom.  The only "boom" that is occurring and will occur is a series of explosions.  The S&P 500, without that "acceleration", has a fair value somewhere around eight hundred.  Yeah - 1/3rd lower from here and fully half off its all-time high.

Let's look at the reality of the housing market, starting from the same place - a wage-earner with a $60,000 household income who bought a $400,000 house in 2005.  The price was the "median" in your area and so is your income.

Let's look at the two scenarios:

1. We "let you" refinance into a 30/fixed. However, you still own a house that was sold at double the sustainable price. Your "new P&I payment" would be $2,386 (6%, 30 year fixed). But you only make $5,000/month (gross), which means your total debt load on the P&I alone is 47%. Deduct your tax liability on that $60,000 (figure a 20% all-in marginal rate) and suddenly you have only about $3,700 a month net-net take-home. You are spending sixty four percent of your net income on interest and principal! Yes, you get a tax write-off on the interest; balance that against insurance costs and they probably net out. To put this in perspective you have $1,300 left for everything else in your budget - food, gas, electricity, car payments, etc. You will eventually go broke with this "refinance".
2. You foreclose. Your home drops in price (after another year or two) to $200,000. You can now buy the house for $1,193 P&I! You still have the same $3,700 in take-home pay, but now your P&I is 32% of your take-home, and you have $2,500 left after making your mortgage payment. That is more $1,200 additional every month, and leaves you able to afford food, energy, gas, and your car payment.

Solution #2 forces you through a "Credit Event" and trashes your FICO but leads to sustainable housing and prevents you from going completely underwater.

This same scenario applies to every other area of finance.

Those commercial construction loans that were made at unsustainable cap rates must be allowed to fail and those properties be sold at "fire sale" prices.  This will lead to sustainable commercial real estate.

The "LBO" loans made on ridiculous terms must be allowed to blow up and those firms go through bankruptcy.  This will lead to sustainable business models and risk-based pricing going forward.

Yes, there is considerable pain associated with being one of the people who is on the "wrong side" of any of these blowups.  If you are a bank or other institution that wrote swaps against these deals, or is holding this paper, you are going to take a terrific beating - perhaps enough to kill you in the process. 

But this, folks, is good, not bad. 

It is only through the imposition of market discipline, which is really just a fancy way of saying "when you do something stupid you go bankrupt", that we prevent future stupidity.

Here's a video I recorded just before the futures re-opened - way down.