December 13, 2005
It's the Credit Bubble Stupid
What Wall Street won’t tell you, Tues., Dec. 13, 2005, 3:35 PM
The bubble in 1999 – you remember the one that crashed equity prices for three years – was not an Internet bubble. It was a liquidity bubble, which was started by central banks and government treasury departments printing money. I'll say that because Wall Street won't.
Governments were, at the time, worried that rolling into the new Millenium in 2000 would crash most computers unless they were programmed to go past the number 99 in dates. So hundreds of billions of dollars around the world were printed to (i) try to re-program computers, and (ii) put cash into the hands of people and corporations that feared economic collapse and deflation if funds had been unable to be transferred electronically.
It turns out that the Internet – the electronic highway – was just entering the second leg of its growth phase at the time, so a huge liquidity pool was made available to Internet developers. This capital was then multiplied many times as it worked itself through the economy in the form of employment and spending.
Immediately after 2000 began -- without a Y2K incident -- it became obvious that central banks would have to remove the liquidity quickly or there would soon be serious inflation problems. From 1995 through the end of January 2000 the average Fed rate was 5.25 pct, but by May 16, 2000 (3.5 months), the Fed had jumped its discount rate to 6.50 pct, and that was the tipping point for equities.
That tightening killed the equity market. And traders, no longer having an appetite for equities – especially the brainless ones that were mere concepts and weak ones with terrible managers at that – pushed their money into the bond market, and high-yield debt. The world’s new appetite for fixed income then drove prices up and yields down.
Low bond yields then kicked off the rush to re-mortgage, and to buy new housing with bigger, cheaper mortgages. So the problem that excessive liquidity started has now evolved into one of its own: a credit bubble.
Here is what Bill Laggner of Bearing Asset Management sent me about what he and I believe to be the problem that Wall Street doesn’t want to talk about.
“There is a credit bubble in the U.S., and it is clearly in an advanced stage. The most significant providers of mortgage credit – GSEs and subprime lenders – are obviously broken. Interest rates, credit spreads, home inventories, and foreclosures are rising, home prices in formerly hot markets declining, and roughly $1 trillion worth of adjustable-rate mortgages expected to reset in 2006 at significantly higher levels. No wonder homebuilding stocks are beginning to return to earth. Meanwhile, Wall Street keeps the game going by securitizing anything with a pulse (thus the strength in brokerage stocks) and momentum money chases bank stocks as a way to play the ending of the Fed’s tightening cycle. With gold approaching $540/oz and the incoming Fed counterfeiter, Ben Bernanke, needing to establish his anti-inflation credentials (after all, his “inflation target” is 1-2% and reported CPI is running closer to 4%), the expected turn of the credit cycle seems like pure fantasy.
One would hope folly of this magnitude would only take place every generation or two, yet it was just 5 years ago the lumpeninvestoriat bought into a “New Economy” hook, line and sinker. The parallels between the 2000 tech bubble and today’s credit bubble are obvious. ”
I have frequently written about the problems with the Mortgage-Backed Asset market, and the Government Sponsored Enterprises (Fannie and Freddie). This is one mother of a problem, but you won’t hear of it from Wall Street that created it by packaging MBS that the Little People were encouraged to buy in the post-Y2K environment. And of course Government GSE's are the partner.
Wall Street has paid tens of billions in fines to Eliot Spitzer’s Office for things like front-running trades in client mutual funds, and for operating dubious research departments that were put into conflict situations by their sales departments.
This is a bigger problem than anything Wall Street has ever laid on the public before. And that’s the reason you won’t hear of it from Wall Street.
And as for an Internet Bubble in the Spring of 2000, that’s a figment of the imagination of the biggest PR firms on Madison Avenue in NYC, paid for by government (or friends of government). The Internet world of 2000 was no different than the Internet world today – building wealth by taking risk capital (that is not stupid) and marrying it to bright, hard-working young creative types. But there was a problem in 1999-2000, and it was caused by the Fed/Treasury combo, aided and abetted by Wall Street who significantly benefited from that balloon in the money supply, as they always do.
So you were fooled in 2000 as to what the problem really was and who caused it. You had your eyes on Internet people, who were not the culprit.
And today, you are being fooled into believing that the problems are in the energy, metals and housing markets. And I’m here to say that (i) the energy companies are doing a good job in finding, processing and delivering energy, (ii) the metal miners are doing the same, and (iii) the house builders are doing the same too. These are smart people who are creating real wealth.
But the U.S. Administration war policy, the Congress spending policy, and the Treasury/Fed combo’s printing of money to pay for it all, combined with low interest rates left over from the 2000-2003 great bear market, has caused this problem. Corporations for the most part, being smart, stayed out of the game, and used their cash for dividends and share buy-backs, and tale-overs, which are ways to pump up share prices.
But with Wall Street packaging high-yield MBS products, and consumer finance companies, including the GSE’s, offering ridiculously cheap mortgages, the sheep were led to water, as it were. Individuals have mortgaged up to buy more things on speculation, allowing Wall Street to transfer all the financial risk to them, which is what Wall Street does. Yes, that’s their job. They are after all dealers.
As agents/advisors, they enjoy the privilege of wearing two hats at once – swingers if you will – because Government allows them to do that. You see, they are the best of bed partners.
So to wrap this up, the credit bubble is what you need to be watching. It grows worse every day. At some point, there will be a pop.
But you won't hear it from Wall Street. And Bernanke and the government will be pointing fingers your way.