Bloomberg Quote of the Day: “The incompetent with nothing to do can still make a mess of it.” – Laurence J. Peter, of The Peter Principle fame, which is the positive side of Murphy’s Law.
…in nearly 36 years in this business TB has never seen anything like this. In fact, the last time this happened was in 1929 when the Austrian bank, Creditanstalt, then the largest in the world, collapsed, triggering Black Friday (the stock market crash, not the happy day for retailers), and ultimately the Great Depression. While TB is not predicting that type of debacle, the similarities are not only worthy of mention but require it.
The US banking system of reserves at that time was one of which smaller banks (C banks) were required to hold more reserves than larger regional ones (B’s), and they in turn had to hold more than the biggest national banks (A’s -duh!). This was due to the perceived enlightened status of the big banks – see where this is headed? The big banks were involved globally with other banks in loan participation’s and when Creditanstalt collapsed it pulled down the others and since the A banks held the reserves of the B banks, things began to implode until the B banks begin to fail leaving the C banks with little, and that was how it developed. There was a classic failure by the Federal Reserve to not see that this was the cause of the problem so over the next four years the Fed raised reserve requirements three times, each time causing banks to call more loans and worsen the Depression. The Fed even disregarded rising unemployment, Keynesians that they were, believing wages would fall and then people would be hired.
Bernanke is no fool, in fact he wrote the paper that is much more accurate than the above synopsis of what happened, and this is a major reason for today’s problem. He has been accused of not being decisive, but in TB’s mind his hand was forced by the stock market bulls who kept trying to tell him what to do with comments like “a rate cut will cause a stock market rally.” With that kind of perception out there had he cut more, it would have created moral hazard by causing stocks to rally…in the short run.
The problem is the bull case is built on historical Fed easings which were not related to credit but to a weak economy. Oddly, the bulls not only say the economy isn’t weak but that it is in fact strong and that even if growth slows the rest of the world can carry us. In fact until three weeks ago you would have been hard pressed to find anyone willing to use the ‘R’ word. But that has now moved up to a 50% or more chance of a recession, or we will have stagflation (the ‘S’ word). But at this point the problem would be deflation in TB’s mind. It seems that while inflation is bad that higher food and energy prices are self correcting…especially now where credit is being restricted…since the food problem is largely caused by corn prices pushing up other grains as well as chicken and beef, and the energy problem is due to a lack of a sound energy policy in the US for decades…note these are both government created!
But the problem is deeper then that and yes, we do have a perfect storm. This is happening at calendar yearend and fiscal yearend for most businesses. We have a government with two parties that don’t much like one another and it is an election year. There is a liquidity crisis over the turn (yearend), and if you don’t believe that you have your head deep in the sand.
First, the Fed introduced the Term Auction Facility (Taffy?) which had its first auction Monday for money for a one month period…in other words over year end. The collateral for said loans would be mortgage backed paper…the quality of which has yet to be determined. It was anticipated that the demand would be for $20 billion yet there were more than $100 billion in tenders. Despite being in an electronic age they are sorting thru the tenders and will announce the results today which could, either way, be a shock for the market.
Secondly, the ECB provided $500 BILLION…that is half a TRILLION, in emergency relief to banks for two weeks…in other words over the turn. The purpose was to drive down the Eurobor rate to closer to the ECB target of 4% by offering terms of 4.21%. The rate then declined to 4.45% from 4.95% a record one day decline following a record increase.
Now ask yourself this: what happens when these temporary measures expire? The banks know that they will then be forced to pay up for money again…when rates rise over the turn they tend to stay elevated most of January…and that is without a credit crisis! But the important thing is that the central banks are concerned enough to do this…never before has this happened…just use of the discount window and that is where TB has his biggest argument with Bernanke…why they didn’t cut the Discount Rate by 50 bp’s instead of 25…or why not 100? The best answer TB can come up with is that the reluctance of the banks to borrow from the window due to fear of depositors and other banks learning of their problem, would only worsen the situation when the Fed cut the rate and money rates over the turn continued to rise as they have. It is a Hobson’s choice…in other words there is no choice at all.
As for the markets, aside from a lack of transparency as to who holds the risky assets, is the problem TB was the first to address: even if the problems are cleared up, where does the replacement revenue come from??? The answer came in an oblique way from Goldman Sachs who while announcing record earnings noted that there would be problems ahead…and that is from Goldie who we think knows it all.
Yet TB keeps hearing one after another advise you to be buying the financial sector as it will be the best performer over the next year. Hello…what about the next three months?…until ‘all’ the bad news is out. But will it be as delinquencies and foreclosures continue to rise and please don’t ask what about the Paulson plan which like the Super SIV was dead on arrival. We haven’t a clue how to handle this.
Slowly, TB thinks the market is coming to this conclusion and that is not a good thing. Remember the old saw: all Fed tightenings end with a financial debacle? Where was it? Who has failed other than a string of smaller mortgage companies. Not one bank yet (in the US). Yet the Fed is easing and provide massive liquidity of a scale not seen before…do we have a problem?…ya think???
Lump of Coal award: tossup between the banking regulators who announced yesterday new guidelines for subprime mortgages…and the media that hailed them as visionary. Hello…these were not new ideas but merely restating sound banking theory that has guided us since the Depression! It is shameful that the regulators (the Greenspan Fed, the banking regulators, the SEC, Congress…they are all culpable as is big business, Wall Street especially who created loans on bad premises, hedge funds who invested in them without understanding them and on a scale of unprecedented leverage. This is why this will be a long drawn out problem. Doesn’t this also mean fewer qualified borrowers?…yet housing stocks have been up two days in a row.
So buy financial stocks…in fact any stocks you like but TB won’t be joining you. He isn’t heading for the hills and selling what he does own but is waiting for the chance…and it will be a big chance. Also, don’t listen to those who tell you that there are defensive stocks…there are no defensive stocks in a rout. The best performer following the 2000 crash was Berkshire Hathaway…but it had not participated in the tech/dotcom rally. This time it is overpriced as Barron’s suggested last week. Since hitting a record high on 12/11 it is down 9%. In a selloff, if you have to sell, you sell what you can sell. Got it?
Despite those record earnings and positive surprise, Goldman Sachs fell 3.4% yesterday. The surprise here is that, while it is the most expensive of the financial stocks, it was already trading below its 200 day moving average and is down 18.7% from the 10/31 high, closed a gap back to 9/16 and has given back more than 50% of the rally from 8/16-10/31 and that 50% mark, $204 is now resistance…closed $201.51!
Overnight, Morgan Stanley reported and took a $9B writedown ($7.8B from subprime with $1.8B exposure remaining). This gave them a Q4 loss of $3.61 a share (back to back quarterly losses)…and had Q4 net revenue of NEGATIVE $450 million! Institutional underwriting revenue -18% (Goldman saw problems coming here too!). Guess what they are getting a ‘passive’ investment from China of 9.9%. Still they declared their 27 cent dividend! Do you see the problem here? …does someone?
Yesterday, Bear Stearns announced top management won’t be taking bonuses this year? Crisis? Stock is down 34% since 6/20. Merrill is down 39%, Morgan Stanley -36%, Lehman -36%, UBS -26%.
TB has spoken with some auto dealers (BMW, Volvo), and been told that sales are miserable. Not only are they slowing but their credit departments are rejecting a lot of the prospective buyers due to tighter lending standards.
That’s enough gloom and doom for now. In Financials, TB believes Merrill will outperform Goldman in 2008, and that WFC and USB are the two best bet in banks…he owns none of these…yet!
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and in no way reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. No fee…nothing to sell…merely observations of events in the marketplace offering a non-mainstream viewpoint…sometimes…usually? Hope you find it useful.
Copyright TBD Capital LLC December 19, 2007
