Keepin Our Heads Out Of The Sand!
A: Look, there are things going on out there that some people feel the need to discuss, some people just don't want to discuss, some people HATE hearing, and some people refuse to believe! Wishing and hoping is not going to solve this situation! Denial works for some people, but not for me. While I eagerly await for the light at the end of the tunnel to show it's first ray, it's good to see the equity markets wake up to what is going on and adjust expectations downward. If the damage lies before the light, then bring on the damage so we can get to the light! And lets continue to discuss these issues head on, which means keeping that head out of the sand!
Hey, guess who joined the club today? Mr. Bernanke!! In a speech to a banking group this morning, the fed chief seemed to acknowledge that the role of biased optimism needs to change to a role of crisis management. According to Yahoo Finance's article, "Fed Chief: Mortgage Crisis To Continue":
Federal Reserve Chairman Ben Bernanke called Tuesday for additional action to prevent more distressed homeowners from falling into foreclosure. "This situation calls for a vigorous response," Bernanke said in a speech to a banking group meeting in Orlando, Fla.So, over the past few weeks the fed is now telling us that the coming quarters are going to bring us:Even with some relief efforts under way by industry and government, foreclosures and late payments on home mortgages are likely to rise "for a while longer," Bernanke warned.
a) rising inflation pressures
b) weakening economy
c) rising unemployment
d) rising foreclosures
e) rising late payments on home mortgages
Man, what took him so long to publicly acknowledge all this? Bloggers have been discussing these concerns for 6-8 months already. If there is a sliver lining that I can think of, is that it seems we are going through the painful process that in my opinion we MUST go through to get out of this mess. It's one thing to watch all the data, indicators, fundamentals, etc.. and discussing the likely path; but it's another thing to experience the carnage. I think we are in the 4th or 5th inning of the painful process that we must go through. Eventually, all the stimulus we had thus far will put a floor on the down cycle. The problem is that the root cause of the problem (housing) is illiquid, takes time to reverse course, and was inflated through the use of leverage that was securitized by wall street. What I mean is, this will take time because of the self-fulfilling relationships of the individual problems we face...
HOUSING DEFLATION LEADS TO DEFAULTS/FORECLOSURES which leads to BROKEN CREDIT MARKETS which leads to MASSIVE WRITE DOWNS OF MBS which leads to CAPITAL RESTRICTIONS which leads to RISING LENDING COSTS + TIGHTER LENDING STANDARDS which leads to SLOWER GROWTH which leads JOB LOSSES which leads to FALLING STOCK PRICES which leads to NEGATIVE WEALTH EFFECT which leads to GO BACK TO BEGINNING!
The cycle feeds on itself. Remember this discussion back in late October of last year, "To Mr. Bernanke: BE STRONG", where I was concerned about commodity inflation & instead said to bring on the recession:
Gone are the days where bad bets are penalized by the tradable markets, because if they were it would cause financial distress to our economic system that maintains afloat from interventions from government and private institutions. That is why free market capitalism is NOT AT WORK HERE!Its not that I want the economy to weaken or stocks to go down, I don't, but I don't have much of a say into that now do I? Its the only way to cleanse the situation we created. Inflating us out of this mess has serious medium term ramifications, and should be a topic of conversation because it could affect all of us.If it was, the markets would have to work themselves out and stocks of banks, lenders, and others who hold these assets would have corrected significantly more; and that is obviously not happening. We have become a society that fears recessions rather than understand them for what they are; healthy and normal disruptions in economic growth necessary to ensure longer term sustainable growth. We need to shake out the bad bets and weak players, let the markets fix themselves, and move on with the lesson learned.
The markets are working, even if that means the marketplace itself is not working. The markets are currently self-correcting in the following ways:
a) seizing up of secondary mortgage markets - the very market where banks offload mortgage backed securities is dead. This is causing lending standards to be tightened, available capital to be restricted, lending rates to rise, risk to be re-priced, and losses to be booked on the bad holdings. Weak corporations will die and likely be taken over or declare bankruptcy. This is a self-correcting process as the industry adjusts to the way it used to be. You can't be a heroin addict for 5 years and expect to go through no withdrawal when you quit! Well, the credit markets are in withdrawal right now. Let the detox continue as we provide some minor painkillers (monetary & fiscal stimulus) to make the cleansing process a bit more manageable; and beware giving too strong of painkillers that will re-ignite the addiction.
b) housing deflation - the turnaround in housing is removing speculative players from the market who helped power the unsustainable boom. In addition, as housing prices fall banks are re-thinking to whom they will lend their capital to and at what rate. In short, the bullshit days of giving anybody a loan because housing goes up are gone! As housing deflation continues & lenders actions help correct the credit markets & clean the books, fundamentals should start to reverse course. These two forces, housing deflation/weak fundamentals & credit markets, are inter-related. It is likely that credit markets will normalize when housing fundamentals start to improve.
There will be great opportunities as a result of this cleansing cycle; so keep your eyes open. In the meantime, lets get more clarity on the depth of the crisis and watch for housing fundamentals to turn before we can start discussing the brighter times that lie ahead. We are not out of the woods yet by any means. Here are some of today's creditville headlines:
Bernanke Plan; Citigroup/Goldman Earnings Estimates Cut (via Bloomberg)
U.S. stocks fell, led by financial shares, after Federal Reserve Chairman Ben S. Bernanke urged banks to write down more mortgage debt and analysts cut earnings forecasts for Citigroup Inc. and Goldman Sachs Group Inc.Ambac Decides Against Splitting (FT.com)Citigroup fell $1.39 to $21.70. Merrill Lynch & Co.'s Guy Moszkowski said he expects $18 billion of credit writedowns related to the company's holdings of subprime mortgages, collateralized debt obligations, leveraged loans, bad consumer debt, real-estate lending and other investments.
Ambac, the troubled bond insurer, has decided against splitting in two as it completes a $2bn-$3bn recapitalisation, insiders said.Under a recent proposal, Ambac, the second biggest bond insurer, or monoline, would have split its operations into a triple-A-rated municipal bond insurance business and a structured finance business with potentially lower ratings. A lower rating on the structured part of its business could have forced banks to reduce the value of guarantees on collateralised debt obligations and on derivative trades.
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