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Last Friday we got a taste of what the future is
likely to be like as we make our way further into the belly of the second
great depression. The Fed rushed to bail out a venerable Wall Street
institution, which was rumored to be insolvent. Sunday
evening, that rumor was confirmed to be true, as
Bear Stearns agreed to sell itself to JP Morgan for a paltry $2 per share. Two
dollars! This for a firm that was trading at $170 just over a year ago, and
was as high as $54 just Friday! If Bear Stearns is only worth $2 per share,
how can we possibly say with any confidence what other "investment
banks" are worth?
While this bankruptcy comes as a shock to nearly
everyone, it should be a surprise to no one. The global financial system has
been teetering on a precipice for years if not decades, pumped up by
unsustainable amounts of debt at every level of the economy, and is primed
for a crash. That the crash has been postponed countless times by even easier
money lent to yet poorer credit risks has served only to instill
a false sense of confidence in markets and to magnify the impending calamity
that seems finally to be at hand. Warnings that have been sounded on websites
such as this one appear finally to be coming true, as confirmed by none-other
than the venerable Wall Street Journal in a front page article titled, "Debt
Reckoning: US Receives a Margin Call."
The US is at the
receiving end of a massive margin call: Across the economy, wary lenders are
demanding that borrowers put up more collateral or sell assets to reduce
debts.
The unfolding financial crisis - one that began with bad bets on securities
backed by subprime mortgages, then sparked a
tightening of credit between big banks - appears to be broadening further. For
years, the US economy has
been borrowing from cash rich lenders from Asia to the Middle
East. American firms and household have enjoyed readily
available credit at easy terms, even for risky bets. No longer.
Did you ever think news
like that would ever make it off the internet and into the pages of the Wall
Street J? Even I was beginning to have my doubts. But the news is seeping
even further into the mainstream. This week's Time Magazine has an article
titled "10 Ideas that are Changing the World." Idea #8 is "The New
Austerity:"
Americans simply don't have
enough money to pay back the mortgage and credit-card debt they've run up. That
reality is forcing banks to retrench as loans gone bad shrink their capital
bases and falling house prices shrink the collateral that homeowners can
borrow against. And it will presumably force chastened consumers to change
their ways as well.
Americans simply don't have
enough money... What does it mean? It means defaults, economic loss
and a spiral of fear and more loss. It means more Bear Stearns. Time's
article quotes David Rosenberg, an economist at Merrill Lynch: "I'm not
saying we're going back to our parents' level of frugality, but what we have
witnessed in the past 20 to 30 years - and especially the parabolic credit
growth of the last five years - is going to be bursting in the next
decade." If not back to our parents' level of frugality, then what? To
our grandparents' level? How
can anything less be avoided, in an era when most
people are already working full speed, maxed-out and yet still need credit to
survive? And now they're cutting off the
credit!? The result for households will be the same as for Bear -
massive liquidation. And the Fed is in no position to do anything about it. The
Fed is currently operating in triage mode - desperately trying to aid the
banks and save the global financial system as we know it. But what ammunition
does the Fed have to save the average American working stiff, who is up to
his eyeballs in debt?
 In 2002, Bernanke - concerned with the possibility of deflation - concluded that
"under a paper-money system, a determined government can always generate
higher spending and hence positive inflation" simply by creating more
money. But so far it appears that only half of this equation is correct. Positive
inflation, definitely. But by lowering nominal interest rates below
inflation, the Fed has made it irrational for individuals to save. Why keep
money in a savings account that pays 0.5%, or even in a money market at 3%
when the "official" B(L)S inflation rate
is 4% and reality-based inflation is closer to 10%? The Fed assumes rational
people will simply spend the money instead of saving it, thereby generating
increased economic activity. But there is in fact a third alternative that Bernanke did not address, and that is that citizens might
choose - Gasp! - to pay off their debts. Time goes
on to say that debt is the new four-letter word, and that citizens are
catching on to the predatory ways of consumer lending. "Several
polls have shown that large majorities are planning to use the tax rebate
coming later this year to pay off debt rather than buy new stuff," it
says.
Deflation was the scourge of the first great depression, and it is what Bernanke was hired to prevent. With his
years of study and deep knowledge of the Great Depression Bernanke is one of the world's foremost academic experts on
the Depression. It would be a supreme irony if the second great depression
were to unfold on his watch. But as I write this - 10pm on Sunday night -
news across the wire is that the Fed has cut the discount rate another .25%,
effective immediately, and is offering more ways for financial institutions
to borrow money to help prevent another institutional bank run Monday
Morning. All this on a Sunday night.
This is unprecedented, and shows just how panicked the Fed is to soften the
crisis. Meanwhile, Asian markets are down 2-3%, as are US futures
indices. So Far, the Fed has proven powerless.
Meanwhile, take a look at these charts of the debt
insurers MBIA and Amabac from the latest Elliott Wave
Theorist (subscription required). Notice how quickly the
reversals came. The report states:
When optimisim
toward a market continues unrestrained despite deteriorating conditions, the
only possible resolution is a "light-switch" type of reversal. When
bulls have committed capital to a market and borrowed more to keep investing,
and when the rising prices fund even more borrowing to keep them going, there
is simply no cushion when the trend reverses. There is no cash on the
sidelines waiting to scoop up bargains; it has all gone into investments and
the loans that back them. Additionally, there is no contingent of bears
waiting for an entry point, and there are no short positions to cover. So there is nothing to stem a free fall.
The
report goes on to state that Moody's & Standard and Poors'
still has AAA ratings on both of these firms. And if you believe that, there
are plenty of banksters and brokers out there that
would love to talk with you.
If these charts say anything it is how ephemeral confidence is and how
quickly wealth can evaporate when that confidence is destroyed. The same
pattern will likely play out for any number of securities, companies and even
households in the weeks and months ahead: Everything appears fine until
suddenly it isn't.
The question now becomes - how far will the Dow itself fall before this is
all over? What is fascinating is that in spite of Friday's panic, the Dow
still managed to close within its range and above its lows for the week. Perhaps
traders felt optimistic that the Fed would get everything sorted out over the
weekend. That didn't quite happen.
Source: GoldSeek.com
Michael
A. Nystrom
Editor, Bull not Bull
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