Are You Half Full or Half Empty?
A: Which are you? If you are half full, you are choosing to look at the fact that the fed took on a ZIRP policy for rates, threw in the kitchen sink, and that the treasury just bailed out the automakers with a $13.4Bln bridge loan. The half full mentality will say that this is all good stuff, it prevented a disaster, and that inflation will succeed in killing off deflation so buy stocks, buy real estate, and buy commodities. If you are half empty you look at the fact that things are so bad, that the fed had to take on a ZIRP policy, that the treasury felt forced to rescue the auto's for fear of collateral damage that bankruptcy would bring, and the more important news that S&P lowered its credit ratings on 11 US & European banks and on GE & GE Capital ratings to negative. For the half full folks, enjoy the champagne, but for me, it's way too early to celebrate.
At 2:14PM on Tuesday, one minute before the fed announced their decision on rates, the DOW was trading at 8,672. Then the following occurred:
1) Fed abandoned rate cuts and instead chose to announce that the fed funds target rate will be in a range from 0% to 0.25%. The reason was that the effective funds rate was already close to 0%, via massive liquidity injections, and a rate cut would be more psychological than real. So, they acknowledged this and chose to just take on a zero-interest-rate-policy, or ZIRP.
2) Fed hinted at the next steps of quantitative easing to combat the credit crisis, which in essence, is the fed printing money. By purchasing longer term treasuries and large amounts of mortgage backed securities, the fed can control rates more effectively. As they buy, the newly minted dollars enter the economic system from the primary dealers that sell the securities, hence the term 'printing money'.
3) Fed announced they will do everything and anything to fight deflation.
The markets surged almost 400 points on the heroin jolt. Today, the treasury announced a rescue for the automakers. They will receive 13.4Bln to survive until March when restructuring plans will be due. If they cannot prove the viability of their new model, the loans will be called in.
Between a ZIRP policy, fed buying massive amounts of mortgages, fed announcing likelihood of buying longer term treasuries, and the temporary rescue official for the automakers, stocks right now are exactly 75 points higher from the level they were trading at one minute before the fed announcement on Tuesday! Certainly not the jolt investors piggybacking the fed were hoping for, and down some 200 points from the close of trading Tuesday.
Does this make more people want to buy cars? Does this make more people want to buy homes? Perhaps, but I would argue that given the stress in the macro environment right now and the pain felt by consumers balance sheets, there is more reason to argue against this. Here is what has happened over the past 1-2 years:
a) Consumers homes are worth significantly less
b) Consumers debts are considerably more - especially those that used their homes as an ATM via mortgage equity withdrawal. The money is gone, but the debts remain.
c) Equity in homes have gone down as a result of (b) above
d) 1.91 Million people have lost their jobs so far in 2008 alone - this number continues to rise and is likely understated. The broader U6 unemployment rate is at 12.5%
e) Consumer confidence remains at very low levels
f) Negative wealth effect from equity markets down 35% in 2008 hurting portfolios and retirement accounts
g) Housing as an asset class has lost much of its luster - generally investors/consumers choose not to buy a depreciating asset
h) Affordability - lets not forget that house prices rose an unsustainable percentage from 2002-2006 as credit went parabolic. Both credit & housing bubbles popped. Even as prices are down 25-35% or so, they are still out of whack compared to price/rent affordability ratios
So I ask you? Taking into account where we are right now, where we came from, and how the near term future looks, do you honestly believe that bringing rates down from 5 7/8's to 4 7/8's will solve our housing problems and bring buyers back en masse? Lets keep it real. If you think so, fine.
If you are keeping your head out of the sand and fighting denial, you will see that things are worsening, not getting better, which is why S&P is cutting the credit ratings on 11 banks and GE/GE Capital.
WSJ.com, reports, "S&P Cuts Ratings on 11 Banks":
Standard & Poor's Ratings Services cut its ratings on 11 U.S. and European banks and put a 12th on watch for possible downgrade amid what it called significant pressure on the large, complex financial institutions' future performance because of increasing risk and the deepening global recession.As much as I would like to be optimistic, especially after the damage done in housing, credit and stock markets, I fear that the real economic pain is still yet to be felt by main street. Lets not forget that this is a consumer driven economy and that this is not just a subprime problem, this is an overall debt problem and it has been spreading to near prime (Alt-A) and Prime, credit cards, HELOCs, auto loans, student loans, LBOs, cov-lite LBOs, commerical loans, neg amortizing loans, etc..
The downgrades come two days after S&P moved the U.S. and U.K. out of the highest of its 10 groupings of banks by country, noting the credit deterioration that is expected to continue. The banks downgraded were the banking operations of Bank of America Corp., Barclays PLC, Citigroup, Credit Suisse Group, Deutsche Bank AG, J.P. Morgan Chase & Co., Morgan Stanley, Royal Bank of Scotland Group PLC, UBS AG and Wells Fargo & Co. Also cut was Goldman Sachs Group Inc. None of the reduced ratings were lower than A.
Leverage is coming down to about 10/12:1 from high levels and this deleveraging process is both long & painful. Where are we now? Rolfe over at OptionARMaggedon had this chart on the leverage ratios:
All of those leverage ratios are high. And they actually understate the truth. For instance, besides the $2.1 trillion of assets Citi has ON its balance sheet, it has another $1.2 trillion OFF its balance sheet. The only reason I didn’t include these in my calculation is I wasn’t sure how much off-balance sheet exposures the other banks have and I wanted the leverage calculations to be consistent. (I tried to look it up in their SEC filings, but disclosure varies by company. Citi is the only one of the bunch that spells it out clearly.)In short, there is a reason rates are at 0%, we have seen the fed delve into buying mortgages, we have seen 18 credit lending facilities, we have seen the fed balance sheet expand to above $2Trln, we have seen the gov't rescue of AIG/Citi/Autos, we have seen the nationalization of Fannie/Freddie, we have seen the shotgun marriages of Countrywide/Bear Stearns/Merrill/WaMu/Wachovia with their new owners, we have seen the failure of Lehman, we have seen a $700,000,000,000 rescue package of which $350,000,000,000 was used to recapitalize banks balance sheets thus far, and we are about to see another $850,000,000,000 fiscal stimulus package early next year.
This is the story of the housing crisis, the banking crisis and the global financial meltdown. Everyone, everywhere was levered to the hilt, using piles of borrowed money to make leveraged bets on everything from real estate, to stocks, to currencies, to bonds, to companies themselves (LBOs), etc. All of these government bailouts, er, “guarantees” are simply a transfer of risk from the balance sheets of various financial companies to governments’. To prevent “A” from falling too far, and thereby wiping out the “E” of the financial companies, the government absorbs the assets itself, immunizing the financial companies from loss.
The trouble is, the losses don’t just go away. Someone will lose. First it’s common shareholders. Next it will be the U.S. taxpayer.
Those that follow the 'Dont Fight The Fed' mantra since rate cuts started late 2007, have got murdered. I say, 'Don't Fight The Fed...Yet'. With fed rates at 0%, they are essentially out of bullets. I'll be looking for when they hike rates for the first sign of stability in the system and that the worst may be over. However, given credit deflation, the death of wall street, the regulation coming, and the new look of securitization process if any, I think the growth rate at the tail end of this mess will be much slower than some hope.
Me, I'm more looking forward to how well the JETS will do than I am the first six months of 2009; where macro data will be ugly. I'm most interested in getting through this whole mess with as few unintended consequences from policies taken to combat this deflationary spiral.