This will be another installment of "the newsletter before the newsletter." The muse struck, so here I write.
In this missive:
- Money Market Funds BREAK The Buck
- Ben Bernanke Is A Liar
- Stock Market Action This Week
- The End Game
- Newsletter update: It's coming...
Money Market Funds BREAK The Buck
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Did you catch the whopper about money funds breaking the buck? Here they come... The list of institutions reported in the Bloomberg story below and the actions taken qualify this as a seven sigma event. This has NEVER happened before. The good news is that the total dollar amount is "manageable" (with Helicopter Ben liquidity injections over the next two years papering over this monstrosity and many more soon to come). In fact, this entire credit crisis revolves around a dollar amount that is containable - even if we ultimately exceed the one trillion dollar hurdle. With an identifiable target, the system can be "fixed."
The bad news is that these damn infectious SIVs and problematic asset-backed paper is darn near everywhere and it only takes a small amount of rotten meat to make a whole sausage go bad. I'm not among bears that believe we are headed for a deflationary crash on the back of a collapse in credit. Again, the system and the powers that be face an identifiable threat -- even though the bad paper is spread across a wide swath of the global financial system. The patient can be treated with liquidity - massive amounts of liquidity.
The specific case of money market funds is worth paying extra attention to. I wouldn't be surprised if over 50 funds need capital injections when all is said and done. That could very well shock people. We are already at a precarious place when it comes to
sentiment. Assaults to the perceived sanctity of money market funds could have unpredictable impacts to mass psychology.
Ben Bernanke Is A Liar
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I kind of miss the Alan Greenspan days. Good old Mr. Magoo would testify before Congress and provide such absurd, obfuscations the English lexicon is now blessed with the term "Greenspan Speak." Many of "our" fearless Congressional representatives trembled at the idea of looking stupid in the face of misperceived brilliance from "The Maestro" (just when did Bob Woodward fall from investigative journalistic grace to become a hack insider?). Greenspan had the talent of not lying quite as often as Bernanke. Anytime Grandpa Al wanted to do away with an uncomfortable subject he'd just embark on a circumlocutious obfuscation and no Congressional representative would dare ask just what the heck was said for fear of being seen as an idiot.
Enter Ben Bernanke and his policy of a more "open" Federal Reserve. Last week he testified before Congress that the risks of economic slowdown and rising inflation were balanced. Nothing could be further from the truth. in fact, we're going to have both, and the Fed is powerless to prevent stagflation. We might get lucky and 2008 will prove to be a healthy year for the global economy overall. Generally speaking, I subscribe to the camp that holds this forecast. But the US economy is still going to experience considerable pain. Last week's testimony was in service of supporting the Dollar - attempting to slow down its fall. To some extent, it worked. Gold and oil and cross currencies were due for a breather and the unwinding of the Japanese carrytrade took a particularly nasty turn on Monday, sending hedge funds scurrying to liquidate positions in commodity-based investments and cyclical momentum stocks tied to the thesis of global economic growth.
The Fed and the Treasury are interested in having a slow, orderly decline in the Dollar, not a crash. The theatrics of the last ten days are not surprising. Now, we are right back where we started from and the bias for a slowly declining dollar, and rising oil and gold have returned.
The Fed will most definitely cut rates no later than the next Open Market Committee meeting, regardless of the propaganda floated since the last cut and throughout last week. They have no choice. The systemic risks to the credit system remain as bad as August. They just can't speak of that reality in plain English and all at one time. To do so would facilitate a Dollar crash, and that's not in anyone's interest.
Stock Market Action This Week
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Today was just another day in our schizophrenic market. For every reason a bull can point to for a bottom setting in, there are more "unknowns" that haunt the minds of both bulls and bears -- for the bears know just how bad things could get if the credit system freezes.
Did I tell you I was thinking of getting a dog? No, really. In fact, hanging out with one like this
http://youtube.com/watch?v=Ljrv979j7tw
might help me get into the minds of average fund managers! Agreed?
It's clear a great many traders are itching to get back into financial services companies. On Tuesday, Goldman Sachs reported that they had net negative exposure to troubled release asset backed paper. They've been particularly successful shorting the market. That announcement, combined with reasonably strong sales reported by WalMart sent the market rocketing higher in a broad-based rally. But no one seems to ask the logical question: who's on the other side of those Goldman shorts? Can you say Citigroup and hapless hedge funds? Just because Goldman happens to have a reasonable balance sheet does not necessarily translate into a signal that it's ok to go back into the water. Furthermore, Wallyworld's sales are up precisely because a great many more American's are getting squeezed -- and the fact that the price of food and gas WalMart sells has been on the rise.
Bear Stearns reported this morning their write-offs for the current quarter would be less than expected. That certainly helped carry over yesterday's festive mood. But by the end of the day, the financials had, for the most part, given back all of today's gains. In technology, bellwethers like Apple failed to have profoundly bullish news carry over through today. It was reported that China Mobile will eventually offer Apple's iPhone to a subscriber base in excess of 400 million. That sent Apple back from the depths of a nasty correction yesterday, but follow-through entirely failed today. One could see similar weakness in the action of Google and other sentiment bellwethers among momentum technology stocks. This is anything but healthy, particularly as it comes in the wake of last week's sizable NASDAQ correction. The schizophrenic nature of the market continues.
We can hope that a great deal of the asset write-downs will have been reported within a couple of weeks. New accounting rules coming into effect will help facilitate this process. It's possible that within about two weeks market volatility will calm down for a period of two months, give or take -- until the next cycle of asset write-down reportage begins. Until then, expect continued massive volatility.
The End Game
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Whatever happens, some elements of the end-game are indeed perceivable. Having a healthy allocation to gold, silver and assets that perform well under conditions of high inflation are an absolute necessity in today's world. It just so happens that many hard asset related investments can be justified for reasons above and beyond the credit crisis. For example, a heavy exposure to energy and alternative energy investments is a sound portfolio decision for a variety of reasons beyond the scope of this particular letter.
This credit crisis will be fixed with liquidity injections AND DIRECT MONETIZATION of troubled assets by the Federal Reserve accepting them as collateral for loans that will, in the long run, be forgiven. We will also likely see some bastard clone of the Resolution Trust Corporation created ala the "Savings and Loans Crisis." As this creature eats bad paper, aggregate national debt will rise on the back of a taxpayer subsidized bailout. The latter might not necessarily be a terrible thing if these problematic securities were sold at reasonable prices ($0.20 on the dollar, anyone?). But instead, bureaucrats will serve their masters and the system and the average price paid for damaged goods will likely be above $0.80 on the dollar, hosing the tax payer. Check back with me in two years.
Maybe we'll be lucky and "our" representatives will come up with one of those cute government program names. "SIV Condom Corporation?" "ADR Act"? (aka "The American Dream Restoration Act of 2008"). Don't ask me. Naming the thing is well beyond my paygrade. Have no fear. Treasury Secretary Paulsen will be on the case. Americans will have a nice sounding name to cheer and salute as the inflation tax sneaks up and bites us in the ass.
Vacuum-cleaning up the bad paper along the lines of an ADR Act will most certainly infuse liquidity into the system. But that infusion is tied to the creation of more debt and is similar in character to much of our day to day system activities anyway. Dealing with the crisis by direct monetization, however, is an entirely different animal - so much so that most people don't think it would dare be attempted. But don't scoff. Back in August, in news reports that didn't receive much analysis, it was noted that the Fed accepted as collateral realestate asset backed paper for liquidity injections. The media reported that this was the first time in history that action was taken. No one in the financial press has bothered to go back to the Fed to see what happened to that collateral. While I can't prove this at this time, I believe the odds are high that collateral was flushed down the toilet, and that the Fed never had any intention of attempting to collect on this particular short-term lending. That was a moderate case of direct monetization, exactly as Ben Bernanke described as being necessary from time to time in his famous speech about how to prevent another Great Depression - helicopter money.
Are you ready to pay nearly $5 for a loaf of bread? In two or three years, that's going to happen -- and I'm talking about bland mass produced bread, not the fine artisan loafs we've got around San Francisco fetching near $4 already.
Newsletter update: It's coming...
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My money management activities have been quite time consuming. Staying ahead of intense volatility hasn't left me with enough free time to finish newsletter infrastructure development. But I hope to have a skeleton operation up and running by the end of the month. Anyone on the "Friends of Eric" list will be alerted to the formal launch of the letter - and if you got this email directly from me, you're on the "FOE" list :-)
With Thanksgiving soon approaching, I'd like to wish you all a wonderful holiday should I not have the opportunity to speak directly with you in the days ahead. Through all the turmoil, we have much to be thankful for. I'm certainly looking forward to a few extra days of downtime for reflection and for catching up on newsletter infrastructure!
Best investing to you,
Eric Dubin
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Bank of America, Legg Mason Prop Up Their Money Funds (Update6)
By Shannon D. Harrington and Christopher Condon
Nov. 13 (Bloomberg) -- Bank of America Corp., Legg Mason Inc. and at least two other companies are propping up their money-market funds to cushion them against possible losses on debt issued by structured investment vehicles.
Bank of America, the nation's second-largest bank, may provide as much as $600 million to funds that bought debt from SIVs, Chief Financial Officer Joe Price said at an investor conference today.
Legg Mason, SEI Investments Co. and SunTrust Banks Inc. have stepped in to make sure their funds don't fall below the $1 a share net asset value, known as ``breaking the buck.'' The 10 largest managers of U.S. money funds have about $50 billion in short term debt of SIVs, some of which has defaulted.
``This is the first real case'' of securities held by money-market funds defaulting, said Peter Crane, founder of Crane Data LLC, the Westborough, Massachusetts-based publisher of the Money Fund Intelligence Newsletter.
FULL STORY:
