There is a guy on the Prudent Bear board who calls himself Raven. Raven comes along every rally and tells the bears they are going to be buried by a record move in the market up. He isn't the only one out there calling for a massive rally to bury all bears and make all that are in rich. CNBC parades these guys across the stage every day. Monday, April 7, 2008, Washington Mutual received $7 billion in new capital for essentially 50% of is stock. The new price was $7 per share though Wamu was trading for around $11. Bulls had another one fixed, at least they think so.
After examining the Wamu deal, I had a sneaking suspicion that quite possibly the buyers found a place to cover their shorts. That would be an innovative deal, to short cut someone else causing a run on the stock by putting up money and thus making it impossible to exit a winning trade. This is a novel idea, especially if the players had use of the short sale money. Under the idea of repurchase agreements, it isn't beyond the realm that this very thing happened. Should a group have shorted this stock at lets say $30 per share and up and built a large position, they would now be in position by taking $7 of this $30 per share and buying 100% of the stock they were short with the funds they received from the repurchase agreement. Instead of putting in $7 billion, they would be walking out with $23 billion. This is a far fetched idea, but with all the scams that go on this day and time and the thieves lurking in the securities game, I wouldn't be surprised.
But, this is a theoretical idea of where to get some money. In any event, a capital infusion in a bank goes into outer space. A bank can only use money as a balance sheet entry and it ceases to exist as soon as it is paid into the bank. This means there is now new debt out there with no mathematical solution. Selling what you don't own to get money and creating money in a fashion that it can only exist in the minds of men and nowhere else are pretty wild ideas. But, where does the consumer who has to either own equity positions in what he sells or go to prison for conversion, get his money?
Greenspan was on the TV today. Greenie didn't have good news and Maria Bartaroma knew it and kept changing the subject. Greenspan was there to defend his record which is getting worse all the time after earning the name Maestro for his management of the Fed. For those that don't understand the system of banking, Greenspan might as well have been using Greenspeak. But, he was amazingly clear on what he was saying. What he was saying is don't look for things to turn around very fast.
The bulls are treating it like it is past and better times are ahead. Greenspan said exactly the opposite. He pretty much said the banks and Wall St. firms had a lot of deleveraging to do. Now, how do banks and Wall St. firms deleverage other than taking loans and securities off their books? Would it be possible that the massive run up in money supply has been through the massive need for money to carry the crap that the banks and Wall St. firms got stuck with? I think it is very possible. Not only possible, but very probable. In fact, I think it is pretty much the case. How much credit can a firm like Goldman carry if they go 15 to 20 to 1? A trillion dollars? $500 billion? Multiply that times 3 or 4 and you might get the idea if it has all been piling up instead of being passed through? Of foreign countries, how many want any debt marketed by Wall Street after this debacle? How much do you think they lost on CDO's? I bet it is many times what the banks have reported. You think they want more of them?
In any case, they either take in capital and make the money represented by the capital disappear or they cut their loan portfolio to deleverage. There is a lot to be sold and no money to buy it, so it will have to be marked down. What do you think these Fed loans are? They are funding loans the banks made to themselves that they expected to borrow from another bank instead. The banking system was insolvent or at least the very largest lending banks were. They are continuing to allow for the use of credit cards, but then again, credit cards are fee generators. But, the prime lending is getting tougher and tougher. With inadequate capital, few banks are in position to take the risks.
What we had was a subprime boom. We have been riding subprime for a lot longer than people think and we have been living off home equity for at least the past 30 years. Now the ball is rolling backwards. There won't be any subprime to get us out of this. This is what the bulls are missing, no subprime, no bull market.
Greenspan said the players were now insisting on re-regulation. We get the idea it was the people that wanted it, the Congress, but he says it is the investors and the banks themselves that want it. This is very important because it is going to restrict the leverage employed and most likely remove so many derivatives from the game. There are those that think the game is going back to normal, but no one wants the products the last game produced. We probably haven't seen the end of the game yet.
Greenspan also said there would be losses as long as the housing market was down. It was reported today that pending sales hit an all time low. What they left out was the all time low was since 2001. The Realtors Association is using bubble data and calling it all time low type stuff. It is missed on this idea that housing has been in a bubble since the mid 1990's, at least the sales have been there. Prior to 1997, we never sold the minimum number of homes sold in a year since, including 2007. This is new or preowned and we are still close to 5 million in preowned home sales. The market had never done 4 million prior to 1997. Thus we are still in a boom, taking on risky buyers in the sale of real estate.
This is not a new paradigm and it won't go on much longer. The PMI companies are getting killed. Next it will be the GSE's and the private label mortgages, which have already been waxed very badly. There is a lot of crying going on when in fact the industry is operating at boom levels and prices are declining despite this fact. To base data against a fiction is deceptive and this is what is going on. People would be stunned if they took this year out of context and compared it to those years prior to 1997, to find that the sales are records against the non-bubble years.
What does this all say? I believe it means we have real troubles. For one, the bulls have been diving into the home builders and the financials. They have also been hot on the gadget companies like Apple. The homebuilders can undersell the market until the market drops to where they can't build at any profit whatsoever. I think we are headed there, quite possible with 2 years supply of homes on the market before this one is done. Every subprime sale that occurred in the previous decade won't occur in the next decade. Before it is all done, FHA, FHLBB, FHLMC and FNMA will all need to be bailed out. So will the PMI companies. Where does the industry go if the zero down game is done?
How important are homesales? Well, when a home is sold, it frees up a lot of cash. Should a 40 year old sell a home he bought when he was 30 for twice the money, quite likely he will take this money and pay his credit cards or put it in the market or save it for college and get a maximum mortgage on his next home and take advantage of the home interest deduction. So, a $200,000 sale will free up maybe $80,000. This might be as much money as this guy makes in a year or 2. The consumer spending boom is dependent on such a game.
I don't know if you know where I am going with this, but Who has the free money to get us out of this? The bulls seem to think it is coming. I don't know where they are going to get the buyout financing that drove the market last time? I don't know where they are going to replace the stock buyback money that was coming out of the financials? Who is going to replace the easy credit given creditless people? What is going to happen to corporate earnings if activity declines even 2%? Have any of you ever examined the earnings of an automobile company during a recession and the boom afterwards? With a very marginal increase in sales, they go from going broke to record profits. What finances China and India? Don't you realize that the US has created all the basis of credit in those countries and without extra dollars, they cannot expand their economies? Does anyone recall what happened to Japan in 1990 after the US sneezed?
The question that keeps getting asked is why isn't the market lower with all the shoes dropping? For one thing, they haven't allowed any shoes to drop. They are all dangling and we haven't yet to see what the impact of keeping these shoes in the air from hitting the ground. What few realize is what the Fed is getting for all this cleaver financing is the capital base of all of these companies. Also, they don't realize that we haven't seen the earnings impact that is going to occur from this mess. Every prediction has been wrong so far because they aren't operating in reality. Reality is there are 3 to 4 million preowned sales in a good year, not 5 million in a bad year. Reality is that people are spending good credit, not soaked in subprime credit. Reality is that AAA means AAA, not junk bond CDO's leveraged to the moon. Reality is that trade is roughly balanced, not out of balance by $700 billion every year and rising.
The market is propped because there isn't anything in the US that foreigners can buy other than the corporations and treasuries. Who wants the crap that Wall Street presented us? What is going to happen when the interest rates rise enough to induce the solvent banks to trade their cash in on t-bills and leave the insolvent ones perpetually propped up by cheap Fed credit in return for their performing assets? When is the market going to value itself according to risk instead of derivative portfolio? We are looking at a risk free rate of return out of the SPX and it will go negative as soon as earnings adjust to the new financial reality