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Friday, September 14, 2007

Kill The Greenspan Put


North American indices have spent the early part of this week trickling higher in anticipation of Fed action early next week. I’m expecting a modestly negative bias today on profit taking and position squaring in advance of a busy week next week.

Commercial Paper Slump Eases; Asset-Backed Drop Slows (Update6): “The decline in the U.S. commercial paper market slowed last week, prompting speculation that the worst of the short-term credit rout may be over.

U.S. stocks rose and Treasuries fell after the Federal Reserve reported short-term debt dropped by $8.2 billion, compared with a decline of $54.1 billion a week earlier. That coincided with Countrywide Financial Corp. obtaining new financing and banks finding buyers for loans to fund Kohlberg Kravis Roberts & Co.'s buyout of Alliance Boots.”

In my opinion, it is premature to call a bottom here. Things are just starting to fall apart in other markets like the UK:

Northern Rock Gets Emergency Bank of England Funding (Update4): “Northern Rock Plc got emergency funding from the Bank of England, the biggest bailout of a British lender in 30 years, after a freeze in money markets left the mortgage provider unable to finance itself.

Northern Rock shares plunged as much as 26 percent to a six- year low after the company said today the central bank will provide an unspecified amount of credit. The Newcastle, England- based bank is the U.K.'s third-biggest lender by gross mortgages with loans worth 17.4 billion pounds ($35 billion) as of June 30.”

At the end of yesterday’s post, Bill Gross The Ninja, I discussed how the first cracks are now appearing in the UK real estate bubble.

“Northern Rock is the U.K.'s worst performing bank stock this year. Its shares fell 46 percent through yesterday, compared with the 12 percent drop of the nine-member FTSE All Share Banks Index. The stock fell 137 pence to 502 pence as of 10:45 a.m. in London, valuing the lender at 2.11 billion pounds.

“The outlook for Northern Rock as an independent entity does not look good,” said Sandy Chen, a London-based analyst at Panmure Gordon & Co., who has a “sell” rating on the stock.”

House Prices Plunge $20 000: “Calgary's resale housing market, which has set a scorching pace for the past two years, has dramatically cooled, with the average price for single-family homes plunging by about $20,000 in August, according to a local realtor.”

Calgary is at the heart of Canada’s commodity lead boom. Real estate prices in Calgary and surrounding areas like Fort McMurray have shot to ridiculous levels that rival and even exceed the excesses seen in the most speculative US markets. The first cracks are starting to appear DESPITE STUBBORNLY HIGH COMMODITY PRICES.

“The average sale price dropped primarily because of a decline in the sales of luxury homes, those over a million dollars.”

A closer look at the data reveals that most of the drop was caused by a drop in luxury home sales, therefore disproportionately pulling down the mean price. HOWEVER, when an 850 square foot condo costs $362 000 and commands a $300 condo fee, even those with salaries of $70 000 are living beyond their means.

Fidelity's Shah Expects Sharper Swings in Markets (Update1): “Fidelity International Ltd.'s Sanjeev Shah, who's taking over the 3.1 billion-pound ($6.3 billion) U.K. Special Situations Fund from Anthony Bolton, said the current turmoil in markets will get worse.

“The environment has changed and it will get more volatile,” Shah said in an interview. “There is more uncertainty in the market in terms of economic outlook.””

I post what some of the big players are thinking because it is important. These thoughts are self-fulfilling prophesies first and then contrarian indicators second. As the hedgies, traders and other managers start to get concerned they will act accordingly and asset prices will behave accordingly. In this case EVERYBODY is reducing their risk exposure. That means rallies are being sold and valuations are contracting. Expect lower highs and lower lows until everybody is fully de-levered and re-trenched.

TraderFeed has great posts on market and trader psychology with the recent post Using Emotion to Change Emotion being particularly relevant during these times of market uncertainty and heightened volatility.
AfraidToTrade has great posts about managing emotions and building sound trading strategies that overcome your trading fears. The Psychology section of the blog is a great resource.

China Raises Rates for Fifth Time to Cool Economy (Update2): “China raised interest rates for the fifth time since March to curb the fastest inflation since 1996 and damp speculation in stocks and real estate.

The benchmark one-year lending rate will increase to a nine- year high of 7.29 percent from 7.02 percent, starting tomorrow, the central bank said today on its Web site. The one-year deposit rate will rise to 3.87 percent from 3.6 percent.”

Stomping on the brakes again… eventually they’ll get this thing to slow down… or skid out because this wild behemoth really isn’t easy to control at all.

Ease Money-Market Crisis by Letting Banks Go Bust: Mark Gilbert: “It's far from certain that lower central-bank rates would unfreeze the money markets. Moreover, central bankers are probably willing to sacrifice smaller lenders so the pain is enough to make financiers more cautious about future investments, provided there's no threat to general stability.”

The Banke of England however, has a different opinion and as I’ve argued in We Need Another Volcker, I believe it is the correct approach.

“The Bank of England, by contrast, has been adamant that it won't rescue the money markets by accepting low-grade collateral, or by offering three-month cash. Indeed, the Fed and the ECB were rebuked yesterday, albeit obliquely, by U.K. central bank Governor Mervyn King for bailing out commercial banks.

King sounds determined to take advantage of the current contagion to try to extinguish the notion of a “Greenspan put” or “Bernanke put,” the idea that central banks will always ride to the rescue.

The U.K. central-bank chief said helping commercial banks salvage their “risky or reckless lending” is especially dangerous because it “encourages the view that as long as a bank takes the same sort of risks that other banks are taking then it is more likely that their liquidity problems will be insured ex post by the central bank.””

The death of the “Central bank put” would beneficial to all in the long run as market participants are firmly reminded that the risks they take are ACTUALLY their own. The current system of privatizing profits and socializing the losses is disgusting and perversion of capitalism.

“The correct number of banks to fail when a credit bubble bursts is not zero. If the best way to avoid the mispricing of risk in future is to sacrifice some of the less-prudent lenders on the altar of liquidity, then let the culling commence. That is especially the case if it erases the perception that central banks will always act as lenders of last resort, even to institutions that don't deserve to survive.” [Emphasis mine]

Think about it. The Fed injects liquidity and cuts rates. What kind of lesson will that send to the irresponsible lenders and consumers of credit? What will that do to their FUTURE behavior towards risk? How big will the NEXT bubble therefore be?

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