Rebel Traders – Analysis Without The Hype

Very unique way of explaining, albeit simply, the concepts of Keynes economics and that of the Austrian economist Friedrich von Hayek.

“There’s something of an illusion of profitability”, says Kenneth Rogoff, Harvard economist. At a gathering of the American Economic Association’s yearly meeting held in Atlanta. Economists from a wide range of backgrounds mulled over the prospects of growth in the United States for the next decade.

[...] experts from a range of political leanings were in surprising agreement when it came to the chances for a robust and sustained expansion:  They are slim.

Many predicted U.S. gross domestic product would expand less than 2 percent per year over the next 10 years. That stands in sharp contrast to the immediate aftermath of other steep economic downturns, which have usually elicited a growth surge in their wake.

“It will be difficult to have a robust recovery while housing and commercial real estate are depressed,” said Martin Feldstein, a Harvard University professor and former head of the National Bureau of Economic Research.

Housing was at the heart of the nation’s worst recession since the 1930s, with median home values falling over 30 percent from their 2005 peaks, and even more sharply in heavily affected states like California and Nevada.

The decline has sapped a principal source of wealth for U.S. consumers, whose spending is the key driver of the country’s growth pattern. The steep drop in home prices has also boosted their propensity to save.

“It’s very hard to see what will replace it,” said Joseph Stiglitz, Nobel laureate and professor of economics at Columbia University. “It’s going to take a number of years.”

One reason is that U.S. consumers remain heavily indebted. Consumer credit outstanding has fallen from its mid-2008 records, but still stands at some $2.5 trillion, or nearly one-fifth of total yearly spending in the U.S. economy.

Another is that many of the country’s largest banks are still largely dependent on funding from the U.S. Federal Reserve and the implicit backing of the Treasury Department.

Kenneth Rogoff, also of Harvard, argued that if the U.S. government ever “credibly” pulled away from its backing of the financial system, then a renewed collapse would likely ensue.

He cited government programs giving large financial institutions access to zero-cost borrowing as artificially padding their bottom lines.

“There’s something of an illusion of profitability,” he said. (Source: Reuters) H/T butch (emphasis mine)

It has been said numerous times that RebelTraders is only a bear site, in that only bearish news is presented. Is that being objective, or is it merely an echo of reality?

Perhaps if you knew a bit more about me you might adopt a slightly different view of what is presented on my site and why it is I am so adamant about certain viewpoints. You may have a perception that I am a greedy, selfish, or even a stubborn individual who cares only about himself.

While I am bearish on the economy and the markets I am nothing of the above. Outside of the markets and this website I am told I am a very generous person. I give to others without asking anything in return. I volunteer a substantial amount of my time to help others through our fire department, being the coordinator for a local Community Emergency Response Team (CERT), and a member of our towns Office of Emergency Management team. Mrs. Rebel and I live in a very small community and we are both heavily involved in organizations that are all centered on helping those in need. And we never ask anything in return. What we do get in return is the satisfaction of knowing we made a difference in someone’s life in a time of trouble. But this is just how my Wife and I are, it is what we enjoy doing.

The birth of RebelTraders on May 16, 2007 was out of that very same mindset of helping others.  I am told by my family that I sometimes care too much and that I give of myself more than I should. Even this very website is free and provided to all without asking anything in return. When the site readership grew I had to move to my own dedicated server because it outgrew the free blogger service ‘blogger.com’ which is where RebelTraders was born. The costs to maintain and operate this site come out of my own pocket each and every day. While there is some advertising on the site it does not make any profit for me. It just goes towards the upkeep of the site and even then I still must put out my own money. Some have suggested I put up a ‘tip jar’ on the site, but I have even resisted doing that for it would make me feel I’m taking money for something I enjoy doing which is helping others.

Some say I have a chip on my shoulders, that I hold extreme anger against those who speak bullish on the markets. The only chip that I have on my shoulder is angst against those who attempt to take money from others for their own financial benefit. Be it through deceptive marketing, misguided information, or outright lies. I know it is a chip that will always be there for a world that has an open and honest Government and honest business practices will never become a reality in my lifetime. But that does not mean I just lay back and just take it. As long as I have my voice and fingers to type with I will speak my mind and say what I see to be the truth, no matter how many people don’t care for it. I’m not here to please everyone all the time. For if that was my only goal then RebelTraders would have never been born.

I have attended many trading seminars over my lifetime. Some were here in my own neck of the woods around Philadelphia and New York, and occasionally by travel. My reason for attending these seminars once in a while is to meet people. I have met some of the best technical analysts and traders in those travels. One aspect of your web host here is that I am a ‘people’ person. I enjoy listening to all view points and believe it or not I am rarely one to tell others they are completely wrong. Instead I will just present an alternative view. I can’t force anyone, nor should I even expect anyone to adopt my alternate view if I have one. It is always up to the individual to decide for themselves what view point is right for them, whether it be right or wrong. I can only offer a viewpoint that may provide some balance to their views.

In early 2007 I became extremely frustrated with the quality and/or skewed information that was being presented to investors and traders.  The reason I was frustrated was that through my own observations, research, and analysis of the technical aspects of the markets led me to believe that a significant bear market was about to befall upon the world. This is why RebelTraders was born.

During those early days trades were discussed, macro and micro economic conditions were presented, and counter analysis was offered in the face of ever increasing bullish talk from CNBC and the Government. In the eyes of some readers, I was being unpatriotic to go against my own Government by disagreeing and even refuting their claims that all was well with the economy.  As time went on the economy continued to show all of the warning signs of significant and long lasting change was coming. And in spite of all the complaints from readers who kept trying to persuade me to think otherwise I kept my view.

As I stated earlier I am keen to other viewpoints, but they must be based on rational thought and data. As an engineer I have spent a good part of my life always debugging and designing systems that were based on facts. An engineer bases his or her work on empirical evidence and that is how I always have approached the markets my entire trading career.

The stock markets are full of individuals and corporations who only have one interest in mind, and it is theirs. Even large investment firms who specialize in managing other people’s money may say they have your best interest at heart but the naked truth is that for the majority of them they don’t care about you. Every company always operates under a ‘what is in it for me’ business model. The primary reason investment banks and other investment specialists are in business is to make money, not to make ‘you’ money. Yes, there are some that base their profits on the growth of your portfolio but that is not where the real money is being made. The real money comes from simply having your account in their files to show a bigger account base which in turn allows them to do more and grow bigger. They can’t grow and make more money if the deposit base is thin.

Your $250,000 portfolio with Acme Investment Advisers Incorporated (made up name) is worth more to them as an account, irrespective of how much money you make or lose under their guidance. Case in point, how many people do you know received a phone call from their investment advisor in late 2007 or even 2008 and were told to sell everything? How many were told that the markets are facing big problems ahead and it might be safer to get out? See what I mean. The only thing that matters to an investment firm is the fact that you have money in their ‘system’ and so why would they want to tell their clients to sell and get out when your account is part of their life blood.

When the financial crisis began to grow even larger some investment firms went as far as to tell their clients to ‘ride it out’, or that these problems were common and you should not worry. Even in my own family we were exposed to that very tactic. In a post I published back on December 2, 2007 I discussed how an investment service attempted to tell  its clients that they should essentially turn off the television and go take a walk. It was not about how much money any client stood to lose, it was about the company losing the account, that’s all that mattered. Your personal gains or losses means squat to them.

The following is the actual letter a family member received in December 2007, again this was in 2007 and was already one month after I called a new bear market (more commentary follows the embed article below).

Rather shocking isn’t it. Telling clients to, in not so many words, just go stick your head in the dirt and ignore everything.

We all know the stock market is speculative and involves risk. But when it comes to the stock market it is also the breeding ground for the largest corruption, lies, scams, false statements, and outright deception. The larger the company is so too is the potential for even larger scandals, lies, and even illegal activity all in the name of making even more money. Just look at the major banks that have become so large that they can’t be killed. Instead their pilferage of the innocent grows to the pilferage of everyone in the form of the largest tax payer bailouts in history.

An individual investor is seldom told the truth of what is going on. They receive nice and glossy year end reports from companies they are invested with. They show beautiful photographs of people hard at work, speak of corporate ethics being at the top of their priority list, and speak about how great the future will be. Remember Enron? How about WorldCom? Take the many other thousands of companies that throughout history have been reduced to rubble, or left impotent by their own lies and fraudulent activity. The only entity that is worse than the stock market with respect to lies and deceptive statements is the Government itself.

So just how does a person who wants to invest money in the markets find any real information. Many turn to the financial news shows and get guidance from the likes of Jim Cramer, the team at the Fast Money desk, or listen to any number of large financial institution spokespersons speak about how this stock or that stock is a great investment. The financial media is just as guilty of always presenting a bullish sentiment regardless of the facts in front of them. Unfortunately no one in the big financial media outlets ever gets held to account for their actions. I read an article just today about Jim Cramer and how many death threats he has had against him. Gee, could it be that his ever bullish mantra has cost people to lose money and they are mad at him? He is on TV so he must be smart and must know what he is doing, right? Unfortunately so many innocent people watch him and think that very thing. If Cramer says it then it must be true is what these innocent people think. So sad a world it is that a screaming manic on television who has even admitted in the past to breaking Securities and Exchange Commission (SEC) rules is being taken seriously.

My mission here at RebelTraders is to do my best at presenting a view of the markets based on technical analysis, macro and micro economic events, and real world observations. My statements sometimes rub people the wrong way, they may disagree completely. Some may even think I have no capability at all for seeing anything good when it comes to the markets and economy. On the contrary, I am not that at all. I so desperately want to report good things going on, I desire the day I can say to everyone that I see green pastures ahead, and to report that the economic problems are all behind us. But wanting to report good things is different than reporting the truth. One thing I will never be is persuaded to do is report what I know to be incorrect. The word ‘Rebel’ may mean to go against a popular view but it does not indicate that I am a permabear, or even stuck in my ways. In the case of RebelTraders it simply means speaking what I see through my own research, which may often go against the mainstream media. In this regard I am a rebel.

My view of where we stand now remains the same. We are in the midst of a secular bear market (not cyclical), the rally from March will fade, and a return to a downward path in the markets will resume yet again. I await the signs of organic growth to return which to date has not. It remains my view that any market advance should be an opportunity to sell (or go short if you are an astute trader).

I foresee home prices declining much further still, credit contraction in the consumer sector will continue well into the year ahead, if not much longer. Foreclosure activity will continue to increase, personal and corporate bankruptcies will rise much faster in the coming year, and the growth witnessed to date in the form of corporate earnings will deteriorate once again after the artificially created growth fades away.

There is still much danger facing our markets and the economy as a whole. Agree or disagree that is my view and I will continue to report what I see, not what I’m told to say.

Clients of the large French bank Societe Generale are being told how to prepare for a possible global economic collapse.

[...] In a report entitled “Worst-case debt scenario”, the bank’s asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems[...]

In a report entitled “Worst-case debt scenario”, the bank’s asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems[...]

[...] “As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse,” said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast.

Under the French bank’s “Bear Case” scenario (the gloomiest of three possible outcomes), the dollar would slide further and global equities would retest the March lows. Property prices would tumble again. Oil would fall back to $50 in 2010.

Governments have already shot their fiscal bolts. Even without fresh spending, public debt would explode within two years to 105pc of GDP in the UK, 125pc in the US and the eurozone, and 270pc in Japan. Worldwide state debt would reach $45 trillion, up two-and-a-half times in a decade.[...]

[...]The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Ageing populations will make it harder to erode debt through growth. “High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt,” it [the report] said.[...] (Source: UK Telegraph)

This is just sad…

We can bailout the nations largest crooks corporations and CEO’s walk away with multi million dollar pay packages yet the victims of this financial disaster can’t even bury their loved ones.

What the hell is this nation becoming?

(hat tip Butch for story)

Bearish commentators such as Karl Denninger have often resorted to the argument of opposing “pulling forward” growth vs “organic growth”. What began principally as the desire to dispel some economic confusion became in the course of my analysis a study questioning the economic model we work upon.

In that respect, it is interesting to address some of Denninger’s latest contributions. It should be precised in the first place that I share the analysis that, economically, the US has been living beyond its means and on a credit generously provided by the rest of the world.

This being said, I believe the argument of “pulling forward” growth is more an ideological argument than a scientific or economic one. And I also believe that Denninger is afraid to go to the end of his economic reasoning, because it means in more ways than one, the end of society as we know it.

A). An incomplete analysis

A first point should be made that discussing the economic recovery and the techniques taken to do so and to encourage people to spend do only 50 % of the job if the original economic and ideological model is not criticized at the core.

We live in a mass consumption society. In this society, “pulling forward” demand is a condition for the existence of many companies (i.e., the need to create desires and cravings that people do not realize in the first place – cfr publicity or Apple who’s products have no other use than being nice and trendy).

That is just as “organic” as government stimulus can be: needs and demand created from scratch. Maybe, before questioning the governments efforts to jump-start the economy, we should inherently question the type of economy we want. “Pulling forward” when understood as creating inexisting demand is the very principle of the American society at heart. If you are against the government encouraging consumption, then you should similarly be against publicity and against the orgy of consumption which has been the great US plague during its credit bubble period.

If you do not recognize that there is something fundamentally flawed in the US model of society, then using government stimulus to help the demand recover and people buy even more, would make a lot of sense. Hence the concept of “organic growth”, is in itself questionable.

B). “Organic Growth”: an apocryphal concept

Here, we have to dispel some confusions often made by Denninger and his followers maybe by lack of economic theory. “Organic growth” is a financial term, designating “the process of business expansion due to increased output, sales, or both, as opposed to mergers, acquisitions, or take-overs”.

The use of the expression “organic growth” when talking about macro-economy is apocryphal and does not correspond to any valid economic theory.

C). The fallacy of the argument

It is one thing to maintain that increasing government spending is a politically irresponsible decision; it is another to oppose so-called “organic” growth and “artificial growth” based on “money being ‘given away’”.You cannot distinguish economic growth based on its origination, or then, you would have to discount 40 % of the US GDP at any given time (which would be a total fallacy, as I never hear Denninger complain of the “pulled-forward demand” in defense-related expenses, for instance, a sector which could not exist without government spending).

Courtesy of usgovernmentspending.com

It is all the more surprising to hear those arguments of “pulled forward” demand, as the same contributors never complain when tax cuts are budgeted. Tax cuts function exactly in the same manner, as they redistribute money from the State towards the citizens, but they have two drawbacks. First, a tax cuts, by essence will be an inequal distribution: they will privilege the richer citizens as only those who pay taxes will receive this “aid”  from the government, thus increasing social disparities. Second, in a Keynesian perspective, tax cuts are mostly saved and not spent, which is a serious inconvenience, when you’re trying to have economic fluxes flow again through the economy.

D). The contribution of government to economic activity

Hence, if we agree that Government spending can contribute to the GDP, and that there is nothing “artificial” about it (of course, libertarian maintain that each dollar spent by the government is one dollar less spent or used by the private sector), the issue of the legitimacy of using government funds for stimulating is solved.

It remains to question whether such spending is efficient on the long term. Here, we can only refer to past experiences of trying to maintain inefficient sectors alive under perfusion of government money, such as the steel sector in the 1970’s. In general, aid targeted at the economy or at various sectors fail to perform their objective, if the underlying issues are not solved first.

However, from a scientific point of view, some research would tend to indicate that in States where the government plays a large role in economic affairs, such as European states, there is evidence to show that growth performs better than in “wild capitalist systems”.

Which is logical, as although less performing, the economy takes less hits in crisis periods. The consideration for this higher security is a much more rigid society with less possibility of social evolution in both ways.

E). Conclusion:  Question the Society of Consumption!

See the article below for a scientific economic study the relationship between government spending and economic growth, especially in a context of market imperfections. So, yes, government spending can help the economy. Is it something to be wished for? That is a another debate, altogether.

I’ll give however a hint as to the answer: the conclusion is not what you would expect.

I do not encourage spending to create demand or spending to produce useless goods just to keep an economic machine going. Considering the limited resources the Earth can provide us with, we are consuming away our resources just to fulfill an endless and ever-growing thirst to possess, while neglecting our duties to the poorest among us and to the future generations.

I do question Denninger’s analysis (and to a degree Chuck’s) when he pretends to maintain this analysis within the framework of traditional classical economy ; In a way, Denninger does not go far enough in questioning the system, he complains about. I do stand for a mutation in the economic culture, where spending, having, using “less” is not always synonymous with something negative. And as an illustration: greenhouse gases have gone down thanks to this recession, and the cars bought thanks to “cash for clunkers” will consume less gas. Those are two positive externalities resulting from the current crisis.

Willing or unwilling, the US is about to learn the lessons and riches of frugality after a decade of orgy.

Government Spending and Economic Growth in a Context of Market Imperfections

Andy Xie, whose insights we have often referenced in our chronicles is back with an analysis of the failure of Keynesian economics in Japan on Caijing.

As previously mentioned in two posts, Andy Xie firmly believes in a second dip taking place somewhere next year in Anglo-Saxon economies.

Before delving more ahead, that specific distinction warrants by itself more attention, as to the foundations of the US or British economies. It is true that they have been based on sand in the form of dangerous credit expansion and a housing market bubble. Something similar to what is happening in China, with the addition of a huge bailout that was partially rerouted towards the stock markets and commodity assets. You can read the full article here.

For Xie, exports were one of the major motors of the Japanese economy (not unlike China).

Anyone who doesn’t believe in the harm of a financial bubble but does believe in Keynesian stimulus magic should visit Japan. A likely dip for the Anglo-Saxon economies next year will underscore these truths. The same goes for anyone who thinks China’s latest real estate bubble, asset borrowing and shadow banking system are worthwhile substitutes for real economic growth.

The world including China can learn a lot by looking at what’s happened to Japan, and what’s in store for DPJ. Since Japan’s stock market bubble burst in 1989 and the land market popped in 1992, the LDP government has run up debt equal to nearly 200 percent GDP in hopes of reviving the economy. And its economy has stagnated.

The burst of the global credit bubble in 2008 brought down Japan’s export machine. That was its only hope. Now, of all OECD economies, Japan’s looks most like a depression. Its nominal GDP declined 8 percent in the first quarter 2009 from the year before. Although its economy rebounded a bit in the second quarter, nominal GDP for 2009 is still expected to decline substantially and will likely be lower than in 1993.

Despite the difference in the return on assets between Japan and the US, it might almost instinctively be understood that Japan was mostly basing itself on “real” economy, whereas the US corporations were using financial engineering to achieve the higher return.

U.S. return on asset (ROA) was twice as high as that in Japan. But, in hindsight, higher ROA in the United States was mostly a bubble phenomenon. Much of U.S. corporate profitability was due to financial engineering. In one aspect, the export performance of Japan’s corporate sector has done very well — much better than its U.S. counterpart. Japan’s exports doubled in yen terms between 1993 and 2008, and the sector’s share of GDP nearly doubled to 16 percent from 9 percent, even though the yen remained strong during the period. The performance of Japan’s export sector shows its inefficiencies elsewhere were largely due to shortcomings in the system.

Where it starts getting very interesting, it is in the policies pursued to stimulate recovery in Japan from the 1980’s onwards, after the country fell prey to a burst real estate bubble: rates at zero and… abolition of mark to market! Sounds familiar?

The consequences of running high deficits and trying to maintain the bubbles has been of maintaining a very high cost of living, thus putting a pressure towards limiting the birth rate and ultimately compounding Japanese economic issues.

This strategy was flawed in three aspects. First, even as the corporate sector earns profits to pay down debt, the government’s debt is rising. At best, it is shifting corporate debt to government debt. In reality, government debt has been rising faster than private sector debt has been falling.

Second, economic efficiencies don’t increase in such equilibrium. Existing resources in the zombie sector are essentially unproductive. Bankruptcies improve efficiency by shifting resources from failing to succeeding companies. When rules are changed to stop bankruptcies, efficiency is sacrificed. Worse, incremental resources are sucked up to pay fiscal deficits used to prop up zombie industries. Japan is thus trapped in equilibrium of low productivity.

Third, a long period of stagnation could worsen irreversible social change. A falling birth rate, for example, is one consequence that is wreaking havoc on the Japanese economy. Japan’s post-bubble policy was to let property prices decline gradually. Hence, living costs also declined gradually. On the other hand, the economy stopped growing, which caused income expectations to quickly adjust downward. The combination of high property prices and low income growth rapidly pushed down Japan’s birth rate. As a consequence, Japan’s population is declining two decades after the bubble. The rising burden of caring for the old will lower Japan’s ability to pay for anything else.

Legacy of the failed policies of stimuluses: Japan’s corporate indebteness is of about 180 % of GDP even if the households are “only” leveraged at 69 % of the GDP. Of course, the Government’s debt is one of the highest in the world at 194 % of the GDP (still some way to go for the US before becoming nipponized).

For Andy Xie, the Japanese experience prefigures what will happen to the US next year:

As the global economy is again showing signs of growth in the third quarter, most governments are celebrating the effectiveness of their policies. Yet Japan’s experience forces us to pause: Its economy experienced many such growth bounces over the past two decades, but was unable to sustain any of them. The problem was Japan only used stimulus, not restructuring, to cope with the bursting of its bubble. After the demise of any big bubble, serious structural problems that hamper economic growth remain. Stimulus can only provide short-term support that makes structural reform possible. When policymakers celebrate the short-term impact of stimulus and forget structural reforms, economies slump again. I think the Anglo-Saxon economies will dip again next year.

He sees the only solution in restructuring at the same time as stimulating. Bankruptcy, from that point of view is an essential tool as it refocuses resources on more efficient companies, rather than on the failing companies.

Andy Xie concludes by exploring some avenues and necessary restructuring for China, but in my view, many of his comments could be transposed to the US:

A bubble rises when there is excess money supply. Is the current, excessive monetary growth due to demand or supply? We can argue that point forever. When the former chairman of the U.S. Federal Reserve, Alan Greenspan, said a central bank couldn’t stop a bubble, he meant money demand would rise regardless of interest rates. I disagree. If a central bank targets monetary growth in line with nominal GDP growth, a big bubble can’t happen. Aside from central bank failure, then, the most important microeconomic element in a bubble is the shadow banking system.

Regulators limit what banks can do by imposing capital requirements. The international standard is 8 percent of total assets, but banks can use accounting tricks to minimize their requirements. But a big accounting loophole can lead to disaster. For example, the loose restrictions on off-balance holdings were major factors in the global credit bubble. Most regulators are now tightening accounting rules for capital requirements.

Shadow banking is a less noticed but more important factor in creating bubbles. Most analysts compare it to the hedge fund industry, which provided leverage for financial speculators with little capital. The shadow banking system is much more because industrial firms engaging in financial activities are more important. Entities such as GE Capital and GMAC provided massive leverage to asset markets with little capital. A shadow banking system is essential to a big bubble.

China’s corporate sector increasingly looks like a shadow banking system. It raises funds from banks, through commercial bills or the corporate bond market, and then channels the funds into the land market. The resulting land inflation underwrites corporate profitability and improves their creditworthiness in the short term.

The following is republished with permission from “The Toastmaster“.  The Toastmaster is a former structured credit research analyst from Wall Street. Thank you for allowing us to publish your article.

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Fundamental State Of Our Economy

A reader asked yesterday what would fundamentally trigger a P3 collapse and consequently lead the world into a global depression. The short and simple answers are massive defaults of existing debt and loss of market confidence. The Federal Reserve’s current policy of quantitative easing seeks to reflate our way out of these impending defaults. It doesn’t take much to see the twisted nature of this logic and that such foolhardy policies will only provide a temporary reprieve. The financial crisis the United States faces is 30 years in the making and the policies being pursued by the Federal Reserve provides only a short-term remedy to what is a very serious and debilitating ailment. For all economists, media pundits, Green Shooters and Bears-turned-Bulls who now hail the Federal Reserve for its successful efforts in steering our economy clear from the Second Great Depression, I ask two questions. What are the fundamental problems of this crisis? And, what have we done to address and resolve those fundamental issues?

As a former mortgage and CDO credit analyst on Wall Street, I was at the epicenter of this credit crisis and witnessed first-hand the monumental implosion in the debt market. Outsiders to this very day place the blame of this crisis on the unscrupulous mortgage industry that aggressively pushed mortgage products onto borrowers they knew couldn’t afford them. They believe these overextended borrowers defaulted on their loans on a massive scale and consequently drove us into a liquidity crisis. I strongly believe this view to be narrow and, in many respects, ignorant. Mortgage credit is a subset, albeit a large one, in the great game of leverage our country is fully engaged in. It may have been the first domino to fall, but it was in no way a stand alone piece.

The fundamental cause of this crisis is leverage and our country’s addiction to it. Consumers, corporations and our government have embraced easy credit for so long that leverage is at the very heart of American culture. Needless to say, but leverage is a double-edged sword. It has contributed to almost 30 years of nearly uninterrupted prosperity; our elevated successes and overconfidence in the idea that is America has blinded us to certain realities; runaway growth can not go on forever and debt must eventually be repaid. Correction and regulation of exuberance and overconfidence are necessary and crucial to maintain the long-term viability of our economic system.

Unfortunately, Alan Greenspan and Ben Bernanke do not share this view. The Maestro believed markets could charge ahead full throttle with only occasional and inconsequential rests so that markets don’t lose their momentum. This view was reflected by his eagerness to lower interest rates too soon and his notorious habit of keeping them low for too long. His Laissez-faire approach to reforms and regulation in the financial service sectors gave birth to many of the products that will lead to the destruction of our financial systems, such as Subprime and Alt-A mortgages, structured credit products, credit default swaps and other complex financial derivatives. Bernanke is no better than Greenspan. Under his leadership, the Federal Reserve made no real attempts to reform what is a deeply impaired and fractured financial system. Even to this very day, when our economy is in the throes of economic abyss, no new and meaningful regulations have been enacted to rein in on the credit markets, derivatives products and culture of Wall Street.

The current Federal Reserve does not believe the fundamental cause of our epic crisis is leverage. Rather, they believe the market failure we saw in 2007 and 2008 was due to a collapse in confidence and the lack of liquidity that ensued. In other words, Bernanke believes markets were on the brinks of complete collapsed because it did not have enough leverage! To better understand Bernanke misguided beliefs, one must first understand the framework in which he approached his doctorate’s thesis on the Great Depression. Bernanke examined the Great Depression through a comparative studies framework; that is, he analyzed different economies around the world and why some recovered sooner than others. As a former econometrics student myself, these types of studies are always tricky due to the presence of confounding variables. Of course, Bernanke uses confidence tests and other complex statistical methods to defend the validity of his conclusions. I am no Great Depression expert, but common sense tells me you can not solve a problem of leverage with more leverage. If I took out a credit card debt that I couldn’t pay off and kept rolling it over onto another credit card, I did not solve anything. I am merely delaying the day of reckoning and magnifying my indebtedness which will eventually lead to more, not less, problems.

If reality reveals anything, we are already seeing the ramifications of Bernanke’s policies. America is currently monetizing its national debt because foreign lenders are increasingly weary of lending to us. Many of our trading partners have already voiced concern about the level of our national debt and the long-term viability of the Dollar as a reserve currency. If Bernanke’s intent was to buy time, I ask, what steps have we taken to reform our banking systems, restructure our securitization industry, alleviate impending foreclosures in both residential and commercial properties, address concerns about our increasingly unmanageable national debt, among countless other fundamental problems that still loom over our financial system? The short answer is nothing. Other than paying worthless lip service for some vague need for reforms, this Federal Reserve and this administration has done nothing because they do not believe the root cause of this mess is leverage.

Bernanke’s defenders would argue that markets have rallied over 50% since March and such confidence is indicative of his policies’ success. This could not be further from the truth. Markets have fallen so much from its highs in 2007 and anyone who has traded markets long enough know markets were technically overdue for a powerful countertrend rally. Bear markets are known for its violent rallies due to massive short covering and performance chasing by asset managers. The P2 rally we are currently experiencing is vigorous and particularly unique in that federal liquidity is being used to support and guide markets higher; consequently, the same liquidity has probably kept this countertrend rally afloat much longer than it would have otherwise lasted on its own. For anyone who finds this PPT theory hard to believe, I ask why? Regulators around the world have long maintained open policies to intervene in currency and debt markets when needed. Historically, regulators have had no need to manipulate the equity markets because there was no national interest in inflating stock prices.

Unfortunately, our financial crisis is quite dire and like very few in the past; we are in a credit recession, not an inventory recession. The ability of companies to refinance and effectively avert bankruptcy is dependent on their share prices. If equity prices were allowed to collapse, these companies would not be able to roll over their existing debts. A collapse in equities may also breach debt covenants for some companies that may lead to asset sales or liquidation. On the consumer side, everyday Americans view the stock market as a barometer of the direction of this country. It is no coincidence that, in general, consumer confidence rises when stock markets rally and vise versa. One of the goals of Bernanke’s liquidity plan is to help stabilize equity prices so that markets have the confidence to help companies, especially banks, in need of recapitalization. This is where liquidity does not resolve the underlying problems of our economy. Rather, it provides a temporary support, creates a false sense of confidence and, in our particular case, false sense of overconfidence that we have now overcome what some believe is a run-of-the-mill recession.

Bernanke’s supporters have also distorted the analytical framework in viewing our current crisis and, in doing so, fooled Americans into believing there were no alternatives to the current Federal Reserve policies. Americans are currently led to believe that had drastic steps not been taken by the Fed, American would be in a Second Great Depression at present. I do not dispute this line of thinking. But I ask, is a severe market correction of 30 years of nearly uninterrupted prosperity avoidable? Perhaps a Great Depression is inevitable and the framework should have been, what can our country do so that we don’t exacerbate and prolong a much needed correction? Economic corrections give markets pause to reflect and correct policies, systems and environment that has led to unsustainable conditions. They allow markets to ultimately flush out excesses so that our nation—our financial systems re-emerge healthier and stronger than before.

The Fed has chosen to avoid this period of reflection at all expenses. The Fed has chosen to avert not a depression, but a much needed and painful de-leveraging process. By bailing out financial institutions and providing endless backstops, the Fed has created a moral hazard environment that rewards companies that mismanaged risks. Such policies has effectively socialized the losses of banks and failed companies, in which America has limited upside participation. Why not nationalize these failed banks and re-IPO them when they are fixed? Let private investors who made foolish bets on these banks take their rightful shares of losses instead of taxpayers, therefore reducing the amount of liabilities our government would have to assume in a nationalization effort. When the economy truly recovers, tax payers would reap all the benefits from years of austerity through re-IPO proceeds and a reformed banking system, instead of the pittance we received from TARP warrants so far. This is merely one example of an alternative solution to fixing our financial institutions that our corrupt regulators and media do not want public discourse on because bankers and private investors ultimately lose in this proposal.

Nothing has fundamentally changed or improved in our economy. Bernanke’s policies merely refashion the crisis. In very blunt terms, Bernanke has transformed a very serious credit crisis into series of outsized Ponzi schemes. Like all Ponzi schemes, either a loss of confidence or defaults will lead to their ignoble demise. Market technicals, which are nothing more than quantitative representation and signals of market conditions, suggest current market climate is reminiscent of the trading environment observed prior to major market crashes.

I, however, am not a technical purist that believes markets are primarily driven off technical indicators and Elliott Waves. I take a more complex view in that markets are reflexive. At times, market technicals and emotions drive trading actions and trends and, in other times, they are driven by real fundamentals. This reflexive nature can best be visualized as a shoe lace where at times, the right side (fundamentals) crosses over and is dominant over the left side (technicals/waves/emotions) and we observe the opposite in other periods.

Fundamentals do not currently support this rally. The rise in equities since March’s low has been driven by market technicals, overly optimistic expectations of improving fundamentals and outright manipulation. Technicals have already been suggesting we are near a top of this countertrend rally. However, technicals mean little when there is a powerful force manipulating markets to conform with its agenda. Our government will not give up so easily and, if anything, they have already proven they will resort to any and all creative devices to prevent a collapse in confidence. If they don’t use PPT to support the futures market, or issue upgrades of leadership stocks and sectors when markets appear ready to break, they fabricate economic data.

How often in this rally have we seen markets go berserk to the upside on terrible, yet better-than-expected, economic data? Only months after when everyone has forgotten about those numbers, our government stealthily revises them to the downside. Need I remind anyone GDP for Q1 2009 was revised down from -5.5% to -6.4%? That’s almost 1 full percentage point. Or what about Q4 2008 when GDP was reported at minus 3.8%, revised down to -6.1%, only to be revised down again to -6.3%? Does anyone see a pattern here? Understate the bad news so we rally off them. Months after market forgets, report the true numbers. Understate the new numbers but make sure they are better than the previous data point. Market rallies off better-than-expected data, with a little push in the futures of course! We see the same pattern in unemployment, claims number and other economic data. You would think market participants would have picked up on this duplicity, but that would be assuming too much about their collective wisdom.

With fundamentals and technicals no longer supporting this rally, this Ponzi scheme becomes a game of confidence. As long as investors believe a green shoot recovery is a quarter or two away, no one will sell and markets may continue to grind along. But as stated above, there are serious underlying problems with our global financial systems. I believe missed earnings and lower guidance in Q3 or Q4 may put a dent in consumer and investor confidence. Consumer spending makes up approximately 67% of the US economy. Short of cooking the books, how do companies expect to beat estimates and raise outlook when consumers are still facing job losses, wage cuts, underemployment and saving more than they have in the past 14 years? Why anyone expects us to blow out earnings in Q3 or Q4 is beyond my comprehension.

Another fundamental catalyst may be another country defaulting on its national debt. Although all the focus is on our national debt, I believe a default and subsequent currency crisis will not originate from the United States. UK’s credit outlook has already been downgraded by S&P; this is typically a prelude for a ratings downgrade on the sovereign debt. Such debt default or loss of confidence in a major industrial nation’s debt could lead to panic selling of risk assets and a rush back to traditional safe havens like the US Dollar and Treasuries.

If anything, our banking system is one of the biggest game of confidence in town, second only to our Treasury markets. I believe most of our banks are insolvent. A Goldman Sachs research report a few months ago estimates that banks are still carrying bad loans near par or assuming unrealistic haircuts. See chart below. The changes to accounting rules for valuing these securities have probably driven most of these values closer to par since this Goldman report back in March. Banks have to maintain this charade because even a markdown of 10% across the books would lead to their insolvency given their leverage ratio.

No one knows for certain what fundamentally will trigger a collapse in confidence, but one thing is for sure; there is no shortage of highly levered problems waiting to explode. P3 will begin with some fundamental event that causes investors to doubt or lose confidence about an imminent recovery. Wave 3 of P3 is when markets finally realize we are deeply entrenched in a bear market. When Wave 3 of P3 begins, no amount of intervention by regulators will make up for missed expectations, lost hope and shattered dreams.

From the folks at Shadow Capitalism

The New Bull Market Fallacy

Yes, that was Trillion I said in the title, twice the nations annual GDP. Now it is becoming very clear why Timmy Geithner was on a road trip last week trying to sell more U.S. debt.

A series of bailouts, bank rescues and other economic lifelines could end up costing the federal government as much as $23 trillion, the U.S. government’s watchdog over the effort says – a staggering amount that is nearly double the nation’s entire economic output for a year.

If the feds end up spending that amount, it could be more than the federal government has spent on any single effort in American history.

For the government to be on the hook for the total amount, worst-case scenarios would have to come to pass in a variety of federal programs, which is unlikely, says Neil Barofsky, the special inspector general for the government’s financial bailout programs, in testimony prepared for delivery to the House oversight committee Tuesday.

The Treasury Department says less than $2 trillion has been spent so far.

Still, the enormity of the IG’s projection underscores the size of the economic disaster that hit the nation over the past year and the unprecedented sums mobilized by the federal government under Presidents George W. Bush and Barack Obama to confront it.

In fact, $23 trillion is more than the total cost of all the wars the United States has ever fought, put together. World War II, for example, cost $4.1 trillion in 2008 dollars, according to the Congressional Research Service.[...]

In his prepared remarks, Barofsky writes: “Since the onset of the financial crisis in 2007, the Federal Government, through many agencies, has implemented dozens of programs that are broadly designed to support the economy and financial system. The total potential Federal Government support could reach up to $23.7 trillion.”

The comment comes in the context of a quarterly report to Congress by the special inspector general. Barofsky will testify Tuesday before the House Committee on Oversight and Government Reform. The office of the special inspector general was created to serve as an auditor of the federal bailout by the same legislation that launched the TARP program itself.

Originally, TARP was intended, Barofsky writes, to facilitate “the purchase, management, and sale of up to $700 billion of “toxic” assets, primarily troubled mortgages and mortgage-backed securities.”

But that plan was soon rejected, and the TARP instead became a grab bag of bailout initiatives, including bailouts for GM, Chrysler and auto parts suppliers as the federal government struggled in real time to contain a spiraling economic disaster. [...] Source: Politico

From the “absurd and nutty file”

Of all the statistics pouring into the White House every day, top economic adviser Larry Summers highlighted one Friday to make his case that the economic free-fall has ended.

The number of people searching for the term “economic depression” on Google is down to normal levels, Summers said.

Searches for the term were up four-fold when the recession deepened in the earlier part of the year, and the recent shift goes to show consumer confidence is higher, Summers told the Peterson Institute for International Economics.

Summers continued the administration’s push-back against critics of President Barack Obama’s handling of the recession, defending the economic stimulus package against Republicans who have tried to paint the program as a failure because it hasn’t stemmed the unemployment rate. [...]

I argue the situation that searches for the terms ‘economic depression’ is a fallacy for a gauge of the real health of the American citizen and of the economy.

It is human nature to desire knowledge when one is scared or confused by any situation, be it swine flu, nuclear war, or economic disasters. Pick any topic and at the on set of pain the desire to understand it is peaked. Then comes a period of complacency and acceptance of what caused that pain.

The number of individuals in the United States facing economic hardship of their own is still increasing, and by some measures is actually increasing rapidly as in the rapid rise in foreclosures and credit card default rates which stand at record levels.

We also know that the unemployment situation measurement (U-6) which measures people working at distressed levels and/or hardships (those working part time for economic reasons) is now nearly 17% and probably much closer to 25% based on my own ‘open eyes’. This means that more and more people are being cut from full time to part time and the number of individuals having to take on additional jobs to make enough money to pay the bills is increasing significantly.

For Larry Summers to claim that the number of Google searches gives him insight into how well his economic team is doing is actually an insult to those in the ‘real world’ struggling who may not even have time anymore to sit on Google and do searches, or to those who have had to cut their cable/Internet service to cut expenses, or to those who are holding yard sales all over America selling everything that is not nailed down to raise more money.

Their are a slew of metrics one can use to measure and/or gauge just about any condition in life. Sometimes, however it requires one to apply logic and the human mind in order to process the data to arrive at a rational interpretation, something we call ‘independent thought‘ which appears to be deteriorating in this world of ours.

The Internet age has brought to the human species a whole new set of metrics in order to measure many snapshots of life at any given moment. As a person who works extensively in public safety I can attest to the public sentiment right now that the H1N1 (swine flu) has become pushed back in the human mind to the place where worrying about next weeks soccer match for little Johnny or the spot in the mind where one keeps thoughts about what they will have for lunch the next day. Even while the H1N1 is still being projected by those in the medical community as being a full blown pandemic and the possibility that the vaccine may not be effective (or even ready in time) for the wave 2 to arrive in the fall and winter.

We have become a people of ‘5 minute’ attention spans. Tell me everything I need to know in 5 minutes while I’m getting the kids ready for school because no one wants to spend (or can’t spend) any more time than that to understand what is happening in the world. People are concerned about what the 5 minute headlines are for that day only.

Complacency is another human characteristic that can’t be accurately gauged for a meaningful conclusion of a situation or event. As everybody is busy trying to make ends meet and raise a family there is simply no time for allocating too many brain neurons to worry about something for too long. We watch our 5 minute podcast of the news, we may be scared about something for a little while and then take it upon ourselves to learn more about it… but it quickly turns to being complacent about it and then it falls back to the  corners of the mind where next weeks food shopping list lays.

Just because someone may have a short attention span and has become quickly complacent of a situation does not mean it has improved. Actually, history has shown us that complacency has been one of the worst human traits we have. It is what puts people into dangerous situations thinking that something won’t affect them.

What I’m attempting to discuss here goes well beyond stock market analysis. But, if we are to apply metrics of Internet searches to economic recovery then we should also understand a little about human behavior before making the claim that Larry Summers is attempting to make that the economy is improving simply based on a computer generated metric of Google searches. It requires human thought to analyze it and put it into context.

Most human beings have an infinite capacity for taking things for granted

– Aldous Huxley 1894-1963, English novelist

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Now this is healthy for the economy… NOT

Budget Deficit

WASHINGTON – The federal deficit has topped $1 trillion for the first time ever and could grow to nearly $2 trillion by this fall, intensifying fears about higher interest rates, inflation and the strength of the dollar. [...]

[...]The soaring deficit is making Chinese and other foreign buyers of U.S. debt nervous, which could make them reluctant lenders down the road. It could also force the Treasury Department to pay higher interest rates to make U.S. debt attractive longer-term.

“These are mind-boggling numbers,” said Sung Won Sohn, an economist at the Smith School of Business at California State University. “Our foreign investors from China and elsewhere are starting to have concerns about not only the value of the dollar but how safe their investments will be in the long run.”

The Treasury Department said Monday that the deficit in June totaled $94.3 billion, pushing the total since the budget year started in October to $1.09 trillion. The administration forecasts that the deficit for the entire year will hit $1.84 trillion in October.

Government spending is on the rise to address the worst financial crisis since the Great Depression and an unemployment rate that has climbed to 9.5 percent.[...] (Source: Associated Press)