“I'm telling you this guy is protected from up on high by the Prince of Darkness.”
-Jeff Rabin, The Usual Suspects
The twentieth anniversary of the crash arrived last week and the bulls were dutifully lined-up for a southbound shakedown.
At the heart of the matter was a run on the banks, which are down 14% for the year and dangerously close to multiyear lows. As off-balance sheet risk becomes a mainstream culprit, the interrogation centered on whether the proposed “super-conduit” could provide the necessary liquidity to stave off a credit crunch
Treasury Secretary Hank Paulson - yes, the same gentleman who assured us in the spring that sub-prime issues were contained - led the charge. He’s gathered the biggest players on the Street, from Citigroup
(C) to JP Morgan
(JPM) to Bank of America
(BAC) as part of his posse to curtail contagion.
We’re all in this together, he argued, so now is the time to stand together in unity.
For better. Or for worse.
I’ve been trading for seventeen years and have used an assimilation of four primary metrics - fundamentals, technicals, structural and psychology - to shape my risk profile. I continue to use this recipe, as we did in front of earnings
, to help guide my decision making process. It’s a useful guide but truth be told, it’s lost a bit of it’s predictive power.
Something has changed with regard to the DNA of the tape. I’ve felt it for a few years but naturally assumed that I - not the tape - had shifted course. The notion that there was an unnatural tone to the market - an underlying tenor, if you will - felt like forced validation or post-rationalization. But still, it persisted. Internally at first and then in select circles.
We used to huddle in hushed tones and talk about “the invisible hand” or the “plunge protection team.” We did so for fear of being called conspiracy theorists or, worse, unpatriotic. The thought that there was a hidden force seemed bizarre. I was taught that nobody was bigger than the market. Most certainly, if there were games being played, it would eventually come out.
Still, some of the my most trusted and widely respected sources confided in me that they saw it as well. They did so in confidence as Wall Street is a small place where credibility is the gateway of continuity. I, too, held my tongue for fear of retribution or consequence. Even still, to this day, there are folks that will view this column as financial sacrilege.
So what now gives this topic license for discussion? Treasury Secretary Hank Paulson, who recently said, matter-of-factly, that there is indeed a Working Group on Financial Markets in force and at play. Further to that, he has openly held discussions with Wall Street firms and hedge fund managers in an attempt to gain leverage in the financial equation.
The market is the world’s largest thermometer and the single biggest proxy of our collective financial health. That fact isn’t lost on those that dictate our policies and they’ve been both strategic and stealth in how they’ve accomplished their directive. They’ve also been very effective.
The greatest trick the devil ever pulled was convincing the world he didn’t exist. What we must now ask ourselves is how we would live our lives - or make our financial choices - if we knew the devil of the details. Therein lies the crux of the moral hazard debate that is sweeping the Street and gaining momentum.
To understand where we are, we must appreciate how we got here. In a finance-based economy with more than 70% of GDP generated by the consumer, this grand experiment began in 2001. We can’t blame Alan Greenspan for his attempt to spur the economy on the back of the tech bubble. It was, after all, the largest financial collapse in history and something needed to be done.
A funny thing happened following that initial spark in the dark. We lost sight of the fact that debt induced growth was not the same as a legitimate economic recovery. Fiscal and monetary stimuli are tools - not a solution - but few questions were asked as long as the markets were buoyant. All the while, the very basis of our investments - the dollar - continued to erode.
To be clear, I understand that the role of the Federal Reserve and, by extension, the Treasury is to facilitate the orderly functionality of the marketplace and provide price stability. And there are times, such as after the towers fell, that their involvement was justified. That is the exception, however, rather than the rule. And the rules have changed in an attempt to keep up with the game.
The Federal Reserve is supposed to act as a buffer when times are tough, a beacon in the light if you will, the lender of last resort. Over the course of time, they have become entirely more proactive. They stopped acting in response to crisis and began targeting financial assets in a series of events that unintentionally created one.
This dynamic has been evolving for years with nary a peep from domestic investors benefiting from the rising tide.
One of the oldest sayings on the Street is that the reaction to news is more important than the news itself. That applies to price action and it also applies to proactive policy. The rates cuts were the first clue. Altering the rules of discount window collateral was equally as telling. The aggressive stance by global central banks speaks volumes that pressures are percolating under the seemingly calm financial surface
The question, of course, is when it will matter. Perhaps the most tangible proxy is, quite ironically, the proposed solution to our current conundrum. The super-conduit is an admission that help is needed to transition risk within the system. Whether it works remains to be seen. The fact that it is being tabled for discussion speaks volumes in and of itself.
Josef Ackerman, CEO of Deutsche Bank
(DB) recently said on behalf of the 31-member board of the finance institute, that it’s “premature to make a firm judgment as not all the details are yet know to us or are fully announced.” To succeed in restoring confidence, he continued, the plan would have to provide “transparency” to the prices of financial assets.
Therein lies the task at hand, not only for the financial industry but for the economy at large. If the curtain is being pulled back for final judgment, the risk to the system is that years of financial engineering will come home to roost.
Verbil Kint once said “there's no mystery to the street, no arch criminal behind it all. If you find a body and you think his brother did it, you're gonna find out you're right.”
I’ve been asking myself this question for many years. And deep down, there’s a big part of me that hopes we don’t find the corpses.
For if we do, the devil we know will be entirely more profound than the devil we don’t.
No positions in stocks mentioned.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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