The Credit Card
While debt is front and center as the issue at hand, credit of a different breed -- credibility -- has emerged as the issue at hand for markets at large.
"All you have is your name and your word." --Ruby Peck
They say that if you're playing poker and don't know who the sucker is, chances are it's you. For those currently holding trading cards, the stakes have never been higher.
Over the last few weeks, as risk chips stacked around the table, investors have been forced to call the bluff of some of the savviest players in the global game.
The winners will walk away with a royal flush of profits, smiling all the way to the casino pool. The losers? They'll self-loathe and second-guess themselves on the hitch-hike home, hungry for redemption and wanting for more.
Let's review the series of seemingly inconsistent hands we've been dealt during what was supposed to be a quiet stretch on the summer deck.
At the beginning of the summer, when "CDO's" and "Sub-Prime Mortgages" were first introduced into the mainstream vernacular, Treasury Secretary Hank Paulson was quick to assure us that the problems were "contained."
To be fair, Mr. Paulson wasn't alone. In fact, he was in very good company. San Francisco Fed President Janet Yellen, Federal Reserve Chairman Ben Bernanke, Dallas Fed President Richard Fisher and Federal Reserve Governor Fredric Mishkin were unanimous in their assuring voices that we had nothing to fear but fear itself.
Fast forward a few months. This is when things really started getting strange.
The FOMC announced on August 7 that, while "markets were volatile" and "credit conditions tightened for some households and businesses," the economy "seemed likely to expand at a moderate pace in coming quarters, paced by solid growth in unemployment and incomes and a robust global economy."
Despite high-profile snafus at Bear Stearns (BSC), Goldman Sachs (GS) and American Home Mortgage (AHM), the Fed seemed intent on appeasing China and other holders of dollar-denominated securities. We chronicled that dilemma as it evolved but the price action at the time, as the ultimate arbiter of variant opinions, failed to validate concerns.
Two days after the FOMC meeting, BNP Paribas, France's largest bank, halted withdrawals from three funds because it couldn't fairly value holdings tied to the stateside sub-prime mess.
IKB Deutsche Bundesbank confirmed that they were holding special meetings to discuss their "financial situation."
The United Kingdom issued a statement that their sub-prime crisis might be worse than it is in the US.
Those concerns, on the margin, were disconcerting. But as actions speak louder than words, the sequence of events that followed offered a more telling strange things were afoot at the Circle-K.
The European Central Bank, in an "unprecedented response to a sudden demand for cash," injected $130 bln dollars into the financial machination.
The United States, Japan, and Australia also stepped up to the plate with piles of dough, upping the ante to over $300 bln.
Even Canada -- Canada! -- chimed in to "assure financial market participants that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of the financial markets."
We wondered aloud at the time: What do they see that we don't? Why, with the mainstay averages still up nicely for the year, was there a coordinated global agenda to calm investors and stabilize a system that we were told was strong, normalized and fluid?
The next day, Countrywide Financial (CFC), the biggest US mortgage lender, said it faced "unprecedented disruptions" in the operations. Was that the other shoe that investors were waiting to drop?
Not so fast Imelda, this story has only just to stretch her legs.
On August 14, as the price action in the financials continued to falter, UBS (UBS), Europe's largest bank, professed that "turbulent markets may cut into profits for the rest of the year."
Santander, the large Spanish bank, offered that they had upwards of $3 billion of exposure to high-risk loans in the US.
Australian mortgage lender Rams Loans Group, citing "unprecedented disruptions in credit markets," promptly took a 20% overnight haircut.
The ECB and the United States continued to pump liquidity into the marketplace as concerns continued to mount.
David Walker, the comptroller general of the US, proclaimed that the US government is on a "burning platform of unsustainable policies with fiscal deficits, chronic healthcare under-funding" and "chilling long-term stimulations" as he mapped the parallels between modern day society and the fall of the Roman Empire.
These are not my words. They come from a non-partisan figure in charge of the Government Accountability Office, which is often described as the investigative arm of the US Congress. "I'm trying to sound an alarm and issue a wake-up call," he said in the midst of his 15-year term that began during the Clinton Administration: "The US is on a path toward an explosion of debt."
The next session, as fate would have it, was Redemption Day for funds with a 45-day advance notice redemption window. As the smartest money on the street, including Goldman Sachs' mighty Alpha fund, took it on the chin, investors were given a chance to leave the dance.
That dynamic, so it's said, will continue to play out in the coming month as the clock ticks and outgoing mail begins to sail.
The next day, Bill Poole, the (soon to be ex-) president of the St. Louis Fed, amazingly offered that the FOMC wouldn't issue a surprise rate cut in the absence of a "financial calamity." As Countrywide Credit tapped their entire $11.5 bln credit line, forced liquidations found their way across a spectrum of sectors and the mainstay averages approached a 10% correction from the highs, Mr. Poole seemingly tied a bow across the box the Fed now found themselves in.
True to the path of maximum frustration, and in the midst of a 300-point decline in the DJIA, the market reversed sharply higher and closed near the flat-line, catching late-to-the-game pressers leaning the wrong way.
Still, the overnight session was an absolute mess, with global markets getting pummeled and tensions rising into options expiration.
And that's when the FOMC, fully aware that the structural machination of August expiration would exacerbate volatility, pulled the trigger and cut the discount rate, completely contradicting what they said two weeks prior.
The near-term reaction, after a few tenuous downside tries, was seemingly what they wanted. Higher prices, albeit mutedly so.
But that's not really the point of this column nor is it the end of the story. In fact, the plot continued to thicken the past few days as the world continued to spin.
On Monday, we learned that Deutsche Bank borrowed money from the FOMC 5.75% discount window. While the amount wasn't disclosed, sources said that the move was orchestrated to show support for the Fed as they continued to combat the credit squeeze.
I don't claim to be an expert on these market machinations but it's my understanding that, traditionally, banks only tap the discount window as a measure of last resort.
As we powered up for trading yesterday, the CEO of WestLB, one of Germany's largest banks, warned that "foreigners were increasingly loathe to extend credit to financial institutions in Europe's largest economy, which could spark a crisis."
Those comments followed similarly strained sentiments from German lender SachsenLB, which said it required a credit line of $23.2 bln due to investments affected by the US sub-prime mortgage crisis, and IKB Deutsche Industriebank, which required a similar bailout.
German's finance minister, Peer Steinbrueck, remained optimistic in the face of the news, offering that he sees no signs of the German economy being affected and that he believes "those involved have the situation in hand."
Shortly thereafter, as the US market readied for trading, Mr. Paulson, ahead of his closed door meeting with Fed Chairman Ben Bernanke and Senate Banking Committee Chairmain Christopher Dodd, stepped back on stage to assure us that we are enjoying the benefit of a "strong global economy" and a "healthy financial system."
Now, I understand why Hank put on a brave face. Perception is reality in the marketplace and investor psychology is fragile. And I also understand that when he resigned as the top dog at Goldman Sachs, he was forced to sell his entire slug of Goldman stock. With tax advantages to boot.
Actions speak louder than words but alas, I digress.
As we continue to listen to the vernacular from the powers that be around the world, the onus is on us to assimilate the cumulative dynamic that has evolved over the last five years.
The Federal Reserve attempted to buy time on the back of the tech bubble with fiscal and monetary stimuli that encouraged risk-taking, reward-chasing behavior. It was a grand experiment of sorts and it continues to brew.
While debt is front and center, credit of a different breed -- credibility -- has emerged as the issue at hand for markets at large.
If and when investors begin to perceive that central banks are no longer larger than the markets -- and this, in my opinion, is simply a matter of time -- a crisis in confidence will ensue.
That's a troubling thought considering the current angst in the context of global indices that remain higher for the year.
Now, I'm not smart enough to know when this will happen and I'm certainly respectful of the fact that a cornered animal will bite, scratch, claw -- and potentially kill -- to ensure survival.
Those animal spirits have laid many bears to rest over the years and, to be honest, I'm unsure if the downside disconnect has now become a tad too obvious.
Psychology, as with the markets, moves in cycles of denial, migration and panic.
One thing is for sure, however. If and when the wheels wobble off the global financial wagon, the warning signs will be obvious with the benefit of hindsight.
Unfortunately -- or fortunately, depending on your preparedness -- the crimson dye will already be cast.
Welcome to the finance-based, debt-dependent, oh-my-goodness mindset, where the only true preparation is legitimate financial education.
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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