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Five Things You Need to Know: The Horror... The Horror...; Coal Mine? What Coal Mine?; Mortgage Applications Fall; Wal-Mart Financial Services; Inflastagdeflation


What you need to know (and what it means)?


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. The Horror... The Horror...

Two Bear Stearns (BSC) hedge funds that invested heavily in securities backed by subprime mortgage loans are close to being shut down, the Wall Street Journal reported this morning.

  • At issue today is the fact that Merrill Lynch (MER), a lender to the funds, has abandoned a plan Bear Stearns had hoped would rescue the funds, and is instead moving to seize collateral and sell it, the Journal says.
  • Already, the fund sold at least $4 billion of mortgage securities late last week, to help pay for client redemptions and expected margin calls.
  • As of a few weeks ago, the two hedge funds held more than $20 billion of investments, the Journal said.
  • The move by Merrill is important for a number of reasons.
  • First, unlike Treasuries which are continually quoted and whose value is therefore easily known, the Bear funds' investments trade infrequently and as a result aren't marked to market.
  • In fact, they are most likely valued based on the funds; own assumptions.
  • As the Journal explains, "A forced sale of the Bear Stearns funds' assets now could trigger a broader repricing of mortgage-backed bonds and lead to losses and margin calls -- demands for additional cash or collateral -- at other funds."
  • But what does all of this mean in layman's terms, you know, to Mr. and Mrs. John Q. Public on Main Street U.S.A.? Simple. It means this:
    Blah Blah Blah Hedge Fund Blah Blah Some Rich Guys Blah Blah Fund Managers Blah Blah Blah Eventually Wind up Working for Some Other Rich Guys' Blah Blah Blah Hedge Fund.
  • But be aware, Wall Street firms have created more than $1.8 trillion (with a T) of securities backed by subprime mortgages over the past six years.
  • Prediction: By 2010, Mr. and Mrs. Public's "Blahs" will be replaced by actual words in a best-selling book by a noted financial writer called, "From Sublime to Subprime: Inside the Rock and Roll World of a Wall Street Mortgage Desk."

2. Coal Mine? What Coal Mine?

Doing some reading this morning about the "Bear Stearns Hedge Fund on Brink of Failure After Bad Subprime Bets," we noticed a handful of separate writers and speculators asking if this is the "canary in the coal mine" for the current credit cycle and/or subprime mortgages, to which we ask in response: Coal mine? What coal mine? There's no coal mine.

  • In order for the coal mine analogy to hold, there would have to have been some thing that was ever actually mined.
  • If there were such a things as a subprime coal mine, it would be the equivalent of digging a random hole on a mountain, sticking a fancy sign up that says "Mine," firing all the miners before they are ever hired, but giving them black lung first and then foreclosing on their homes.
  • Canary in a coal mine? No, it's more like a canary in a microwave.

3. Mortgage Applications Fall

Meanwhile, mortgage applications fell 3.4% for the week of June 15, according to the Mortgage Bankers Association, the third decline in four weeks.

  • Both components - Refis and Purchase Applications were weak.
  • Refis declined 4.2%.
  • Purchase Applications declined 3% for the week.
  • Factor in that purchase applications tend to go up ahead of anticipated higher rates, and that multiple applications are increasingly becoming the norm due to tighter lending standards, and the report is actually even weaker than the headlines make it appear.

4. Wal-Mart Financial Services

Wal-Mart (WMT) said it intends to open 1,000 Wal-Mart MoneyCenters in a major expansion of financial services, according to Reuters.

  • Earlier this year Wal-Mart withdrew an application with banking regulators to operate specialty banks due to strong opposition from community banks and politicians.
  • But the company is intent on delving deeper into financial services.
  • Jane Thompson, president of Wal-Mart financial services, said the company would have "a lot of things that will be coming out this year," Reuters reported.
  • Wal-Mart currently has 225 MoneyCenters.
  • In addition the company will launch Wal-Mart MoneyCard, a reloadable prepaid Visa, that it is rolling out nationally with GE Money and Green Dot.
  • The company says the card can be used at all locations where Visa is accepted.

5. Inflastagdeflation

If you spend any meaningful time reading up on today's economic views, you will find three prevailing idées fixes. Here they are, in order of dominance:

A. Inflation is understated. General price level measurements are being manipulated, or are failing, or are simply false; we are facing a dramatic buildup in inflationary pressures. Look at what you are spending each month on food and gas prices - the argument goes, both of these are showing increases with secular tailwinds, so focusing on "core" inflation that excludes food and energy is neglecting the most important inflation story of the past 30 years.

B. Inflation is yesterday's story. What we are experiencing now is stagflation. Wages and incomes are stagnant, housing is slowing, the consumer is on the brink, which is why we continue to see deflation in things we want (cf. Best Buy (BBY), Circuit City (CC)) even as things we need (cf. food, energy, education) show inflation, and growth is slowing by virtue of the fact that producers have no pricing power in a credit-fueled (as opposed to organic) growth environment.

C. Inflation? What inflation? Housing prices are deflating. Consumers are cutting back. Producers have no pricing power. Intel (INTC) just slashed chip prices by 50%. Ryanair (RYAAY) just today cut prices on 3,000,000 seats. Vodafone (VOD) just announced a round of price cuts. Even in "hot growth" areas such as India aluminum makers are cutting prices... for the fifth time this year. Consumers are lowing their appetite for debt. Gas prices and food costs are up, but those are consumer taxes that ultimately lead to more deflation.

  • So, are we experiencing inflation, stagflation or deflation? The truest answer is, "Yes, we are."
  • It would be nice to paint a black and white scenario the way economic textbooks do with, say, the 1970s period in America.
  • Looking back, it all seems so simple now, doesn't it?
  • Paul Volcker assumed Fed Chairmanship in 1979, limited growth of money supply, and reduced inflation from a peak of 13-some-odd-percent to below three-and-a-half percent in a matter of a little less than two years.
  • Of course, if you actually experienced that time, the story isn't quite as simple as the textbooks make it appear.
  • Remember the tractor-blockade of the Eccles Building?
  • Remember deregulation of federally chartered Savings and Loans?
  • And hey, what about those high interest rates of the early 80s as part of the Volcker inflation-fighting regime, and the increased loan growth and lending to real estate speculators despite it all?
  • Well, things are always more complicated than what we'd like.
  • So, where that leaves us today is smack in the middle of inflastagdeflation... with only the last remaining vestiges of this credit cycle allowing us to cling, somewhat desperately, precariously, to the "inflastag" part of the story.
  • Why is the "inflastag" part of the story so important?
  • Well, we know that deflation incentivizes savings and postpones spending since prices will be lower and purchasing power greater in the future.
  • This depressed spending and increased savings weakens the economy further, especially an economy three-quarters supported by consumption.
  • Most importantly, we will one day find, is that deflation worsens our debt-servicing burden because our debts remain fixed in dollar terms, even as our wages and incomes fall, and the future value of those repaid dollars increase.
  • We have a tendency to underestimate the unfolding of long-term events since we can only grasp them in terms of historical recounts that reveal them in neat bullet points - like these - and quickly summarized and digestible tidbits.
  • Meanwhile, next time you come across an economic viewpoint that decries the failure of policy makers to account for headline inflation, or one that blasts the lack of economic growth apart from credit demand and availability, or one that looks at producer price cuts and wonders how in the world someone can claim we are living in an inflationary time, you can quickly agree... with each of them.
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