More Stock Market Mayhem

[Rajiv]

More Stock Market Mayhem by Mike Whitney

Last Wednesday, the Federal Reserve dropped its benchmark interest rate by 25 basis points to 4.5 per cent citing ongoing weakness in the housing sector. As expected, the stock market rallied and the Dow Jones Industrial Average went up137 points. Unfortunately, Bernanke's "low interest" stardust wasn't enough to buoy the markets through the rest of the week.

On Thursday, the hammer fell. The Dow plunged 362 points in one afternoon on increasing fears of inflation, a slowdown in consumer spending, a steadily weakening dollar and persistent problems in the credit markets. By day's end, the Fed was forced to dump another $41 billion into the banking system to forestall a major breakdown. This is the most money the Fed has pumped into the financial system since 9/11/2001 and it shows how dire the situation really is.

Why do the banks need such a huge infusion of credit if they are as "rock solid" as Bernanke says?
.
.
.
.
In the last two months, the pool of qualified mortgage applicants has contracted, as has the market for merger and acquisition deals (private equity). So the banks are probably doing more with the Fed's $41 billion injection than just beefing up their reserves and issuing new loans. The market analysts at Minyanville.com summed it up like this:

"Banks are taking the liquidity the Fed is forcing out there through the discount window and repos. After using it to shore up the declining value of their assets, they have excess to lend out. Finding no traditional borrowers that want to buy a house or build a factory, the new rules the Fed has set forth allows the banks to pass this liquidity onto their broker dealer subsidiaries in much greater quantities. These broker dealers are lending thus to hedge funds and margin buyers who are speculating in stocks. Remember, the Fed is powerless unless it can find people to borrow the credit it wants them to spend. By definition, the last ones willing to take that credit are the most speculative."

This is a likely scenario given the fact that the stock market continues to fly high despite the surge of bad news on everything from the falling dollar to the geopolitical rumblings in the Middle East. Last month, the Fed modified its rules so that the banks could provide resources to their off-balance sheets operations (SIVs and conduits). If the Fed is willing to rubber-stamp that type of monkey-business; then why would they mind if the money was stealthily "back-doored" into the stock market via the hedge funds?

This might explain why the hedge funds account for as much as 40 to 50 per cent of all trading on an average day. It also explains why the stock market is overheating.

The charade cannot go on forever. And it won't. Rate cuts do not address the underlying problem which is bad investments. The debts must be accounted for and written off. Nothing else will do. That doesn't mean that Bernanke will suddenly decide to stop savaging the dollar or flushing hundreds of billions of dollars down the investment bank toilet. He probably will. But, eventually, the blow-ups in the housing market will destabilize the financial system and send the banks and over-leveraged hedge funds sprawling. Bernanke's low interest "giveaway" will amount to nothing.

[Tulpen]

Re: More Stock Market Mayhem

Very true.

We could safely assume that the fed knows about these things, so the question is why does the fed under Bernanke lowers interest rates twice?

Are they pressured to act in such a way?

[touchring]

Re: More Stock Market Mayhem

I think they got no choice, it's either hyperinflation or depression. The Feds has gone for the first option.

Very true.

We could safely assume that the fed knows about these things, so the question is why does the fed under Bernanke lowers interest rates twice?

Are they pressured to act in such a way?

[GRG55]

Re: More Stock Market Mayhem

Very true.

We could safely assume that the fed knows about these things, so the question is why does the fed under Bernanke lowers interest rates twice?

Are they pressured to act in such a way?

One viewing of Jim Cramer's infamous video rant, and recalling all the bleating from Wall St., through the financial media, in advance of the August rate cut & Sept FOMC, is probably a good indicator of where we've come to.

Before this cycle is over the Fed may have to take rates below the previous 1% floor, this time to deal with a real financial emergency.

[touchring]

Re: More Stock Market Mayhem

One viewing of Jim Cramer's infamous video rant, and recalling all the bleating from Wall St., through the financial media, in advance of the August rate cut & Sept FOMC, is probably a good indicator of where we've come to.

Before this cycle is over the Fed may have to take rates below the previous 1% floor, this time to deal with a real financial emergency.

$3000 gold?

[DemonD]

Re: More Stock Market Mayhem

I think they got no choice, it's either hyperinflation or depression. The Feds has gone for the first option.

One could argue that hyperinflation would cause a depression sooner than the opposite policy. Paul Volcker's Fed, looking at the data, did not cause a dust bowl, drought, hunger, nor is there a worldwide depression which the US fell into back then... etc etc.

This is something that irks me to no end. "Deflation caused the Great Depression." So wrong, so wrong on so many levels. DEFLATION DID NOT CAUSE THE GREAT DEPRESSION!!! Hyperinflation in Weimar Germany was definitely depression level - so you can have a depression either way. I firmly believe that there can be no "great" depression without a prolonged drought/weather/catastrophe scenario. All of that "deflation is the devil" crap is maybe the biggest red herring the big bankers want you to believe, so sick of it.

[metalman]

Re: More Stock Market Mayhem

One viewing of Jim Cramer's infamous video rant, and recalling all the bleating from Wall St., through the financial media, in advance of the August rate cut & Sept FOMC, is probably a good indicator of where we've come to.

Before this cycle is over the Fed may have to take rates below the previous 1% floor, this time to deal with a real financial emergency.

great point. there's a chart here somewhere in one if ej's pieces that shows inflation just plummeting and the fed just hammering rates down behind it in 2001. they threw everything and the sink at it. and that was for that dinky dot com bubble. compared to the this credit thing? i'm no deflation theory fan but what are they going to throw at this thing that they didn't toss at the dot com bubble crash?

[touchring]

Re: More Stock Market Mayhem

One could argue that hyperinflation would cause a depression sooner than the opposite policy. Paul Volcker's Fed, looking at the data, did not cause a dust bowl, drought, hunger, nor is there a worldwide depression which the US fell into back then... etc etc.

This is something that irks me to no end. "Deflation caused the Great Depression." So wrong, so wrong on so many levels. DEFLATION DID NOT CAUSE THE GREAT DEPRESSION!!! Hyperinflation in Weimar Germany was definitely depression level - so you can have a depression either way. I firmly believe that there can be no "great" depression without a prolonged drought/weather/catastrophe scenario. All of that "deflation is the devil" crap is maybe the biggest red herring the big bankers want you to believe, so sick of it.

I think it's a chicken and egg issue. But if the chicken is sick and dying, you need to apply the anti-biotics. If the chicken dies, there's no more egg to speak off.

The Feds is not going to tell you, we're reducing rates because your banker is going bankrupt in 6 months if we do not do something drastic.

With credit tightening by the day, American real estate will soon start free falling and financial institutions are heading for bankruptcy - this is deflationary, and no amount of money printing can counter this.

Credit is still tightening, $80b siv fund fails, Citibank $17 billion write off - the evidence to date shows that the rescue ops is failing.... The worst case scenario is now possible.

[DemonD]

Re: More Stock Market Mayhem

I think it's a chicken and egg issue. But if the chicken is sick and dying, you need to apply the anti-biotics. If the chicken dies, there's no more egg to speak off.

The Feds is not going to tell you, we're reducing rates because your banker is going bankrupt in 6 months if we do not do something drastic.

With credit tightening by the day, American real estate will soon start free falling and financial institutions are heading for bankruptcy - this is deflationary, and no amount of money printing can counter this.

Credit is still tightening, $80b siv fund fails, Citibank $17 billion write off - the evidence to date shows that the rescue ops is failing.... The worst case scenario is now possible.

Worst case scenario? Not possible if it's just the banks and finance. Worst case scenarios involve radiation, billions dead, catastrophe, etc. This is a bank meltdown and inflation scenario. Has happened before, big time in the 1980s, and there was NO DEPRESSION. There won't be any this time around, I'm arguing, although matters will be worse if we go hyperinflationary. If you really believe in worst case scenarios you should be stockpiling water, canned goods, barrels of gasoline, weapons and ammunition, and forming militia alliances.

Doing such things in 1980 would have been a waste of time. Hell, doing such things in 1929 would have been a waste of time.

Edit: If you specify worst case scenarios for BANKS, then I would say this is nearly a best-case scenario for the rest of American and likely the world. It has been documented many times how insidious the FIRE economy has been on the average american and good riddance to bad rubbish I say. The collateral damage to joe 6 pack will be there but will not be all that bad as it has been in the past, and will be okay in the future.

[GRG55]

Re: More Stock Market Mayhem

Worst case scenario? Not possible if it's just the banks and finance. Worst case scenarios involve radiation, billions dead, catastrophe, etc. This is a bank meltdown and inflation scenario. Has happened before, big time in the 1980s, and there was NO DEPRESSION. There won't be any this time around, I'm arguing, although matters will be worse if we go hyperinflationary. If you really believe in worst case scenarios you should be stockpiling water, canned goods, barrels of gasoline, weapons and ammunition, and forming militia alliances.

Doing such things in 1980 would have been a waste of time. Hell, doing such things in 1929 would have been a waste of time.

Edit: If you specify worst case scenarios for BANKS, then I would say this is nearly a best-case scenario for the rest of American and likely the world. It has been documented many times how insidious the FIRE economy has been on the average american and good riddance to bad rubbish I say. The collateral damage to joe 6 pack will be there but will not be all that bad as it has been in the past, and will be okay in the future.

We need more optimists like DemonD around here...

[touchring]

Re: More Stock Market Mayhem

Worst case scenario? Not possible if it's just the banks and finance. Worst case scenarios involve radiation, billions dead, catastrophe, etc.

I'm referring to worst case scenario for the credit crunch.

[metalman]

Re: More Stock Market Mayhem

More Stock Market Mayhem by Mike Whitney

The charade cannot go on forever. And it won't. Rate cuts do not address the underlying problem which is bad investments. The debts must be accounted for and written off. Nothing else will do. That doesn't mean that Bernanke will suddenly decide to stop savaging the dollar or flushing hundreds of billions of dollars down the investment bank toilet. He probably will. But, eventually, the blow-ups in the housing market will destabilize the financial system and send the banks and over-leveraged hedge funds sprawling. Bernanke's low interest "giveaway" will amount to nothing.

so much wrong with this i don't know where to start.

wish socialists like whitey had a deeper understanding of the system they're criticizing. this is just a bunch of whining. he needs to change his name to "mike whiney"

[Ann]

Re: More Stock Market Mayhem

so much wrong with this i don't know where to start.

wish socialists like whitey had a deeper understanding of the system they're criticizing. this is just a bunch of whining. he needs to change his name to "mike whiney"

You mean "Whitney" don't you? Not my cup of tea but please get his name right. Thanks!

[grapejelly]

Re: More Stock Market Mayhem

I don't think the Fed is relevant at all.

Think of it like skirt lengths or fashion colors. Every year or so there is a different skirt length or color that is fashionable. Do the Parisian designers create this color or skirt length? No. They try to predict what the market will want.

The Fed must respond to the market. People will buy US dollars or sell them. There will be contractions in credit that the Fed has to deal with. But none of it means the Fed controls anything or can choose anything. They must react to what the public wants.

The Fed has no choices in anything that they do.

[EJ]

Re: More Stock Market Mayhem

More Stock Market Mayhem by Mike Whitney

Is the Ground Giving Way?

In 1996, the article "MZM: A Monetary Aggregate for the 1990s?" was published by John B. Carlson and Benjamin D. Keen John B. Carlson is an economist at the Federal Reserve Bank of Cleveland, and Benjamin D. Keen is a graduate student of economics at the University of Virginia.

Introduction

The Humphrey–Hawkins Act of 1978 requires the Federal Open Market Committee (FOMC) to specify annual growth ranges for money and credit early each year. These ranges are reconsidered at midyear, and preliminary ranges are specified for the upcoming calendar year. In the past, financial market participants paid close attention to the announcement of the monetary aggregate growth ranges in order to assess the intentions of the FOMC, the policymaking arm of the Federal Reserve System. Large deviations from range midpoints were often associated with policy actions designed to bring money growth back to its intended path.

In recent years, however, the reliability of various money measures as useful indicators on which to base policy has become seriously compromised. Consequently, the role of money in policy decisions has greatly diminished. In July 1993, Federal Reserve Chairman Alan Greenspan reported that “... at least for the time being, M2 has been downgraded as a reliable indicator of financial conditions in the economy, and no single variable has yet been identified to take its place.”

Soon thereafter, the Fed indeed began to use Money at Zero Maturity (MZM) as the the measure of the money supply on which it based policy decisions, not as a monetary target but as a trailing measure of the money supply, or so we were told in 1999 by contacts at the Boston Fed. We subsequently switched to using it ourselves for that reason, and so you rarely see M* money graphs on iTulip but will find MZM graphs.

The article contains the following item in the conclusion that relates to the difficulty in measuring the money supply in the era of deregulation and financial engineering:

The relative stability of MZM demand tends to confirm Motley’s (1988) and Poole’s (1991) conjecture that zero maturity is an important theoretical distinction for determining which assets should be included in a measure of money. Interestingly, Poole invoked the “temporary abode of purchasing power” principle advocated by Milton Friedman, while Motley drew on the notion of “liquidity preference” proposed by Keynes. Nonetheless, both argue that zero-maturity instruments tend to be better insulated from the effects of deregulation and financial innovation.

That was before the widespread use of structured credit, and especially the use of credit swaps and other related credit derivatives, changed the face of money and credit creation.

One of the lessons of the 1930s was that what cannot be measured cannot be controlled. Failure of measurement of new forms of credit is one of the reasons for the credit contraction after the 1929 crash. While the risks of margin debt were well understood, the latent risks in opaque investment pools was not. The Fed believed it was increasing the money supply in a way that effectively supported the credit structure, but as pyramided investment trusts that used a combinations of equity and debt imploded on each other, the primary source of credit which had driven the boom, especially in commercial real estate, collapsed, while short maturity money stayed healthy.

Are we seeing a repeat?

Assuming the Fed is still primarily using MZM (Greenspan said so as recently as 2005), a quick look at what MZM has been doing lately shows that money supply growth is healthy.

Note that MZM continued to grow during the past two recessions.

The risk is that the collapse in structured credit will bring down the financial economy, which is no longer the tail and but the dog of the US economy, and that will bring down the real economy. During the whole episode, MZM may appear healthy and the Fed will think it is doing its job.

Just as we'd like to see FIRE Economy money supply, inflation, GDP, and employment statistics, but think of what it means that the Fed is operating without these, too.