A reader asked me to weigh in on the Frannie situation, bailout, whatever it is.One way or another this picture of a road overrun by lava must provide an apt metaphor to some aspect of this story.
Barry (multiple posts) has some coverage as does Barron's, Mike Shedlock (multiple posts) and the NY Times. The expectation is that we will know something this afternoon, US time, before the Monday Asian sessions start.
As an immediate reaction I would not be surprised if equities rallied for a day or two or three. A bailout removes one bit of uncertainty and a market not looking too far into the future could easily pop.
Mish, linked to above spells out the numbers and they are huge. Also there is potential consequence for the foreign holders of Frannie paper (there have been several commentaries about demand from China waning) depending on how the bailout would be orchestrated, executed and then what the unintended consequences would be.
Most folks attribute the real estate/MBS/and whatever else crisis to the Fed having kept rates at 1% for too long. That no doubt is part of the equation but the history of Frannie and the leverage they were allowed to accumulate is also part of the story. Had they not been allowed to lever the leverage (my little play on words) there would have been less liquidity to fuel the house mania--not that it wouldn't have happened necessarily but some portion of this mess can be attributed to the business model.
If this makes any sense then it may be that the full extent of the consequence of all of this takes years to play out. Accessing capital may be problematic for years which will make economic growth very difficult to come by. Mish's argument that treasuries are cheap has a much better chance of standing up in that light.
The outcome that I think I see from this not going well is "stumble along the bottom" where equity and home prices take much longer to start to come back. They do not necessarily have to keep cascading lower. Thought of in equity price terms, couldn't the S&P 500 spend most of the next few years trading between 1050 and 1200? Hasn't it spent most of the last few years trading between 1300 and 1500?
I'm not too focused on trying to be correct. A scenario with a really bad outcome (worse than I am spelling out) as a result of deleveraging is possible. I don't think really bad is most probable but if it is really bad what should be done portfolio-wise? I would want to continue to have more cash than normal and some double short. I think there are certain soft commodities that could do well as a function of supply and demand dynamics. Country selection would become more important (Vietnam for all its problems is having a pretty powerful rally lately) as countries that really are in their own world or have stuff the rest of the world really needs might do ok.
Despite my ardent beliefs in normal bear market cyclicality I am very optimistic by nature. Whatever does come from this, if you work hard now, you may need to work harder. If you resourceful with how you live, you may need to be even more resourceful. The manner in which the US seems to be evolving will bring challenges that we can either take head on or try to avoid.
I'm sorry I don't have all the answers but I think it is more important to to figure out some idea about what you would do with your portfolio than correctly quantify exactly what happens.
4 comments:
Roger, I haven't seen much commentary about what the bailout will mean for interest rates. I don't pretend to understand, but it seems to me that rates will have to rise to finance whatever capital gets injected into Fannie and Freddie. I'm confused about implications for the yield curve. Can you help?
Thanks very much.
well, i doubt i can help. i have been thinking that US rates should have already gone up.
Mish makes an argument that we are having serious deflation which if correct means rates are now high (read his posts on this). If rates are now high then it is unlikely they go up anytime soon.
Grand Slam for Bill Gross...
Some time talking are you book does really work...
AI
Read an article in Forbes this week where they attribute much of the mortgage security problem to a rule passed by FASB to the effect that all companies have to mark their CMOs or CDOs to market every day. The problem being that most investors (banks, governments, institutions, etc.) don't buy these instruments to trade. They buy them to hold to maturity for the income. Therefore, according to the Forbes article, there really is no market for these securities. No market means no way to "mark them to market." Thus, people began to wonder what the securities were really worth. Throw in rising mortgage defaults, foreclosures, and "walk aways" and you have sudden panic over value and risk.
More than anything this whole mess has been the result of a loss of confidence. Billions have been lost or written down on these mortgage backed securities, when 95% of them are sound and paying requisite income every month. Because the holders (banks mostly) cannot determine a market value they have been forced by this rule to write them dowm drastically. All these write downs have destroyed a large amount of capital. Thus, the deflation.
Only if confidence can be restored will the credit markets go back to normal. With all the doom, gloom, and despair I see in the MSM and financial media it does not augur well for a restoration of confidence anytime soon.
Maybe I am too simple minded, but that's the way I see it.
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