Going To The Mattresses
Tuesday the Federal Reserve’s Open Market Committee made a three-quarter point cut in the Fed Funds rate. So what does that mean, I should re-finance the loan on my Beamer?
Not hardly. It means, in short, that your mattress is looking like a good investment option right now. I’m not kidding.
* * * * *
If you haven’t already, you first need to go back a couple of blogs and read my treatise on the causes and fallout from the Sub-Prime Mortgage Crisis. That’s where all this mess gets started.
Go ahead, I’ll wait…
So, you’re all up to speed on the hyper-capitalist mercenaries and the banks they swindled, we can move forward.
A few months ago, big banks like Citicorp, Merrill Lynch, and Goldman Sachs announced they were writing off hundreds of millions of dollars in bad debts. One by one the heavyweights of finance came out, tails between their legs, and admitted they had more sub-prime exposure than they originally realized. They took pretty sizable hits against quarterly earnings, their stocks all took a nose dive, and the markets followed suit with large percentage drops in indices all over the globe.
The U.S. Federal Reserve took a concerned stance, holding some between-session meetings and lowering some of the key interest rates under their control. The markets came under control, easing downward over a period of months while enduring slightly more frequent and variant up- and down-swings.
All seemed fine, given the circumstances. Until last week.
Citicorp announced that they had underestimated their sub-prime exposure during the last quarter, and would be writing off more debt. The net result was a four billion dollar quarterly loss. That’s not a typo, in 90 days Citibank lost four BUH-illion dollars.
That news had the weekend to sink in. Citicorp has entire skyscrapers FULL of accountants, financial analysts, auditors, statisticians, and actuaries. But even with all that financial acumen at their disposal, they still not only managed to invest in all of this junk, they lost track of exactly how much they owned. This raised innumerable questions.
Was there more? How bad would the next disclosure be? And that’s just Citicorp. There are hundreds of other banks who have already admitted to having suffered sub-prime losses: how much to THEY have that has yet to be uncovered? If Citicorp fell victim to this, who knows how many of these other banks have those kinds of losses looming in their future.
But Citicorp is huge, they can absorb a hit of this size. Some of these smaller banks might not be able to — we could be looking at some pretty big institutions going belly-up.
So on Monday the 21st, the other major world exchanges reacted to this weekend of festering financial worry. Tokyo, Singapore, London, all of the major indexes took a Hercluean nose-dive.
One of the things that is an observable feature of the world financial markets is the moderating effect of the U.S. market as the last voice of the business day. If Tokyo goes south and London goes south, but the U.S. starts lower but ends with little loss or even a small gain, then when Tokyo opens the next day things don’t go so badly. However on this day, Martin Luther King Day in the United States, U.S. markets were closed. There was no possibility of New York saving the day. The Asian markets would have to brave the storm on their own.
When Singapore followed Monday’s 5% loss with a 7% loss on Tuesday, apparently the Fed OMC members’ pagers went off with an invitation to an emergency meeting before the market open on Wall Street. The result was the three-quarter-point announcement, literally seconds before the market open in New York.
* * * * *
The Federal Reserve Open Market Committee meets about once a month to discuss the condition of the economy, the various indicators that suggest the direction the economy is headed, and possible actions that may need to be taken to either stimulate or dampen the economy. These meetings are very closely watched by, well, pretty much every financial entity on planet earth, as their action (or lack thereof) will determine everything from that day’s market activity, to long-term demand for durable goods, to housing starts, to the trade deficit, to currency exchange rates. These meetings are planned out years in advance, and by the time the Fed actually does anything, the dubious entity collectively known as the “consensus opinion” usually has figured out exactly what they were going to do.
So if the Fed is usually as easy to read as a dime-store novel, why is everybody so bent out of shape? Because Tuesday’s Fed action was done in a between-session meeting, and came with no warning whatsoever. In fact, the Open Market Committee was scheduled to meet next week. Additionally, a three-quarter point cut is the first of its kind since 1982, and has been called a “once in a generation” occurrence by more than a few financial pundits. And Fed announcements are usually made around lunch hour, well after the market open, and well after the bulk of the big trades for the day have already gone through.
All of this points to one thing: panic. The Fed, under the inexperienced leadership of Chairman Ben Bernanke, is flummoxed and is overreacting.
Changes in the Fed Funds rate take about 9 - 12 months to have any effect on the broader economy. The Fed knows this. The rate they manipulated is related to the rate at which banks loan money to other banks. It has nothing to do with the consumer market whatsoever, and only indirectly affects the rates at which a business, for instance, would be able to obtain credit.
So why do it? Two reasons: to try to get central banks in other major economies to follow suit; and to instill confidence in the marketplace (both the consumer and the finance/investment players) that the US Federal Reserve is on the case, and the US economy is not going to fall into recession, or worse.
Did it succeed? Not even a little bit. The Canadian central bank moved their rate a quarter point, the European central bank didn’t budge (and in fact came out with a statement saying they thought the Fed was cuckoo), and the other major central banks are still giving the matter some consideration.
As for instilling confidence in the market, the immediate reaction seemed good. On the day of the announcement the market plummeted on the open, as predicted, but then rebounded to recoup almost all of its losses. But the rest of the week was bedlam. Huge swings in the market, near-5% intra-day swings in the major indices, and closing numbers either up or down 1 - 3%. Precisely the opposite of what the Fed was trying to achieve. Panic selling followed by bargain-hunter fits of euphoria, and SOES-bandit (day-trader) paradise which increases volatility with highly-leveraged large-volume trades. In simple terms, the market is in a state of unbridled chaos, and the major players all know it.
So what is going to happen? The major players in the marketplace are institutional investors: major banks, pension funds, etc. They have positions that represent large percentages of blue-chip companies’ floats. Those investors can smell the blood in the water, and are right now making contingency plans: one for a stay-the-course-but-minimize-volatility position for the middle-term; one for a gradual liquidation; one for a full-fledged flight to cash and AAA debt.
After the 1987 crash, the Fed installed what are called “trading curbs” designed to slow the process of automated trade execution when the market is headed south fast. Well, guess what: it’s been 20 years, every major institutional investor has a way around those curbs, and they have largely become immaterial. If things go in the toilet, we are looking at a 20 - 50% collapse in less than a week, and no stimulus package or rate cut will be able to prevent global recession.
There is only one position to take in the market right now: cash. Liquidate stocks immediately, regardless of loss, and wait this out. If we see a month straight with no swings of more than 1% of any major market index, it’s safe to get back in the game. Gold is still at historic highs, and might experience a bigger collapse than the stock market if there is no wealth left to prop up the high prices. Bonds normally respond inversely to stocks in terms of price, but the risk is no less in a market this volatile. So in the mean time, you can still earn 4% or more in a nice, sedate Money Market account with any one of a hundred institutions, including (in all likelihood) your current brokerage.
Trust me: in December 2008, a gain of 4% on the year will look like financial genius. You heard it here first.
