Wednesday, April 9, 2008

Soros Believes Global Subprime Costs to Reach $1 Trillion & Fed Makes Plans for more Historic Actions

I continue to be bemused by the equity market denials in the face of a news flow that is approaching putrid. I know.. I know... it's ALL priced in.

Fedex warned a few weeks ago, not a problem - everything will be fine in 6 months - take the stock up.

UPS warns last night - not a problem - everything will be fine in 6 months.

Washington Mutual (WM), the nation's largest S&L, needs to essentially dilute itself by double to survive, and was being considered by JPMorgan (JPM) as a take out candidate for LESS than it trades today ($8) - not a problem - everything will be fine in 6 months.

Housing prices continue to contract at historical rates - not a problem - everything will be fine in 6 months.

Jobs evaporating but since its only 5% (no, it's really 12% but the government adjustments make it 5% so people can say, hey its historically low) - not a problem - everything will be fine in 6 months

Consumer dying on a vine but hey ABC retail company beat analyst earnings estimates that were lowered 3 times in the past 90 days - not a problem - everything will be fine in 6 months.

Inflation ramping across the globe - not a problem - everything will be fine in 6 months.

Food riots starting in the developing world - not a problem - everything will be fine in 6 months.

I could go on - there are about 50 other line items; I'll spare you. But this market is being propped up in faith of the Federal Reserve bailing it out PLUS faith in the Federal government bailing it out. In a capitalist system the irony is hilarious. The entire lynch pin is bailouts. A faith in the Federal Reserve that even the Federal Reserve does not have in itself.... even more ironic. Otherwise they would not be coming up with back up plans that would be even more interventionist!

If everything is "not a problem" I wonder why the Federal Reserve is drafting plans for even more historic moves - as I said the past week this increase in money supply of epic proportions (diluting every dollar you have in your pocket) is outright fear of deflation (1930s style). But that't not a problem either. Nothing is a problem. At this point I believe the market must be pricing in a direct nuclear strike on NYC - that would probably be met with a 20% gain in equities since the nuclear fallout would be cleaned up within "6 months". Nothing is a problem. Everything is priced in.

The Federal Reserve has 2 jobs - provide price stability (which it has completely ignored since last summer), and keep job growth near peak (which the other branches of government are helping it do with skewed statistics). As Jim Rogers says, nowhere are the actions it is doing now anywhere in it's charter. It's become a plaything to support asset prices... and it continues down it's path of morphing into a Plunge Protection team tool. Can you imagine the biggest credit contraction in history, along with the first nationwide home price crash and not one public homebuilder or major bank is going to be allowed to fail? Instead our government is giving the homebuilders tax breaks, and the banks cannot fail because any major bank to fail is interconnected to all others and hence if 1 fails, it would cause contagion. (sounds like Japan all over again - no one is allowed to fail) So all you need to do as a bank, is grow to a size large enough where you are connected with as many others as possible... then take all the risks you ever want - because you will never be allowed to fail since the whole system can crumble. What kind of system do we have where 1 bank can bring down the entire financial system globally? A useless one where regulation has been p*ssed on. So the morphing shall continue for the Federal Reserve... I don't see anything about preserving jobs or price stability in this article.
  • The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail.
  • Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed; issuing debt under the Fed's name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.
  • No moves are imminent because the Fed still has plenty of balance sheet room for additional lending now. The internal discussions are part of a continuing effort at the Fed, similar to what is under way at foreign central banks, to determine its options if the credit crunch becomes even more severe. Fed officials believe the availability of such options largely eliminates the risk of exhausting its stockpile of Treasury bonds and thus losing its ability to backstop the financial system, as some on Wall Street fear. (and this is their job?)
  • The Fed, like any central bank, could print unlimited amounts of money, but that would push short-term interest rates lower than it believes would be wise. The contingency planning seeks ways to relieve strains in credit markets and restore liquidity without pushing down rates.
  • The Fed is reluctant to heed calls from some Wall Street participants and foreign officials for the Fed to directly purchase mortgage-backed securities to help a market that still is not functioning normally. (they're not even allowed to do it by law, that's where Congress can come in and "help")
  • Before the credit crunch began in August, the Fed had $790 billion in Treasury securities on its balance sheet, about 87% of its total assets. Since then, it has sold or lent about $300 billion. In their place, the Fed has made loans to banks and securities firms to assist them in financing holdings of mortgage-backed and other securities. Some on Wall Street say the potential for further declines in Fed treasury holdings could leave it out of ammunition.
  • The Fed holds assets to manage the nation's money supply and influence the federal-funds rate, which banks charge each other on overnight loans. When the Fed buys Treasurys or makes loans directly to banks, it supplies financial institutions with cash; in effect, it prints money. The cash ends up as currency in circulation or in banks' reserve accounts at the Fed.
  • Since reserves earn no interest, banks lend cash that exceeds their required minimum. That puts downward pressure on the federal funds rate, currently targeted by the Fed at 2.25%. The Fed could purchase securities and make loans almost without limit, expanding its balance sheet. That would cause excess reserves to skyrocket and the federal funds rate to fall to zero. The Fed would contemplate such "quantitative easing" only in dire circumstances. The Bank of Japan took this step this decade after years of economic stagnation.
  • Fed officials also are investigating the feasibility of the Fed issuing its own debt and using the proceeds to purchase other assets or make loans. It has never done so; the legality is unclear.

As I've been saying for months; unprecedented times we'll come back and read in history text. [Mar 22: A Historic 9 Days for the Federal Reserve]

As for George Soros, good news and bad news. When last we heard from the legendary investor (before the Federal Reserve made it clear it will print as much money as possible and sacrifice the middle class via inflation to prop up the banks), he was saying things were extremely dire [Jan 22: Soros Says World Faces Worst Financial Crisis Since World War II] The good news is he sounds so much more happy now; now the world only faces $1 Trillion of losses in subprime ($200B down, $800B to go!!) Fantastic. I am surprised the market has not ralled 5,000 points on this prediction. This is on the low end of the Roubini $1-$3 Trillion figure [Mar 13: Scary Stat of the Day: Roubini Calling for $1-$3 Trillion in Losses] I also assume all the losses will be taken in the next 30-90 days because we can't have these writeoffs ruining our happy autumn because that would just RUIN our "everything will be fine in 6 months" thesis. See folks, this is the beef with the "financials will be back, retail will be back, housing will be back, and everything will be fine in 6 months" scenario. It's taken 9 months to drag out $200 Billion in global losses from these "black box" banks who refuse to provide transparency. And thats with housing prices at much higher prices then they are now (or will be in the future), that's with employment at higher rates, thats with positive GDP for much of that time frame, thats when people had far less stress on their credit cards, or auto loans, or student loans, or personal loans.... yet it took 9 months to get that first $200 B of confessions. So if any of these lunatics aka some of the greatest investors of all time, are correct and we're looking for another $800B (or more), in writeoffs how are we going to get that all done in time for our party in 6 months (when all problems go away?). And how will we replace all that lost capital? Oh wait... that one I know... print....print....print...print. As an aside I continue to be shocked gold is not $1200+ off all this news... but since everything is going to be fine in 6 months maybe I should be more shocked gold is not back down to $200. Because in a non inflationary, everything is fine (Ben promised world) gold should be near worthless.

  • Billionaire investor George Soros said on Wednesday that global losses are likely to top $1 trillion from the subprime mortgage debt crisis, which he called the most severe since the Great Depression.
  • "Losses being recognized now amount to $1 trillion," from the subprime mortgage debt crisis, said Soros, when asked about a similar estimate from the IMF. "I think that is a fair estimate, but that number is likely to still grow," as house prices in some countries including the United States continue to come under severe pressure, he said.
  • "Certainly the regulators have failed, for instance, to regulate the mortgage market," Soros said. (George, all regulation is bad, Fox News told me this - regulation kills business and innovation - get with the program! Self policing is the way to go - humans look out for the best interests of each other - this episode clearly shows that. The free market regulates itself!! Wait... that's true only on the way up -on the way down socialism of losses onto the taxpayers back fixes everything! But nevermind that small issue - just keep repeating "regulation is evil and stifles business" 100x a day and eventually you will believe it)
  • He added that the "acute" phase of the financial crisis may have passed with the collapse of Bear Stearns Cos (BSC), but warned that he expected that there will be an impact of the credit market crisis on economies that is yet to come.
  • Soros said global economies are in a period of rapid deleveraging and that will keep financial markets volatile. "We are in a period of financial wealth destruction ... and now we have deleveraging," he said, adding the situation will lead investors to preserve capital. He declined to comment on what he's investing in at the moment.

Anyhow, dear readers, nevermind this... as we preach on a daily basis... keep the faith and "everything will be fine in 6 months". Keep the faith, keep piling into equities (I highly recommend financials by the way), and shut your eyes and we'll wake up in 6 months all better off (and rich). Just believe Dorothy. Just believe.

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