Lenin and Trotsky agreed on
a strategy for the socialist revolution in Russia â€“ by any means necessary. With developed
capitalist economies running headstrong into nationalizing key industries starting
but not ending with banking under the too big, too connected and too
influential to fail principle, one can easily imagine Paulson and Bernanke are
the modern day revolutionaries bringing socialist principles to banking under
the strategy of by any means necessary.
However, I am not making a
case for a Darwinian outcome nor for a Soviet outcome. Both are
unacceptable and neither Paulson nor Bernanke are closet socialists. But
there actions to date speak of far greater fears over the health of the banking
system and economy than I think many give them credit for. Indeed the
actions foretell a by-any-means-necessary response because they perceive the
scale of the problem is so enormous that a revolutionary response is
Think for a minute about the
ideologues in the White House who operated on the assumption that less
government regulation and less government period in markets was best for
everyone now leading the largest government intervention into the banking
system in the nationâ€™s history. Things have to be really bad to allow
this about face. This brings me to the Fed Chairmanâ€™s appearance this
week in Congress where in his prepared remarks he said a second stimulus
package, which Democrats to that point had been advocating, would be
helpful. Well Iâ€™ll be a monkeyâ€™s uncle. Now the White House is on
board. Is this a dream/nightmare?
My point is underestimating
the power of the banking and economic crises and adverse feedback loop has been
the main characteristic of markets for much of the last 14 months. The
Fedâ€™s balance sheet has nearly quintupled this year and is approaching
$2trln. The Fed has cut 375bps since last September and will cut more
October 29 (if not sooner with other central banks in light of the collapse in
equity prices today). The Treasury has committed $250bln into
recapitalizing banks and has another $450bln earmarked for buying distressed
ABS. All arguably needed and yet still not sufficient.
Why? Because the
problem is not staticâ€¦it changes and it is compounded by, and compounds, the
economic crisis. Just when you thought things were cooling down wham and
there is a run to dollars, bonds and out of stocks and EM...the anti-risk
trade. All this makes me think that there are large segments of capital
mkts that are completely illiquid and fund managers are being forced to sell
anything that is the least bit liquid to cover margin calls, redemptions, or
So a partly nationalized
banking system is not the ticket to normal capital mkts with liquid market
segments. Six years of leveraged investing and structured yield plays
does not unwind in 13 months much less 4 weeks. The tide is still rolling
out and exposing new naked swimmers...credit cards, corporate debt (see Bloomberg
on the CDO mess brewing), corporate FX exposure (see WSJ article today on Latam
corporate currency trading gone wild), Latam corporate local currency debt,
leverage loans, convertibles, swaps, credit, commodities...nearly everything.
So policy response has closed gap on banking problem but the banking
problem is not static...it is morphing into new problems and non-bank
corporate/household problems also proving a little underdressed as tide rolls
I still out of the bunker
but have not taken off the lacrosse helmet. God bless Warren Buffet for
buying for his country, but that is so not a successful strategy for this
crisis. Buying equities 10% from the lows two quarters from a bottom is
rational. And since the deeper recession scenario is now the favored one,
equity bear market should last at least until halfway through the recession
which makes next summer the earliest we should expect a bottom in stocks and
frankly this may not happen until late 2009 if the 2-year recession is in our
future. As for the reflation trade â€“ it is coming but will be much later
than most expectâ€¦even with the Fed balance sheet exploding and the treasury
dropping debt from helicoptersâ€¦and yes with all that is wrong with the US banking system and economy the dollar collapse on
reflation will be a very long wait.
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