Gravity Sucks

As anybody who's ever ridden a bicycle or even stood up knows, what goes up must come down.

This is as true for the stock market as it is for anything else. Granted, it's a whole lot harder for the market to fall back to sea level, something about retained earnings and asset values underpinning stock prices, but trust me on this: it is not impossible.

Enter Paul Krugman:

...The bailout plan released yesterday is a lot better than the proposal Henry Paulson first put out — sufficiently so to be worth passing. But it’s not what you’d actually call a good plan, and it won’t end the crisis. The odds are that the next president will have to deal with some major financial emergencies.

Absolutely.

I'm not arguing that this is the mother of all financial crises. I am arguing, however, that the MOAFC stands a better chance of happening now, when the market is weakened and the solutions ineffectual, just like an opportunistic flu is more likely to incubate when the body's defenses are weakened.

The trouble with this bailout package is, it's like giving a bandage to a patient who's suffered a heart attack because he got a papercut filling in his admittance forms.

The real trouble is, well, ask a hundred pundits the cause of this problem, and you'll get a hundred different answers, all of them wrong.

Ask a hundred different economic pundits and you'll get a hundred different answers, of which 95% are incomplete.

Make no mistake about this: this crisis is pervasive and infiltrates the coziest sectors of our economy, and the world's economy. There was no single simple cause and there will not be a single answer, although the ultimate solution may end up being enormously simple. I think. I'll post more on my solution later this week.

We were worried about avian flu? This is an economic avian flu.

Curiously and coincidentally, this flu, like the avian one, has its roots in Asia. America exports debt. Period. We're good at it. We export roughly $700 billion annually (there's a reason that the bailout was pegged at that figure, and that's the reason right there).

Asian nations, flush with cash as their economies have overheated, have invested heavily in American debt, first in Treasuries bill and notes, and then when the purchase of those became unprofitable (for the same reason mortgages became attractive) in mortgage backed securities.

The gamble everyone made was that housing prices could only keep going up. Remember the title of this column?

As housing prices peaked and slid down a little, banks stopped lending money, forcing Fannie Mae and Freddie Mac to step in to keep the supply of mortgages consistent with the (overmarketed) demand.

How many Ditech.com and Countrywide commercials were there each hour just a few years ago? Five? Ten? Twenty? It's no surprise that these companies were the canary in the flu mine. They had the riskiest loans with the least capitalization, and needed to borrow the money they were lending.

And banks were only too happy to lend to them. Why? Because banks knew that the Fed and Treasury would step in when things got hairy. After all, the Fed helped arrange the bailout Long Term Capital Management. They'd have to step in where people's homes were at risk!

This is not the only cause of the current crisis and books will be written about them all, until eventually a comprehensive picture is put together, but I think this is a reasonable timeline of this crisis and how it unfolded. Call it the tree on which to hang the ornaments.

But like a Christmas tree, what goes up eventually must come down...

What Was Left On The Cutting Room Floor

(hat tip Karyn Mannix)
I'm struggling with how to characterize the jitters of the market and the surprising (if feeble) news out of the Federal Reserve this morning.

On the one hand, I can't recall a moment in history when the US had this much warning of a total meltdown in what many of the uninformed take to be the economy: the New York (and other) Stock Exchange. Stock exchanges tend to be lagging indicators of the economy, tho, so the steep drops we've been experiencing are echoes of what's really going on in the commercial sector of the country.

On the other, I can't recall such a feeble response: a stimulus package that actually might harm the economy longer term, as well as a pissant rate cut of a three-quarters* of a percent in the prime rate.

The tax cut and rebate package on the face of things sounds like a pretty good deal: put money immediately back in the hands of taxpayers, while giving businesses a break on their earnings.

The administration doesn't seem to get it. This is not a temporary economic correction, this is a full-blown recession that's teetering (if not already fallen) on the brink of depression.

If we take Paulson's words at face value, and assume he's just talking things up to avoid panic, well, a) he's not succeeding too well, based on the futures market as of 9:15 this morning, and b) we'd like to think that behind the scenes, there's some furious activity to fix things quickly.

There's some evidence of that, but it's easy to infer there are some major obstacles to creating an effective response.

Rumours on the European markets are that the Federal Reserve cut is the first of a series of central bank rate cuts, primarily in Europe, to be announced. Could be. As I said, I can't recall any emergency rate cuts in my lifetime. It would be indicative of a collaborative effort to announce the US rate cut before the others are announced.

The problem for Europe, however, is they've actually been raising their central bank rates in order to stem inflationary pressures. A cut now would send a very mixed message to their markets.

The Fed's quarter point three-quarter point* rate cut serves only to aggravate the markets here. They will open down about 300 points, and investors were expecting (funny how yesterday, there wasn't even the merest hint of a rumour of a rate cut, and now suddenly, they were "expecting"?) a half a point cut.

Not that any of this will really make a difference, of course. While credit markets are tight, it's not because interest rates are high, it's because the markets are terrified of the outcome of the mortgage default crisis. You could lower the discount rate to zero (a prime rate of 3%), and banks still wouldn't lend.

Asia is in total meltdown already, which means that China is experiencing its first market crash. There's no way of telling what response Beijing will make. This side note is a way of saying, "Gee, I sure hope they don't start calling in their chits on the American economy!"

The Bush legacy seems to be even further in the hole. His Hail Mary pass of a Middle East settlement is in disarray, and his one hope for any positive news was four years of relative economic strength. Not Clintonian, but Bush would have been able to point to positive growth, especially if you look at the last five years of his administration only.

Alas, even that slim margin of growth has been squandered, along with several hundreds of billions of dollars in Iraq and trillions domestically. Had we not had tax cuts of the severity that Bush insisted and the Republican Congress lapped at like Tommy Lee on Pamela Anderson, we might have some programs in place already to deal with the problems ahead.

Instead, we squandered like a drunk sailor on shore leave with a stolen credit card. Hey, the rich sure as hell won't ever have to pay these bills back, why should they care?

* The Fed sent out a press release correcting the initial announcement.