What the Fed is Really Doing
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“The Fed’s on top of the situation,” says George W. Bush. But all eyes are on the Fed once again today, as it cuts interest rates again. The decision is a given. The only question is by how much.
European stocks seem to believe it. They’re up across the board as real asset commodities ease. Investors are starting to get nervous about racing commodity prices. It has been an “orgy” of speculation according to one hedge fund manager. Investment consultant David Roche, writing in today’s FT, sees 30% falls for some commodities including oil as global demand slows.
But all eyes are on the Fed once again today, as it cuts interest rates again. The decision is a given. The only question is by how much. Perhaps by a whole 1%…whopping in normal times for a monetary policy committee. But these are not normal times. This is the worst financial crisis since the Second World War, thinks ex-Fed chairman and suspect #1 bubble blower, Alan Greenspan.
He adds writing in the FT; the crisis won’t be over until US house prices stop falling. And to help do that, interest rates are coming down. Will it work? Actually, that’s not the real point, says a US hedge fund manager in an email exchange yesterday. The reason lies elsewhere:
“…It’s very simple.”
“There are a LOT of mortgages now…all over the country where the mortgage amount significantly exceeds the price of the house. People have no desire or incentive to make payments on such mortgages; even if the interest rate was zero, it still would not make sense, so people are walking away from these mortgages, and when the Banks foreclose, they wind up selling the property at a foreclosure auction, thus driving real estate prices down even more, and creating more of these “underwater” mortgages.”
“Now, of itself, this would be bad enough, causing bank failures and what not. But the Fed, because this is an election year, is trying to bail out the banking system. Now, the people at the Fed aren’t morons, they know full well that they can’t prevent bank failures by simply lowering interest rates, that’s not going to work when the mortgage is underwater. So what they’re REALLY doing (though of course they can’t say that out loud for obvious reasons) is DEVALUING THE CURRENCY, so that in notional dollars, the prices of houses will go up.”
“Now devaluing the currency would ordinarily work, the problem is that the entire US economy is based on petro-dollars. In other words, all oil is sold in US dollars, therefore, most every country’s (China/Russia/Brazil/Japan, you name it) foreign currency reserves are held in US dollars. If the fed devalues the US dollar low enough, OPEC could decide to start selling oil in a more stable currency, like the Euro or the Swiss Franc. Not only that, but a lot of trade between countries like say China and Russia used to be settled in US dollars, but now everyone is moving to Euros. If this trend accelerates, it would REALLY devalue the dollar, much more so than the Fed wants to do, and what’s worse, cause long term US interest rates to really shoot through the roof. If this happens, and it very well could, the major bank failures in the US would look like a minor problem in comparison.”
“Not that the Euro is a great currency, he adds (rather more emphatically, in truth!) but it is a legitimate alternative in the eyes of the world”. [See Bill’s ‘Schools of Thought’ commentary below.]
*** So did JP Morgan do a good bit of business snapping up Bear Stearns at $2/share?
Possibly the greatest financial deal ever said one talking head on CNBC last night, adding that JP Morgan Chase was the only US bank left standing with the balance sheet to do it.
Mr Market nodded approval. The shares jumped 10%. The last time a bank bought a securities firm in the US, it paid 20.5x times earnings says the Wall Street Journal. That was a year ago when Citibank bought Nikko Cordial. JP Morgan paid just 1.4x earnings.
A year ago Bear was worth $20bn, notes the FT. JP Morgan paid $246m but assumed further “transaction costs” of $6bn for potential hits. Bear’s office alone is worth in excess of $1bn plus it gets some decent brokerage businesses to boot. Best of all it has palmed off $30bn of the riskiest assets to the Fed. In the UK, New Labour image makers will be delighted. If the home of capitalism can nationalise a swathe of its financial industry then what’s the beef about Northern Rock? Economist Irwin Stelzer of the US says:
“Look for direct intervention in the housing market…Look, too, for nationalisation of some of the outstanding debt, as occurred in the 1980s and 1990s when some 1,000 savings and loans banks (thrifts) went bust. The taxpayer will end up assuming the risk that outstanding loans on the banks’ books will not be repaid.”
“If it looks like nationalisation, and feels like nationalisation, it is nationalisation. And there is more to come.”
*** “Stock market forecasters give fortune tellers a bad name”, quipped Buffett once.
So it is for the former Goldman Sachs US investment strategist and permabull Abby Joseph Cohen. Goldman has an enviable reputation for getting it right, particularly now as its peer group flounders in a swamp of mortgage paper. Abby Joseph Cohen was a high profile exception. Her clarion calls may have stirred the animal spirits of the bulls, but have proved a less useful guide to US stocks.
At the start of this year she predicted the S&P 500 would finish at 1,675. It may yet but would have to appreciate by about a third of its present level to get there. No matter. She now to be a “senior investment strategist”, reports Bloomberg carefully, as opposed to the “US investment strategist”.
Her replacement in her former role, David Kostin, is no bull. His call is very different. He sees another 10% fall to 1,180 before recovering to 1,380 by year’s end which, given it started the year at 1,468 is net bearish. Now all we need to see is 1,675 by year end.
*** “Why haven’t you been playing recently?” a colleague enquires of a regular tennis partner, a London-based bond trader.
“I’ve been going to leaving parties. We’ve laid off 300.”
One type of party with further to run.
Regards,
Rob Mackrill
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