Tuesday, September 1, 2009

Market Update

It appears as if the market joined K10 in a vacation last week. I hope it had as much fun as I did. Very little happened while I was gone, the indexes were virtually unchanged, and no new economic discoveries were made. Perhaps the most surprising news is that AIG's stock somehow managed to trade at the preposterous price of $55, before falling back to a merely ridiculous $42. Traders and investors continue the great debate over whether the economic recovery is for real or if we've just experienced a quick bounce due to the record amounts of government stimulus. A Bloomberg article pits Goldman Sachs' ever-bullish Abbey Joseph Cohen against a slew of bearish hedge fund managers. Meanwhile, Calculated Risk highlights a few articles on August auto-sales and posits the important question of whether cash for clunkers was a real boost to auto sales, or if it merely cannibalized regular sales during the typically strong month of August, before falling back to abysmal levels. Meanwhile, Bank of America is wheeling and dealing with the government, to try to pay back roughly $20 billion of the $45 billion it has borrowed from TARP. Also, the bank hopes to pony up $500 million to shelve the government profit-sharing-I mean loss-sharing agreement on certain assets. If the bank can make these arrangements then it is no longer considered a special needs patient and can go about its business promising to pay its bankers egregious sums of money without any clue as to whether it can afford to or not. Speaking of loss-sharing agreements, the WSJ reported yesterday that the FDIC had agreed to absorb up to $80 billion in losses on many of the deals it had struck with acquirers of failed institutions. The FDIC has estimated that it will have to cover $14 billion in future losses on these deals. How close are these estimates to reality? Let's see, last year the FDIC had $42.5 billion in its insurance fund coffers. It now has $10 billion as of the last quarter-end. Thankfully, it can borrow $100 billion from the Treasury without having to ask for permission, and another $400 billion if it says "please." So far 84 banks have failed this year and 416 are on the FDIC's problem list. So I'm not all that comfortable with the FDIC's estimating abilities. The regulator is just hoping that spreading the losses out over time will reduce the pain? Perhaps the economy will just recover and will make the losses easier to absorb? Wouldn't that be convenient?

Regular readers of Mock the Market know that I must side with those who believe that the recent enthusiasm about the prospects for a robust economic recovery is overdone. The problem is that we went through a period of enormously easy fiscal and monetary policy in response to the tech bust, September 11 and the accounting scandals of the early 2000's. The most basic economics course will teach you that this is a recipe for inflation. Since the Fed based its monetary policy decisions on the CPI (which doesn't take housing prices into its calculations), instead of things like the quintupling of home prices in Arizona, Florida and California, it failed to notice the asset price bubble that was inflating. As assets went up in value, consumers used them as collateral to borrow more. But you can't solve the problem of an entire society that lived beyond its means by borrowing against assets that have now lost significant value by offering them zero percent financing. The reality is that we will be operating at much lower rates of economic growth until the debt overhang is resolved. It's just going to take some time.

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