The Market Ticker

Hmmmm.....

Let's survey the landscape on the back of three back-to-back weeks of gains in the stock market, amid every crooner in the land claiming that "the bottom is in" and even better - "buy now or be priced out forever."

Heh, we've heard that before, haven't we?

I think we have.

Let's take a look at the facts.

First, we'll look at the credit card issue, since The Fed proposed new rules today to "curb abuses." From that report we find the following nuggets:

"The Consumer Federation of America estimates that credit card debt held by consumers is about $850 billion, some four times what it was in 1990. The group says the average debt for those 58 percent of card-holding households that do not pay their balance in full every month is about $17,000."

We also know from a study done by Fitch that 30% of all credit cards are exhibiting patterns of use and payment that show high risk of default. Since we can assume that none of the 42% of the people who pay off monthly are at risk of default (for obvious reasons) this means that about half of the people carrying balances are currently at high risk of default on their credit card bills.

This, over the last few years, has been dealt with by cash-out refinancing the money from one's house, paying off the card, thereby freeing it to be used again. Many people refinanced "serially" in this fashion over the last few years. In fact there is roughly $1 trillion of this debt outstanding between 2nd lines and HELOCs.

How is it performing?

Well, today we find out that S&P will no longer rate 2nd line debt, citing "anomalous" behavior. What is that "anomalous" behavior? Specifically, people walking away. And the performance of that debt is rather simple:

"The downgrades last month left all of the securities with ratings of BBB or lower, compared with 20 percent before the action. BBB is S&P's second-lowest investment grade. About 96 percent dropped to non-investment-grade, or junk, assessments.

'The problem with seconds is it's either good, or it's zero,'' said Brad Golding, a managing director at Christofferson Rob & Co., a New York-based money manager."

There's no middle ground, and S&P can't figure out which is which . That puts a nail in the coffin formed in the belief that you can simply look at FICOs or other forms of consumer "behavior" to figure out who's going to default and who's not.

Did 'ya read that underlined part? Go back and make sure you do. All of this debt is rated BBB of worse - 96% of it worse. BBB, you see, is the lowest "investment grade."

Most of these bonds were originally rated "AAA", "AA" or "A".

Below "BBB" there are a few more levels, including things like "BB", "B", "C" and of course the best of all, "D". As in default.

So the bottom line here is that we have 96% of second line tranches that are either barely investment grade or worse. And the "worse" is bad news, because once in "speculative" territory actual default rates ramp precipitously.

The nasty here is that according to Moody's a bond rated "AAA" should have less than a 7% risk of falling below "AA", an "AA" bond should have less than a 7% risk of falling below "A", and an "A" rated bond should have less than a 5% risk of falling below "BBB", all within five years of rating.

But in fact 96% of all of these bonds failed that test - not 5-7%.

Fraud? You tell me. It sure looks that way from my perspective, and I don't understand why we as citizens are allowing this, or why Congress is. This goes beyond an "honest mistake"; these firms all have economists and people who understand math on their staff, and it is simply beyond the pale that they "rated" debt issues without investigation of the underlying credit quality, not to mention accounting for societal factors (is it even possible to pay back the debt involved, given the overall level of debt load in America?)

Yet there have been no Congressional investigations, no subpoenas, and no indictments.

Speaking of fraud, you do remember that AMBAC has found that 75% of the bonds they examined in detail had violations of the representations and warranties underlying their "wrap", right? It looks like HUD's claim from a couple of years ago that at least 50% of the loans written in the last few years had some sort of fraud associated with them is in fact true.

Now let's talk about what's worse; that would be the Treasury "Borrowing Advisory Report".

Its four pages and required reading, because it gives you a window into the Treasury funding market, which is the underpinning of all debt markets in the United States.

In short, if you don't read this, you don't know jack about what's coming in the bond markets, and without that, you can't make investment decisions.

Here are the money quotes; note that I have omitted some of the more-fluffy material:

"Expectations for economic growth in the first half of 2008 have continued to fall and a number of primary dealers judge the economy currently to be in recession.

A recent survey of primary dealers estimates that the deficit for the 2008 fiscal year ending in September will exceed $400 billion with some economists expecting a deficit of more than $500 billion--a significant deterioration from fiscal 2007's deficit of $163 billion. Economic stimulus measures will complement the forces widening the budget deficit. This year's shortfall may surpass fiscal year 2004 as the largest on record in nominal dollars.

Housing remains a notable drag through a variety of channels and that weakness now is being augmented by a more cautious approach to spending by businesses and consumers.

There was also universal agreement on the Committee that the Treasury needs to prepare for additional financing needs over a more intermediate term. In fact, several members argued that the current deterioration in the fiscal outlook might be more than temporary and that the risk of further deterioration outweighs the risk of a surprise improvement in the deficit.

Furthermore, additional members again reiterated their concern that this latest "cyclical" deterioration in the fiscal outlook is particularly troublesome as the longer term "secular" forces of entitlement spending and the aging of the baby boom generation and their effect on the budget deficit are no longer that distant in the future.

The majority of members believe that the addition of the year bill combined with increases to the size and frequency of existing coupon debt over coming quarters will still not be sufficient to satisfy the increased financing needs of the Treasury over the intermediate and longer term.

Committee members were in agreement that the problems in the housing market were significant, and many were concerned that without intervention the problems would grow worse. In fact, housing price data from S&P/Case-Shiller was released hours before our meeting and highlighted that the decline in housing prices is not over but that prices are actually accelerating to the downside. For example, while year-over-year prices were reported to be down almost 13%, prices on a 6-month, 3-month and 1-month basis have declined 21%, 25% and 28% annualized, respectively."

Bullish for the markets? Specifically, additional issue is likely to lead to materially higher interest rates, and we know how good that is for things like the housing market, right? $500 billion in deficits before the end of the fiscal year in September?

And speaking of those deficits, you want to know what's going to add to them in a big way?

The Fed and Congress.

See, The Fed violated the Constitution, and now, having been unleashed from a formal appropriations process as required by that same document, suddenly Congress feels it can call on Sir Fedsalot to fix anything - on the public tit - without being held to account for it! And call on it they have:

"There is 'a potential crisis in the student-loan market' requiring 'similar bold action,' Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans. In a separate letter, Pennsylvania Democratic Representative Paul Kanjorski and 31 House members said they want Bernanke to channel money directly to education-finance firms.

Student loans are just the start. Former Fed officials and other Fed-watchers say that Bernanke's actions in saving Bear Stearns will expose the central bank to continuing pressure to use its $889 billion balance sheet to prop up companies or entire industries deemed important by politicians. The Fed satisfied Dodd's request today, expanding the swaps to include securities backed by student debt.

'It is appalling where we are right now,' former St. Louis Fed President William Poole, who retired in March, said in an interview. The Fed has introduced 'a backstop for the entire financial system.'"

You forgot the word "illegal" Mr. Poole.

Now do you know why I was so pissed off about this? The entire purpose of a Federal Reserve Bank chartered by Congress but operating independently is to stop this sort of crap and force it through Congressional Appropriations - you want to prop up something, you have to vote on it. Having voted on it and gotten the President's signature, you can proceed - but not until.

Suddenly all that's out of the window. And in a world where deficits are running $500 billion a year and counting, perhaps as much as a trillion this year, we run a very real risk that the Treasury Market suffers the dislocation that I have been warning about.

Should it happen, the 1930s are coming back to visit America, and that event is one you can't stuff back in the bottle once it occurs.

Now let's look at employment. Specifically, the employment report Friday. As mentioned in the previous Ticker there are some problems:

"The drop in the U.S. unemployment rate in April partly reflected a jump in part-time workers, raising concern businesses are still scaling back, economists said.

The number of Americans saying they worked part-time last month due to economic reasons -- either because their hours were cut or they couldn't find full-time work -- jumped to 5.22 million from 4.91 million in March, the Labor Department reported today. That helped the jobless rate unexpectedly fall to 5 percent from 5.1 percent.

The 19 percent increase over the last six months in the number of people not working a full day because of slack business conditions is the biggest in six years. Fewer hours and smaller pay increases, just as food and fuel prices surge, may continue to undermine consumer spending."

May continue to undermine consumer spending?

One thing we know - consumers will spend so long as they can get credit. Many analysts have thought otherwise only to find their predictions in the dustbin of history. The argument of The Bulls basically devolves down into "The consumer will never stop because he will keep charging his way to prosperity."

There is a problem with this argument, and its the same problem that underlay the Housing Bubble in the first place.

That's mathematics.

See, house prices can not grow to the sky (at a rate that exceeds income growth) nor can spending grow at a rate that exceeds income growth - at least not for very long.

We don't teach our children that, but we should.

The truth is that about 22% of GDP goes to debt service - that is, interest - on existing debt. It doesn't pay down principal, it doesn't do anything productive for society, it builds nothing (other than the banker's vacation house in the Hamptons!) It comes right out of your pocket and into theirs, and it is an absolutely stunning amount of money, to the tune of more than $2 trillion a year, and that's private debt service, not government. In fact, the government spends less on their debt service (from our taxes) than we do as a percentage of GDP!

This has in fact gone so far that we now need five dollars of new debt to produce one dollar of GDP increase. Attempting to push this further is only going to result in a bigger blast radius; the debt must be paid down when possible, and defaulted if not.

The bad part of doing so is that you can't consume with dollars that are used to pay down debt. Therefore, the prudent says we will see not only the new debt stop going into GDP (because it can't; we simply can't afford to take on any more) but in addition the payoffs will reduce GDP as well, forcing it negative.

By how much? That depends on how much of the debt defaults. The more debt defaults, the shorter the pain lasts, but the more severe it is. In any event this is a recipe for a deep and serious recession, not a short and shallow one.

The Press is finally starting to get the idea that perhaps trying to get everyone to buy a house isn't such a good idea. Specifically, believe it or not, The New Republic (and CBS!):

"Indeed, we ought to consider what role the federal government has played in creating this mess. By stimulating home ownership while failing to account for the reasons home ownership is valuable to society, Washington has simply sought to buy our votes with our own debt. As the subprime crisis accelerates and threatens to spread through prime and near-prime markets, policymakers face a watershed moment. To keep us from an economic nightmare, they need to replace the dream of home ownership with policies that actually increase wealth -- not just the illusion of it."

Oh my God, the truth! And from the mainstream media.

Then there's JP Morgan/Chase. You know, Jamie Dimon, who claimed they would have been "just fine" had Bear Stearns imploded, just a short while after Bernanke dissembled about the end of the world? Yes, that Jamie Dimon. What did he have to say over the weekend? Try this on for size, as a counterpoint to the pumpers on CNBC:

"JPMorgan Chase & Co does not expect the U.S. financial crisis to end soon and will remain very cautious, its top executive said in comments published by a German weekly on Saturday.

"But we are not done with the crisis for a long time," Dimon said, adding that it was not the company's job to make bets on the future.

"Imagine we would need to walk up to our shareholders one day and say, sorry but the recession in the USA is so bad, we're broke. We need to be able to rule out at all times that it will not come to that," Dimon said.

Now read the above Treasury paper quotes as well.

The "primary dealers" are people like Dimon - they see the day-to-day and know that this is not over. You're not being told this up front by Bubble TV nor Bubble Newspapers because all of them are heavily invested in trying to suck YOU in to be the bagholder on this mess, just like it was in 1999 and 2000, all the way down until we finally did hit a bottom in 2003.

And just like last time, and indeed just like every bear market in history the true bottom will come when nobody wants to own stocks, everyone believes there will never be any sunshine again, when it will be financial tornado after financial tornado and the market crooners claiming that its all going to be ok will have all shut up and hung their heads in despair.

Of course CONgress is still hell-bent and determined to try to buy more votes (with our own debt), as has been seen recently.

If you're interested in about a 40 minute audio presentation of the stupidity in this regard, listen to this presentation by Nesbitt Burns' Don Coxe - its good - and pretty much lays out at least the macro-level view of the world.

Never mind that the S&P announcement on the 28th on Bloomberg related to CDOs, which I covered in a ticker earlier this week, in which S&P laid forth the stark reality of what is both at The Fed and also sitting on the balance sheets of the investment and commercial banks - at par:

"The CDOs covered by S&P's revision are at least 40 percent invested in some U.S. home-loan bonds created since Sept. 30, 2005 or pieces of other CDOs with such holdings, according to a statement today. The most-senior bonds from the CDOs originally rated AAA should recover 60 percent of principal owed, while securities rated A or lower will get nothing, S&P said.

Investors should recover 35 percent of principal after defaults on securities from the CDOs junior to their so-called super-senior classes but also originally rated AAA, S&P said today. Originally AA classes should recover 5 percent, it said."

Let that sink in for a while folks - if you have "Senior Tranches" of CDOs that are "AAA" rated, you are going to take a 40% loss. If you have ordinary "AAA" rated CDO tranches rated "AAA", you're going to take a 65% loss.

Remember folks, these pieces of the CDO tranche process are the ones that are sitting on the bank's balance sheets and, now, are also the ones that are sitting at The Fed!

Absolutely NONE of these writedowns have been taken.

NONE.

How does all this end?

Very badly.

If you want to know how badly, read that Treasury Report and think about it long and hard.

I'm surprised they published it, to be frank.

No, my friends, our capital markets problem and the consumer issues are not over.

We have roughly $1 trillion worth of 2nd Line/HELOC spending from the last few years that has been withdrawn. It will not, and cannot, return - that money is gone, leaving the debt behind.

Housing prices will correct to at least their long-term trendlines, and likely beyond. This is a mathematical certainty.

Lending will return to sound standards simply due to self-defense by the banks, not from desire. This means 20% down will become the norm once again to get a mortgage, along with a fixed-rate, 15 or 30 year loan. The world of "HELOC" and "Cash Out" refinances is essentially gone on a permanent basis.

We have recognized $300 billion of losses but it has all been derivative loss. The $2.5-$3 trillion in credit loss from housing is still to come, plus all the credit card and other debt that cannot be paid down, likely a couple hundred billion more - at best.

The capitalization of the banks is nowhere near adequate as of yet to clear that bad debt. Financial institutions need to raise tremendous amounts of capital beyond what they have raised thus far in order to survive.

Bernanke's games will not solve this, as providing the banks with more "vig" to make this possible just sucks the money out of your pocket anyway (where do you think it comes from, ultimately?) either via direct monetary inflation if he does something stupid, or via taxes and direct payments if not.

Either way the check is now on the table and must be paid.

We're nowhere near done with this mess.

Well well well.

So The Fed comes out with more expansions of throwing their balance sheet to the wind, and the market spikes, then thinks - "heh, wait a second, what are they REALLY trying to pull here?" and pulls back.

Let's remember that everyone - and I do mean everyone - has been running around saying "The Credit Crunch is (mostly) over."

Ok, if that's true, then why did The Fed add 50% to the size of the TAF today (so existing loans could be rolled and more made?) and why are they now willing to take collateralized credit card and auto loans? Houses at least have some security; autos are typically upside-down instantly on issue, and credit card debt is, of course, completely unsecured.

Someone's lying.

Watch what people do, not what they say.

Speaking of liars, it did not take long to figure out what's up. Here 'ya go - this afternoon S&P downgraded Countrywide (NYSE: CFC) citing essentially what I reported on last night regarding BAC not assuming CFC's debt obligations. (sorry, no link yet - will update when I get one - its a flash message so far)

Now this, folks, is much bigger than it looks. Much, much bigger.

See, I'm willing to bet that basically ALL of CFC's packaged MBSs that they haven't been able to peddle off into the secondary market - and only God knows exactly how much that is - plus whatever else of their debt may be packaged up and securitized - is sitting at The Federal Reserve under the TAF! So now, under the rules (assuming The Fed follows them) they are required to "PUT" anything downgraded back on the submitters, and they must either be bought out immediately or replaced. While this probably doesn't cause much impact today, as its the corporate ratings and not the MBS that got hit, how long do you want to gamble that will hold up, when you consider that S&P just said "nuts" to any further ratings on HELOC-based debt in general!

This is just the beginning of the mess.

Eventually, as the insanity continues to unwind, there won't be enough "money good" debt left to support the TAF and other facilities.

Indeed, the announcement that they will take credit card and auto loan debt means that day has already arrived!

Why? Because why would they "expand" the facility to take this unsecured (and loosely secured) debt if there was plenty of solid paper out there that could be pledged?

Fact: The good paper is exhausted - its all pledged. Ben is of course not coming out and saying this, but that's what the facts are.

We are sitting on the edge of that bond market collapse I have been talking about.

As the quality of debt continues to degrade The Fed will be forced to either pull its support or accept lower-quality paper.

The former ends the game and forces all the insolvent institutions underwater.

The latter ends the game because The Bond Market will associate the lower credit quality (properly so!) with our sovereign debt, as when (not if) it fails we the people will be forced to eat it. This results in an immediate ramp in the cost of government debt and, as that's the reference, all other debt follows in rate upward.

This is precisely how we get a 1930s rerun and if Bernanke doesn't purge this crap off The Fed's balance sheet instead of expanding the amount of it he is holding, and Congress doesn't force his hand the risk will continue to rise until an "inflection point" is reached in the bond market.

The question now becomes whether Bernanke wants to choose to end the game and have this happen in a controlled fashion or whether he prefers to have the market choose for him, which will be extraordinarily disorderly in its effects, scope and timing.

The employment number (which The Fed had, by the way) came out and its better than expected - but negative.

Why not down huge? Government hiring. Lots of it. Oh, and a "Birth/Death" adjustment of over a quarter of a million jobs - fictional jobs, I argue.

"Birth/Death" is a model attempt to count small businesses that otherwise don't get counted, and either die or are born. Let me ask you - drive around your town - are small businesses going under or starting up? On balance.

Well, the BLS says they are starting up to the tune of over 250,000 jobs in the last month alone. Do you believe it?

Then let's add that we now have 306,000 people who are now working part-time for "economic reasons." This, by the way, are people who were full-time employed and are now part-time. 306,000. Oh, and that's 849,000 people more than the same time last year. And average weekly earnings were down.

Is all this good?

Well, actually, no its not. Tax receipts are way down at the national level and in fact sales tax receipts are down on a national basis too.

So how did we "birth" all those jobs if nobody paid taxes into the state government from all these allegedly created small businesses?

Folks, Bear Markets are irrational.

Always.

If you do not have sound money management behind your actions in a market like this you will be destroyed - no matter whether you are a Bull or a Bear.

Back in the summer - early August - I wrote a ticker that I called "Come to Jesus".

It is even more important now than it was then. Go back and read it if you've forgotten what I wrote, because I keep seeing people both cheering and crying alternatively in the forum, and its obvious that this hasn't sunk in - never mind that its in the banner and thus right "in your face" every time you log in.

Go back and look at the Bear Market of 2000-2003. There were twenty percent moves in both directions during that market, which is more than enough to destroy your account several times over if you're imprudent and/or leveraged beyond where you should be.

It is not my place to offer investment advice, and as the disclaimers all over the blog and forum point out, I don't. I neither want to run someone else's money nor do I. That's your responsibility.

I don't know how many times I have to pound the table on the fact that most investors are best off in Cash during Bear Markets, not trying to play short.

The reason is simple - Bear Market have a long and storied history of blowing up both Bear and Bull believers accounts!

Now if you wish to believe the numbers in the employment report, with finance allegedly reporting gains in employment, have at it.

If you want to believe that The Fed is expanding its credit window to take credit card asset-backed securities because everything is ok, that's fine too.

If you expect the market to blow up imminently, you may be waiting a long time.

Or not.

The problem is that its virtually impossible to time these things.

So if you're day trading, there's money to be made, if you're quick. If you're not quick, you'll be dead eventually, no matter how right you are. Its just how it works.

If you're not day trading then you come up with your thesis, doing your own work, you stay in a position that cannot get you into margin trouble, and then you sit back and wait to see if you're right or wrong.

If neither of these ideas appeal to you then you're doing the wrong thing being in this market.

This is not going to be over any time soon guys.

If you want an example of what can (and does) happen, look at Sun Microsystems (JAVA). One miss, and its down 17% premarket. Go long? Anyone remember the famous blowup of Apple during the tech wreck? Again - go back and look at historical charts. Its right there guys and dolls.

Apple up 50% in less than two months? On the basis of what? Did they not report margin compression and saturation of one of their key markets - the iPOD? Yes they did. But their stock screams higher.

Amazon? Look at their P/E. I know, they're a tech company. Are they? Or are they a retailer selling an insane multiple?

Is this 1987?

Or is it 2000?

Do you remember what actually happened in 2000?

The tech market blew up but it was followed by a huge rally that lasted four months and recovered the majority of the original losses, only to be followed by an eight month long grueling decline that took the NDX from over 4100 to under 1400!

And if you bought the "dip" at 1300?

You were destroyed, because over the next 18 months you lost nearly half your money AGAIN, with the final plunge going all the way down to 795!

The total losses were about 80% but many people literally lost everything because they bailed at the bottoms from longs and bought the rallies, only to have them blow up and kill them.

The SPX wasn't materially better. In the video last night I pointed to the huge dump in the summer of 01 - before the 9/11 attacks. A criticism levelled in the forum was that there were "obviously" people who knew and were trading ahead of the attacks.

Ok, then explain the March '02 peak at 1175ish to the low at 760 that same year in July, and how well that 36% decline over the space of four months treated you. Where were the terrorist attacks during 2002? Hmmmm....

Next, lets look at the CNBC callers. Did we ever see "puking up stocks" that marks a bottom?

NO.

That never happened.

We priced in "worst case scenarios", according to Piper-Jaffray on CNBC? Where was the selling capitulation? Absent, that's where.

People try to draw parallels to 1987, but is that fair? I think not, for the simple reason that in 1987 there was no economic weakness to go along with the market stupidity.

This time we have the largest credit bubble in the history of the United States - ranking even ahead of the 1920s stupidity - and it has burst.

Folks, there is a real $10 trillion worth of wealth that will be lost among American Consumers in their home values, and a real $2.5-3 trillion in actual credit losses that will be taken.

We've seen $300 billion in derivative losses written down, but near-zero in credit losses thus far.

So before you smile, consider this - if things are so good, and worthy of trading just a few percent off all-time highs in the equity markets, why does The Fed have more than half its balance sheet committed to propping up the credit markets, and why are they taking trash paper as collateral?

If you're not prepared to trade a bear market, get out and sit on your hands. Even if you have big losses here and now, because trading "in anger" will only cost you more, and ultimately, if you keep attempting to do that, you will lose your entire account balance.

Professional traders who remain in the game for any length of time know that the tape is never wrong, and your account is marked to the market every night. Your beliefs are not material to the tape in the short term, but in the end, fundamentals always win out.

The wisest man knows when not to play; greed is fine, but unbridled greed always leads to disaster.

Just ask the house flippers in California.

Or anyone included in the 47.7% increase in bankruptcy filers in the US.