Early Bird Special

Take a load off Fannie
Take a load for free
Take a load off Fannie
And you can put the load right on me
--The Band

The problems now surfacing in Fannie Mae (FNM), and her cousin Freddie Mac (FRE), were 'easy' to spot many years back. However, shorts who immediately acted on that perception may not have lasted to collect their reward when, years later, Fannie finally came unglued.

Count me among them. Short FNM since 2003, I was worn down by the market's ebb and flow while waiting for 'the big one'--that period when the collective market 'saw' Fannie's fundamental problems. Classically, I capitulated last summer--just before the financials blew.

There's little room for 'woulda, coulda, shoulda' in financial decision-making. Still, it's hard not to look at the 75% decline in Fannie over the past 12 months and marvel at the market's ability to dissolve an individual's commitment to an investment thesis at precisely the wrong time.

no positions

Return of Fannie & Freddie

They gave you life
And in return you gave them hell
As cold as ice
I hope we live to tell the tale
--Tears for Fears

Fannie Mae and Freddie Mac were at ground zero in the mortgage market meltdown. These government sponsored entities (GSEs), with their implicit backing from the federal government, helped push borrowing rates below market and foster risk taking on a broad scale.

That all came crashing down in 2007-2008 when market forces began correcting the excesses.

In late 2010/early 2011, it appeared bureaucrats had a rare moment of clarity, with many Congresspeople floating proposals to wind down the GSEs.

That moment was fleeting, however. The end of 2011 found Congress taking steps to increase, not decrease, the Federal Housing Authority's influence on the mortgage market. Increased revenue streams from Fannie/Freddie fees, increase in max FHA loan size, and expiry of tax deductions to private mortgage insurers are all likely to push more biz toward the GSEs.

Moreover, the FHA has been stepping in to back more mortgages. The volume of FHA backed loans has more than tripled over the past 4 years.

When Fannie and Freddie collapsed, each was carrying more than a $trillion in assets against a sliver (~$20-30 billion) in equity. With that much leverage, housing prices did not have to decline much to render the GSEs insolvent and push them into government receivership.

These new actions finds federally sponsored housing entities levering up again.

You can bet that, once again, when these institutions inevitably lock up again, the feds will surely be pointing fingers at the other guy.

position in SPX

One Hundred Days to Nowhere

Been away so long I hardly knew the place
Gee it's good to be back home
Leave it till tomorrow to unpack my case
Honey disconnect the phone
--The Beatles

Today's news that the US government will take over Fannie Mae (FNM) and Freddie Mac (FRE) is a watershed, but not unexpected, event. Indeed, if you've been reading Minyanville, then this announcement should not surprise you much. MV has been elaborating the F-Troop situation for years.

I have no doubt that many mainstream media commentators, as well as political pundits, will portray this situation as a 'market failure' and that government intervention was necessary to preserve social welfare.

Critical thinkers likely won't drink that kool aid. Fannie and Freddie are 'government sponsored entities (GSEs)' which, by definition, are vehicles of bureaucratic intervention in market functioning. Fannie, for example, was born from FDR's New Deal programs in 1938 with the goal of boosting home ownership above what free markets would have permitted alone.

There is nothing 'market failure' related about the F-Troop case. Instead, this situation is the product of potential energy turned kinetic from pressures building over years of bureaucratic market distortion.

Claims that placing FNM and FRE in government receivership are necessary to preserve social welfare are contestable as well. Consider those likely to benefit from this bail out, including holders of GSE debt and mortgage backed securities (including bond firms like PIMCO), politicians promoting housing market preservation and housing for the poor, mortgage holders who borrowed more than they should have, lenders who lent more than they should have, among others.

Who gets hurt? Those who were prudent. People who didn't reap reckless rewards during the preceding housing boom, but who will pay for the recklessness of others as the boom inevitably busts.

As such, the rich get richer and the poor get poorer. For those concerned about increasing disparity in class wealth, look not on 'free markets' as the cause of this phenomenon. Consider instead the consequences of government intervention that distorts markets, and of our ongoing willingness to privatize gains and socialize losses.

no positions

Home Invasion

A jumpin' up, fallin' down,
Don't misunderstand me.
You don't think that I know your plan,
What you try'n to hand me?
--James Gang

Insightful personal account by WSJ's Paul Gigot on the historical heavy handedness dished out by political and business friends of Fannie Mae (FNM). Mr Gigot concludes:

"The abiding lesson here is what happens when you combine private profit with government power. You create political monsters that are protected both by journalists on the left and pseudo-capitalists on Wall Street, by liberal Democrats and country-club Republicans. Even now, after all of their dishonesty and failure, Fannie and Freddie could emerge from this taxpayer rescue more powerful than ever."

Although this is a riveting life-is-stranger-than-fiction tale (that continues to unfold), because of its powerful backing, it seems doubtful that the movie version of The Fannie Mae Gang will appear anytime soon.

no positions

Fading Fannie

Why don't you all just f-f-f-fade away
--The Who

Funny how this story pretty much came and went with little fanfare. When historians look back on this period, however, the influence of the GSEs will likely loom large.

Even now, with their reduced market values, Fannie and Freddie remain instruments of government policy. GSEs originated in the late 1930s to express the New Deal policy of putting those who could not afford houses into houses. That policy has shifted to one of across the board buying of mortgages to keep the wheels on the real estate market wagon.

In fact, when one thinks about it, perhaps it's better for bureaucrats if Fannie and Freddie exit the public eye. Out of sight, out of mind...

no positions

Fannie's Friends

When the walls
Come tumblin,' tumblin'
Crumblin,' tumblin'
Down
--John Mellencamp

You'll never see clips like this one on mainstream news outlets. The timeframe is 2004 when the Office of Federal Housing Enterprise Oversight OFHEO, a government agency charged with overseeing the government sponsored entities (GSEs) of Fannie Mae (FNM) and Freddie Mac (FRE), reported issues with FNM's accounting practices.

As shown in the video clip, Democrats rushed to defend the GSEs and did their best to discredit the OFHEO report. They claimed that the report unearthed problems that didn't exist. They even trotted out racism as a motive for the negative findings.

To be sure, the producer of this video is clearly partisan with the other side of the aisle, and insinuates that the Republicans in the video represented the 'good guys.' But Republicans at the time were mostly calling for more regulation of the GSEs--which was not the right thing to do.

Ironically, btw, if you fast forward to the Goldman (GS) situation today, then the roles of Democrats and Republicans are pretty much reversed.

The point of the matter is that politicians tend to staunchly defend their special interests, even in the face of evidence that suggests a catastrophe ahead. And they have no problem turning their hats around if they smell political gain.

How did the FNM situation turn out?

The time bomb went off about 3 yrs later. The thinly capitalized GSEs quickly became insolvent, and their implosions occurred at ground zero of the credit meltdown.

The right thing to do in 2004 and now is not more regulation and oversight of the GSEs. Instead, these entities need to be taken apart and tossed on the scrap heap of history. Unfortunately, FNM and FRE are now wards of the State--which means We the People own them. And...they're back at the heart of the mortgage business once again.

As they are apt to do, politicians have built a new bomb. And it's ticking.

no positions

Leaking Losses

Come out upon my seas
Cursed missed opportunities
Am I part of the cure
Or am I part of the disease?
--Coldplay

Not quite apples to apples, of course, but asking why Washington focuses on British Petroleum (BP) while largely ignoring Fannie Mae (FNM) and Freddie Mac (FRE), who are 'leaking' as much money per quarter as BP has pledged in entire clean up escrow, is a good question. After all, using the $145 billion figure (which is likely conservative), cost of GSE probs so far is equivalent to about 6 Gulf oil spills.

We know the reasons. Salience and vividness effects make a major oil spill nicely exploitable from a political standpoint.

Moreover, Fannie and Freddie are government creations. Thus these institutions are likely to be protected rather than criticized and disassembled. Near the bottom of the article there are some nice quotes from bureaucrats who were already circling the wagons around the GSEs years before the bubble burst (more in this vid clip).

It is rare indeed that government points fingers at itself.

no positions

Free Markets? An Urban Legend

Too many shadows, whispering voices
Faces on posters, too many choices
If, when, why, what?
How much have you got?
--Pet Shop Boys

Pundits continue to claim that the causes of current economic and financial problems relate to 'free markets run awry' and that increased regulation is necessary.

If such a statement appeared in a manuscript undergoing the rigor of peer review in the academic community, any competent reviewer would highlight the claim as 'empty' and in need of support.

Presenting compelling evidence that markets operate in a free state today would be a tall order. It's much easier to build the opposite case--that markets today are not free at all. Rather, regulation and other forms of intervention influence markets in a decisively 'controlled' fashion.

Consider, for example, some of the restraining forces that can be reasonably linked to current credit market problems. Let's make a partial list:

Federal Reserve. Through its monetary policy, the Fed essentially seeks to fix the price of money and credit. Indeed, the underlying assumption of central banking is that bureaucrats in a room know better than the markets about what the 'proper' price/supply of money and credit should be. It's no stretch to surmise that prolonged periods of keeping money and credit too 'easy' precipitates an orgy of borrowing. The data (e.g., extraordinary credit/debt levels, declining value of the US Dollar over time) support just such a relationship.

Government sponsored housing entities (GSEs). Fannie Mae (FNM) was founded in the late 1930s under the proposition that we needed government intervention to place more people in houses than free markets alone would permit. Once again, the underlying assumption is that policymakers know better than markets. Thus FNM and its younger cousing Freddie Mac (FRE) were structured to lower the cost of borrowing due to their implicit (now explicit) government backing. Thus, borrowers borrowed more and lenders lent more than they would have in an unregulated situation.

Accounting regulations. FASB and other accounting standards have made it nearly impossible for even managers inside financial organizations to understand just how much risk is on the balance sheet. Since organizations were complying with the rules, many folks (fund managers, retail investors, heck even regulators) are likely to presume that things were 'ok.' We're now facing the consequences of decision-makers complying with standards that encouraged disengagement from risk management.

FDIC and other 'endorsed' insurance. Backstopping bank deposits with a government guarantee disengages bank customers from doing due diligence when seeking a depository. Lacking incentive to seek value, customers did not buy in line with their preferences. Thus, depositers dropped funds in risky institutions. And many inefficient operators, who would otherwise be eliminated in a market-based system, have persisted.

Broker-dealer licensing. Requiring security sellers to be licensed by NASD or other agencies also offer customers less incentive to do homework when choosing financial advisors. In a free market system, principles would be forced to study scrutinize their choices before retaining an agent. Instead, lack of engagement in the process provokes an agency problem, where financial advisors and other intermediaries take excessive risk for their clients.

Bailouts during crises. The S&L crisis. The Mexican peso crisis. The Asian contagion. Long Term Capital Management. Post 9/11. Bear Stearns (BSC). AIG (AIG). Lehman (LEH). Fannie/Freddie. WaMu (WM). Wachovia (WB). The pending Bank Bailout. How many times does the government step into these crises with some sort of relief before investors understand that they will be 'helped out' if they take too much risk? Probably not many. The moral hazard issues here are obvious and active.

We could go on, of course (tax laws, Patriot Act, etc) but hopefully you get the picture. The data suggest that our markets are anything but free.

position in USD

Counter Views of Regulation

David Norris: Who the hell are you guys?
Richardson: We...are the people that make sure things happen according to plan.
--The Adjustment Bureau

Caroline Baum includes some interesting info in an article about policy contributors to our current economic predicament. Democrats on the campaign trail such as Mr Bill are blaming 'deregulation.'

Yes, CB, I laughed too. It was during Bill Clinton's tenure that much of the deregulation that Mr Bill rails on occurred. Glass-Steagall was repealed in 1999 and replaced by the Financial Services Modernization Act, which was signed into law by Clinton in 1999. The law removed  G-S imposed 'walls' between banks, investment banks, and insurance companies, thereby facilitating huge increases in institutional size and leverage. Clinton also signed the Commodities Futures Modernization Act in 2000, which exempted over the counter derivatives from regulation.

While the irony of Democrats like Clinton fingering deregulation is humorous, blaming our economic malaise on deregulation is hollow rhetoric. CB argues deregulation only accelerated the problem. I would have used the word 'exacerbated.' At best, deregulation exacerbated the problem.

Ground zero of the 2008 credit collapse was the housing market. People buying houses that they couldn't afford, lenders dishing out credit to poor credit risks, and mortgage-backed securities that carved up and distributed risk like metastatic cancer throughout the financial system.

Baum correctly identifies government policy seeking to get more people into houses as a root cause. Indeed. Government sponsored entities (GSEs) Fannie Mae and Freddie Mac were born out of FDRs New Deal fantasies that more Americans should be able to 'own' a house. The GSEs became the primary vehicle for expressing this policy by forcing mortgage rates lower than free market rates. Supporters, primarily Democrats, defended Fannie and Freddie thru the mid 2000s even when audits suggested dangerous leverage.

Reflecting on my personal situation on a college campus, I have encountered few students who are aware of counter views of regulation like the ones laced in Baum's article or in this piece. Yet, these counterviews are difficult to disprove out of hand, suggesting their possible validity. As such, regulation should be viewed as a classic classroom debate topic.

Why is critical thinking about regulation so low--particularly at the collegiate level where lively debate is supposed to occur?

Burned at the Stake

Walk on by
Walk on through
Walk till you run
And don't look back
For here I am
--U2

In the witch hunt to assign blame for the current credit crisis, a growing collective claims that the causes relate to excesses inherent to free markets. Through this lens, unfettered markets are seen as fostering long cycles of greed and fear that manifest in massive booms and violent busts.

Such perspective is interesting, given that few of us have observed truly free markets in our lifetimes. The free market construct, by definition, engages buyers and sellers in voluntary exchange. Market participants are fully responsible for gain or loss associated with their actions. Outside entities generally intervene to mitigate market processes or outcomes.

In reality, modern markets feature a variety of interventionist measures such as price controls, taxes, and regulations. Market interventions are often rooted in times of crisis such as large bankruptcies or wars. Because people tend to restrict information processing and centralize control during times of acute threat (Staw, Sandelands, & Dutton 1981), they are more likely to sacrifice freedom for security in the form of increased state control over markets during economic crises.

Over time, however, the state commonly converts event-driven interference into institutions that influence market behavior on a regular basis. The Federal Reserve, government sponsored enterprises such as Fannie Mae (FNM) and Freddie Mac (FRE), and the Federal Deposit Insurance Corporation exemplify institutions spawned from acute economic events but designed to routinely alter the course of market actions and outcomes.

As such, pinning recent credit turmoil on 'free markets' is nonsensical, since our markets have not been free for many years. The follow-on question is obvious:

"If free markets aren't at the root of the problem, then what drove the extreme credit conditions at the epicenter of the current crisis?"

Although market interventions are often proposed as stabilizing measures, critical thinkers need to consider the role of interventionism in amplifying economic and market cycles.

References

Staw, B.M., Sandelands, L.E. & Dutton, J.E. 1981. Threat-rigidity effects in organizational behavior: A multi-level analysis. Administrative Science Quarterly, 26: 501-524.

Transition Condition

Nothing is planned
By the sea and the sand
--The Who

One phenomenon that is perplexing many who believe in the Big Inflation thesis is the behavior of bond markets--particularly government bond markets. Theory says that yields should go up with inflationary expectations. People should be selling bonds today out of worries that the real value of their bonds will go down as their coupons get paid back in dollars that are lower in value.

That theory has not been working out well in practice. Despite the $trillions created by the Federal Reserve over the past couple of years, and commodity prices screaming higher, long bond yields have not gone to the moon as many inflationistas have forecast.

Perhaps the theory doesn not account well for the dynamics of transitionary periods.

For more than two decades, central  banks have been suppressing interest rates and offering credit on the cheap. This credit has gone into all kinds of risky assets--stocks, commodities, real estate, plants and equipment. Bonds are also a risky asset class although they are often perceived as less risky than other categories. This is particularly true of bonds issued by the US government.

The easy credit spawned a secular boom in leveraged risk taking. Individuals, organizations, and governments have all borrowed at low interest rates and invested in assets deemed to return something more than the cost of carrying the loan. This behavior is also known as the carry trade.

Leverage magnifies returns when prices are going in your direction. A few years back people could buy a $500,000 house with little money down and low interest rate, and flip that house a year or two later for $750,000, generating an enormous return over the cost of carry.

As many have discovered over the past couple of years, leverage magnifies losses as well. When firms like Bears Stearns and Fannie Mae (FNMA) were levered 30:1 or higher in mortgage related derivatives, it did not take much decline in home prices before their assets were less than liabilities, creating conditions of insolvency.

In leveraged systems, falling prices motivate many to close out their carry trades. Risky assets are sold, dollars are bought back, and loans are paid off. We saw, and continue to see, a lot of this since 2007-2008.

But not all carry trades are taken off. Some leveraged investors, rather than totally getting out of risk, merely substitute less risky assets. Thus, rather than using credit to buy stocks, carry traders buy bonds instead. Leverage is still in the system, but it is located in assets classes deemes 'less risky.'

One explanation as to why bond yields have not yet backed up is that much leverage remains in the system. Carry traders are content to earn the spread between nearly 0% borrowing cost from the Fed and ten year T-notes paying 3.1%.

But this is a transitory situation. Huge amounts of leverage cannot last forever. Central banks can seek to force spreads open but over time they must collapse as resources borrowed from the future are paid back (or defaulted upon). Short rates will rise and/or returns on risky assets will fall and the carry trade spread will be crushed--regardless of government intervention to the contrary.

At some point, then, we may witness another counterintuitive situation as markets rebalance. It does not seem out of the realm of possibility that bonds could sell off big-time as more and more leverage leaves the system.

position in SH

Extreme Measures

So forget all that you see
It's not reality
It's just a fantasy
--Aldo Nova

How weird is it getting out there? Take a look at some of the proposals and actions towards end-of-week:

1) Steve Forbes proposed on CNBC that the government suspend mark-to-market rules for one year so that securities holders would not have to realize near term losses. Guess I missed the textbook chapter on Pretend Accounting.

2) Government lowered the capital requirements for Fannie Mae (FNM) and Freddie Mac (FRE), freeing these government sponsored entities (GSEs) to purchase more mortgage backed securities on their balance sheets. How this does anything more than increase the leverage in an already overlevered situation is beyond me. (The obvious implication is that takes us one step closer to the nationalization of the housing market)

3) An editorial in the Wall Street Journal opines that the government buy and bulldoze foreclosed homes in order to reduce supply and increase prices.

No way, you say? Did you know that FDR oversaw the burning of crops during the Depression in a futile attempt to prop up ag prices?

no positions

Break It Down Again

When it's all mixed up
Better break it down
In the world of secrets
In the world of sound
--Tears for Fears

I've heard a few folks claim that what we're experiencing isn't deflation, but a period of de-leveraging. They go hand in hand, of course. Deflation is contraction in the quantity of money and credit. And credit contracts via a process of deleveraging.

Our monetary system is tilted way towards the credit category. Credit means borrowing, and when you've borrowed, you're leveraged. You've borrowed to 'lever up' potential returns. These potential returns could be financial, or, more broadly construed, could represent targeting a lifestyle or standard of living that couldn't be achieved without borrowing.

Leverage works both ways. When market winds are at your back, returns are magnified. But when market winds face you, losses are magnified. As such, leverage increases risk.

Broad market headwinds have turned leveraged market participants into net sellers. They need to sell to de-lever, cut losses, and reduce risk. And they're selling everything. Stocks, bonds, real estate, oil, gold, commodities.

These broad price declines are a consequence of the de-leveraging, or deflation.

After the Fannie Mae (FNM)/Freddie Mac (FRE) 'bail out rally' yesterday, hard selling resumed today as chatter got loud of next shoes to drop. Lehman Brothers (LEH) may be next, as the stock tanked nearly 50% today on huge volume to close in single digit midget territory.

Observing the current price action, I can't help but think that, if we're approaching a time where a bunch of leveraged players simultaneously decide it's time to hit the eject button, then a major stock market dislocation may be eminent.

positions in oil, gold

Mother Goose

"Son, your ego's writing checks your body can't cash."
--Commander Tom 'Stinger' Jordan (Top Gun)

Over the past few months we've heard a litany of complaints about economic decisions made by government officials and regulators. Here are a few I ran across just yesterday.

"OFHEO regulators were lax in their oversight of Fannie Mae (FNM) and Freddie Mac (FRE)."

"Paulson mistakenly let Lehman fail."

"Central banks around the world are not moving quickly enough to unfreeze global credit markets."

"Greenspan kept interest rates too low for too long and precipitated the housing market bubble."
"Bernanke hasn't lowered rates enough and is exacerbating the housing market decline."

Such complaints are as old as our choice to let bureaucrats govern economic decisions rather than letting market participants police themselves. Lacking the incentive and information of the market context, bureaucrats will consistently make erroneous economic decisions. Moreover, central planners will be slow to recognize their errors and to revise their decisions.

In the wake of bureaucratic errors strewn over decades, one would think we'd realize the folly of this approach and hand control back to market mechanisms. Instead, we seek more state control--or control from a different set of bureaucrats (e.g., "Our central planners are better than theirs.")

This is the mother of all wild goose chases.

no positions

Fed Leverage Update

Nothing's so loud
As hearing when we lie
The truth is not kind
And you said neither am I
--Toad the Wet Sprocket

By my math, Federal Reserve balance sheet currently sports leverage of 54:1. That's higher than Fannie, Freddie, Bear, Lehman prior to the 2008 credit implosion.

Indicator of how risk has been socialized, meaning that risk has been transferred from private to public balance sheets.

position in SPX

Here We Go Again

I don't know where I'm going
But, I sure know where I've been
Hanging on the promises
In songs of yesterday
--Whitesnake

Fannie Mae (FNM), Freddie Mac (FRE) et al just celebrated their 75th birthdays. This piece provides a nice chronology of the story. Many folks like to blame Democrats for the damage that these institutions have wrought. After all, FDR originated them.

But this article offers ample evidence that Republicans have been just as complicit, if not more so, in escalating housing market distortions over the past three quarters of a century.

The message once again, although most folks don't want to hear it, is that our housing problem did not stem from 'free market' causes, but rather from fatal flaws inherent to any central planning initiative.

And yet here we go again, escalating housing market intervention to ever higher levels.

no positions

Hover Craft

"Mr Preston, this operation will be a failure if we all die."
--Major Brad Little (Fire Birds)

Late last week rumors began circulating that the Obama administration, desperate to gain political points ahead of the Fall elections, might try something novel in the mortgage markets in order to light a fire under the economy. Over the last day or so, the chatter has been getting louder.

The rough idea as I currently understand it is that the federal government would order lenders to forgive some portion of mortgage principal for those borrowers who are upside down on their houses. Because the government effectively controls the two big guns in the mortgage market, Fannie Mae and Freddie Mac, it could effectively use them as conduits for swallowing the writedowns or reimbursing lenders for the forgiven mortgage amounts.

Presumably, the mortgages would then be refinanced at lower, government suppressed rates, and the commensurate lower principal amts would translate in lower monthly payments. How much lower would depend on who would qualify and how much principal would be forgiven.

Obviously, the underlying thesis is to put more money in the hands of consumers and to reverse the sour social mood w.r.t. consumption.

I have seen no figs on the cost of such a program but it would be big. Just to toss a number out there, if 10 million homeowners are upside down by an average of $50,000 and all of that difference is forgiven, then that would cost half a trillion dollars.

Such a progam would certainly be radical. Largely immeasurable would be systemic costs related to loss of confidence in contracting and to moral hazard effects--both of which would likely be larger than anticipated. My instinct tells me that the long term damage that such a program would would be devastating.

Moreover, there is some question whether the underlying thesis of this program would be validated. In other words, it is possible that consumers will use all that newfound cash to save and pay down debt--rather than spend it. Stated another way, we could wreck the system all for naught.

To cornered politicians however, desperate situations require desperate measures.

While I've been favoring a deflationary theme to how things evolve over the next year or two, the prospect of a Armegeddon-like response like this now finds me wanting to hedge my bets a bit. Bought some SLV today and will be keeping an eye on gold and silver as the inflationary canaries in the coal mine.

position in SLV

Own to Rent

When it feels like the world is on your shoulders
And all of the magic has got you going crazy
--DeBarge

A couple weeks back we noted increased govt activity in the housing markets. More today, as plans circulate to get the Federal Housing Finance Authority (read: taxpayers) to provide incentives for investors to buy properties foreclosed by Fannie and Freddie and then rent them out.

More central planning for the housing industry. It does seem pretty clear that we will never learn...

no positions

Lesson of Leverage

Time respects no person
And what you lift up must fall
They're waiting outside
To claim my crumblin' walls
--John Cougar Mellencamp

In the economic context, leverage is borrowing resources to live larger in the present than one otherwise could. Anyone carrying debt is leveraged to some degree.

Borrowed resources are employed now with the promise to pay them back later--usually with interest. Leverage thus entails risk--there is a chance that resources borrowed today cannot be paid back tomorrow. That risk may be borne by the borrower, the creditor, some combination of the two, or, as was made clear during the recent credit crisis, the public at large.

During the recent credit debacle we learned that the risk associated with leverage can be quite latent. Leverage was building in the system for years as credit was made easier. Government, organizations, individuals all levered up.

Early on, things seemed fine. In fact, higher near-term standards of living facilitated by leverage created the illusion of prosperity. "New era" claims abounded. "Housing prices can only go up..." "Policymakers have our backs..." Collective optimism increased which drove leverage to greater heights.

As we now know, there was no new era. The prosperity was a mirage--a state of borrowing from the future to fund higher living in the present.

At some point the mirage disappeared. Collective risk appetite declined. Incomes did not permit repayment of debt. Credit spigots closed. A downward spiral insued as the potential for loss associated with leverage became actual loss.

Did we learn the lesson of leverage? Not hardly. Today's systemic leverage is much higher than prior to the credit collapse. The Federal Reserve's balance sheet, for example, currently shows assets of about $4 trillion against capital of about $55 billion. That's leverage of 73:1--far higher than Fannie Mae's at the height of the real estate bubble.

Government and corporate borrowing are once again at epic levels.

Will 2014 be the year where we are presented with another opportunity to learn the lesson of leverage?

Stress Fracture

Look around everywhere you turn is heartache
It's everywhere that you go
You try everything you can to escape
The pain of life that you know
--Madonna

Blood continues to flow on The Street related to the financials. While overall market indexes trade relatively sanguine, individual financial issues continue to get crushed. Rumors swirling around Lehman (LEH), American International Group (AIG), and Washington Mutual (WM)--among others--suggests some type of announcement perhaps this weekend.

The volatility in these financial names is breathtaking and volume is gargantuan (the 3 names mentioned above combined for over 1 billion shares traded today!). Just as a snapshot for my future reference, some select closing bell prices today:

Fannie Mae (FNM) $0.74 (-5%)
Freddie Mac (FRE) $0.46 (-22%)
Washington Mutual (WM) $2.73 (-3%)
Merrill Lynch (MER) $17.05 (-12%)
American International Group (AIG) $12.14 (-31%)
Lehman (LEH) $3.65 (-14%)

Although it seemed straightforward to articulate the plausibility of this credit crunch situation years back, my mind balks at digesting some of the prices I see on the screen as the scenario is realized.

I have to think bureaucrats will be busy whipping up a Weekend Surprise to in yet another valiant attempt to stem the red tide. Also, I wouldn't be surprised to see a Fed easing either at their confab next week or sooner (although the bond market, much to my amazement, currently isn't pricing in a cut).

no positions