Past Tense

I'll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around
Pick up my guitar and play
Just like yesterday
Then I'll get on my knees and pray
We don't get fooled again
--The Who

Ponder these quotes from Thomas Jefferson:

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, (i.e., the "business cycle") the banks and corporations that will grow up around them will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered."

"I believe that banking institutions are more dangerous to our liberties than standing armies."

TJ definitely 'got it'...

Do you think we'd have a Federal Reserve today if TJ was still the man?

Raw Deal

Jewel box life, diamond nights, and ruby lights
High in the sky
Heaven help him
When he falls
--Sade

The more I reflected on the Fed-orchestrated buyout of Bear Stearns (BSC) by JP Morgan (JPM) last week, the angrier I got. In a market system, you can't have two parties appropriate the property of a third party without consent. John Hussman discusses it more elegantly than I:

http://www.hussmanfunds.com/wmc/wmc080324.htm

This deal is illegal. Congress needs to stop it.

Whether we step up and uphold principle here may go a long way in forecasting where we're economically, and socially, headed.

no positions

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

Land of Confusion

Ooh superman where are you now
When everything's gone wrong somehow
The men of steel, the men of power
Are losing control by the hour
--Genesis

I've heard a number of commentators opine that yesterday's buyout of Bear Stearns (BSC) by JP Morgan (JPM) was not a bailout and didn't invite moral hazard. How can such a deal promote moral hazard, they argue, given the carnage in BSC stock and the thousands of Bear employees likely to soon hit the bricks?

Get real. Anyone with eyes can see that this deal was cobbled together to protect the broader interests of those lugging excessive risk and who stand to be crushed in a credit market seizure induced by the insolvency of a major broker dealer.

And, indeed, the risk takers were back in gear only one day after their reprieve, walking the Dow up 400+ points today.

It does appear that we've transformed into a Bailout Nation, willing to privatize gains and socialize losses. Ironically, this intervention does nothing but increase the wealth divide that so many complain about.

The meddling also increases the potential energy of market forces currently being restrained from a natural cleansing process.

At some point, however, these forces likely won't be denied.

no positions

Iron Curtain

This wouldn't be the first time
Things have gone astray
Now you've thrown it all away
--Bryan Adams

To top off a wild week, perhaps the craziest thing I saw was Friday's proposal to permit managers to revalue Level I assets perceived as 'wrongly' mispriced by the market.

A Level I asset is one that trades routinely, such that representative prices are regularly available. General Electric stock (GE), for example, whose 10 billion share float trades nearly 50 million shares daily, is a Level I asset. If you owned 100 shares of GE, the value of your position would be $3382 as of market close on Friday (100*$33.82 closing share price). Simple.

Let's say that you disagreed with the market's current price of a GE share. Instead, you think it should be worth $50/share. Essentially, this new proposal would allow you to 'legally' revalue your GE position to $5000 (100*50).

And so we have it--a government sponsored proposal for the mark-to-fantasy balance sheet.

"Pay no attential to that man behind the curtain..."

no positions

Dollar Dust

Crossing that bridge
With lessons I've learned
Playing with fire
And not getting burned
--Seal

The Fed's actions this week to accept risky mortgage paper as collateral from financial institutions in exchange for Treasuries has been crushing the dollar to new lows. Having trouble connecting the dots? The Fed puts junk on their balance sheet. If the junk goes down in value, the Fed could a) take the loss and perhaps go bankrupt b) print money to make up the difference.

The market whiffs b)...more potential dollar supply and, voila, greenbacks get sold.

Some are suggesting that a stronger economy will cause the USD to rise despite these clearly inflationary efforts. Hard for me to see.

Instead, I think the best case for a dollar rally is if folks determine that none of these interventionist policies will stave off recession. If people recognize this and become risk averse (hoard cash, pay down debt, unwind risky positions), then demand for dollars should increase.

This, of course, is the deflation scenario. Should this come to fruition, risky asset prices should fall as the dollar rips higher.

Bad Dream

Some will win, some will lose
Some were born to sing the blues
Oh, the movie never ends
It goes on and on and on and on
--Journey

Laugh of the week has to be the Ambak (ABK) situation. Initiatives discussed to keep the struggling mortgage insurer afloat have included breaking the company into 'good' and 'bad' liability entities, a straight buyout by a group of financial companies, and government sponsored relief. A day or so back, ABK announced that it will head to the capital markets to raise funds.

Currently, this company enjoys a top shelf credit rating from S&P and Moody's. The question, of course, is how does a company that needs a financial bail out merit such a high credit rating?

For the answer, study the fragile condition of the credit markets, and the domino effect that would be put in motion with an ABK credit downgrade.

no positions

Price of Ignorance

With a little perserverence you can get things done
Without the blind adherence that has conquered some
--Corey Hart

We've been conditioned to 'expect' rising prices over time. But are price increases a natural consequence of economic activity?

Suppose that, prior to lighting off economic activity, a finite supply of monetary currency is created to facilitate exchange. Further, suppose that the physical nature of the money makes it infinitely durable and that it never needs replacement. In fact, suppose that we lose our wherewithal to create additional money and we must eternally live with the initial supply. What will happen to prices 'naturally' over time?

They should fall.

As society advances and productivity improves, more output is created per unit of input. A dollar that bought one loaf of bread in the beginning should buy two or more over time.

During the late 1800's, the US saw precisely this phenomenon. During one of the most productive periods in US industrial history (which also corresponded to a period when the US Dollar was backed by gold thereby limiting its supply), broad price declines were evident. Purchasing power increased as money bought more goods and services. There was little concern about the dangers of falling prices. People were better off and standard of living increased (Rothbard, 2002).

Today, drums beat a tune against declining prices and for inflation. There is chatter that the Fed might adopt a policy of targeting a certain annual increase in prices. Critics suggest that they've been engaged in this activity for years with predictably detrimental results.

Don't be fooled. Price declines should be a welcome consequence of economic activity.

Reference

Rothbard, M.N. (2002). A history of money and banking in the United States. Auburn, AL: Ludwig von Mises Institute.