Credit Bubble Collapse or The Vindication of My Armenian Grandmother

You cannot cover shit with snow.

I have much that I wish to say about what happened this week, but I'll be brief.

Point 1: The financial media has done an extraordinarily poor job in informing investors as to the nature, extent and consequence of the credit bubble. Worse, our economic leaders, such as Paulson, Bernanke and other respected people, failed in their duty to give the public an honest assessment of the nature, extent and consequence of the credit bubble. (I almost made that point two, but elected to conflate it here).

Point 2: It was never a subprime issue, but a credit bubble, caused by real interest rates that were too low for too long.

Point 3: So much of the wealth creation in the past 24 months or so in this country has been based on FEES earned from the offering, conversion or securing of the underlying FINANCIAL instrument or in its attendant risk or interest profile (credit default swaps, interest rate swaps). What you finance matters. Financing homes is not the same thing as financing an long term economic producing asset--one that produces goods/services that for long term economic gain.

Point 4: The reassessment and repricing of risk serves as a liquidity reduction in the market. Remember that there was a global liquidity boom which fueled asset prices. Now we have a global liquidity ka-BOOM.

Point 5: What is to become of the duration and/or magnitude of the current stock market decline is anyone's guess. But I'll offer these subpoints for consideration:

• Hedge funds were highly levered--regardless of what their overall strategy was. Accordingly, any contraction in leverage will require their selling assets to maintain asset to collateral ratios required by their lenders. I don't know if the average leverage employed by hedge funds is greater or less, but I'll go out on a limb and conjecture that it is more. So the contraction of liquidity will affect all funds.
  

• Hedge funds have proliferated since the last stock market debacle, and many of these managers will be inexperienced in how to deal with such a situation.
  

• Therefore, more hedge funds that are more levered = greater risk to my inexperienced eye.
  

• Hedge funds account for more than 50% of the trading volume (according to one source that I read and reported here). I would bet that most lenders are contacting their hedge fund clients to find out exactly WHAT they are holding to assess their own exposure. Further, they will likely be discussing how to re-calibrate debt to collateral ratios. I'll surmise, then, that there will have to be a selling of assets to meet margin calls. It would seem to me, then, that all sectors will be subject to further selling pressure--particularly some of the momentum names (RIMM, AAPL) and much-favored sectors such as oil/gas, commodities--regardless of underlying fundamentals.
  

My typical caveat--I could be wrong about all of this.

I do believe that the reaction of the Asian/European markets is going to be important. It could add a little hot sauce to however our own markets would react on Monday. Remember, they, too, are finding that they are very exposed to this morass of debt instruments that are declining instrumentally in value. Tim Wood on FSOonline feels like a further decline is coming. I will say that he and Gary K have been spot on (meaning they've not been hopeless handwringers, but have been participating in the moves up but preparing and looking for the inevitable move down) Concurrent with my writing the last sentence my e-mail beeped. I see that M is seeing a tradeable low coming--which means it is not here now.

I do believe that if these issues are as widespread and as deep as I think that they are, we will have a world-wide recession. BRIC still lives, but don't think for a minute that the consumptive power of Americans has been outstripped by those countries. Remember, they still have to be inculcated in the joys of living beyond ones means which requires a seismic shift of behavior tectonic plates that moves one from being an ardent savior to a hapless debtor.

My every wish for your safe passage.

Powered by ScribeFire.