Wednesday, April 15, 2009

The Next Bubble

The next stock market bubble we have in this country will be based on financial services, even more than the current one. You heard it here first, just remember.

As you recall, I've wondered what the hell we were going to base our economy on now that a giant chunk of the secured and unsecured debt we were letting consumers spend on (and securitizing to beat the goddamn band) turned out to be vapor.

Financial services is looking like the next big thing, idiotwise. Lucky us, the bubble is being inflated now.

Exhibit A:
No more mark to market rule. This means that banks holding crappy assets based on securitized debt that's about as solid as Burnham Wood (Pause for laughter. ... Ok, the rest of you can look that one up.) can pretend that the assets they hold are not worth what the market will pay for them. Instead they can insist that these things are worth what they cost in the first place, or some other outrageous lie.

If I tried this out myself, the conversation would look like this.

Me: Hi. I'd like a loan of $100,000.

Bank: What do you have for collateral?

Me: Here's this security that I bought last year for $10,000.

Bank: What's it worth today?

Me: $8.95, but I paid a lot for it, and I'm pretty sure that it will go back up eventually.

Bank: Call us when it does. Good bye.

Exhibit B:
Banks are currently paying 0.2% to borrow from each other through the Federal Reserve, which has sworn a Solemn Vow not to raise rates for a Really Really Long Time.

As you know when the cost of financing is low, the appetite for risk is going to go up, which is one of the reasons we are having a Financial Crisis in the first place. (Back in 2003 Fed Chairman Alan Greenspan lowered rates to 1% and kept them there till June of 2004.)

I realize that we need to unfreeze the credit markets, and I can't think of anything else they should have done instead, but I think that one of the unintended consequences of this move will be to encourage more risky investments by the same banks who Never Seem To Learn.

Exhibit C:
TARP is fucked.
Allow me to elaborate: the Treasury Department is in the process of creating a public-private partnership to buy troubled assets from banks to get these dogs off the balance sheets.

Surprise, Uncle Sam is using our tax revenue to provide 'co-investments' to guarantee 93% of losses and recoup only 50% of profits. Anyone investing won't take much of a hit if prices goes down, but keeps half of the upside if these odd mortgage backed securities turn out to be worth something.

This is the good part: Banks taking part in this program can be the same banks that taking TARP money in the first place due to these toxic assets eating holes in their balance sheets.

Forget for one moment the idiocy of a bank claiming to be paralyzed due to the crummy investments it made, begging for government handouts and then buying more of the same shit with taxpayer money.

Now think about the opportunities for collusion.

Banker Blaine Waspington-Smythe at Bank A calls up his golfing buddy Biff at Bank B. Blaine has a crappy asset worth maybe 10 bucks. Biff has a similar crappy asset also worth 10 bucks.

During the auction run by the government, Biff bids 50 bucks for Blaine's asset and Blaine bids 50 bucks for Biff's asset. Blaine and Biff walk away immediately with 40 bucks each on that asset, plus the ability to use the price as a way to value some of the stuff they haven't sold yet.

Even if the these assets turn out to be worth nothing, Bill and Biff still come out ahead because they are only responsible for 7% of the downside.

Irritated yet?

Exhibit D:
I'll make this short because my blood pressure is going up. There's talk of reinstating the uptick rule, which makes it harder to sell short.

For those of you not obsessed with financial minutiae, selling short is essentially a bet that a stock will go down.

Eg. You get a broker to lend you some stock currently worth $10,000. You sell the stock and hold 10 grand. If the stock goes down, as you predict it will, you buy the shares at the lower price and return them to the lender and keep the difference (plus a fee).
If the stock goes up, you are hosed, but them is the breaks.

But if we reinstate the uptick rule, nobody can short a stock until its price rises first. Which means that if you think banks stocks are dogshit because they bought worthless crap backed by vapor-credit and mortgages nobody could pay, its harder for you to bet that their stocks will go down.

Truly the seeds of our own destruction are within us.


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