How do you make sense of the markets, post housing crash?

ANOTHER Financial Sector binge covered up by the chief enabler -- the Fed.

Investors bidding up commodities, equities and currencies is the same thing -- dumping the dollar.

Look for a serious run on the dollar soon. By election time '08.

Why?

Think of the recent Fed bail-out as giving away money to the Financial Sector. Jim Cramer and the other hysterical old ladies of the high rolling investor class dropped their macho risk tolerance facade and started crying just long enough to get Papa Ben Bernanke to give them more money. Now they are busy converting that money into real wealth -- stocks and commodities, oil, gold, wheat -- and into secured financial wealth -- bonds.

The Fed's bailout follows the pattern of 1987 and 1998. Unregulated markets made fools of geniuses, upon which the Fed lent them the financial stability of the country so they could be geniuses again.

Now the market knows. Don't worry about risk. Papa Fed will bail you out. It's no accident that instead of vigorous industry, plant and equipment, we have instead the equivalent of a mammoth video game parlor called Wall Street. Fine for entertainment, but these games have real guns, and those are real people losing homes, families and hope. One of the things those real people don't understand is they are paying the freight

Certain inflation will follow the dollars fall and this bidding up of commodities. Pensions and endowments will lose their real value to that inflation. The financial system is gimmicked and rigged to such an extent the Fed has lost control.

It's not inflation OR recession. It's inflation AND recession.

If the Fed tries to stem the inflation or support the dollar with higher interest rates, it becomes a deep recession.

Why a run? This country's trade deficit over the past thirty years has put trillions of dollars in foreign hands. The money is in the form of securities, because those securities were a good deal with rising values. No longer the case. With the value of the securities fading and the value of the dollar falling, the foreign holders are seeing their investments eroded from two sides. Better get out sooner than later, hence a run.

Tomorrow:

5 Lessons from the financial meltdown in housing
and
7 Remedies for the Financial Sector

Caveat Emptor, Economics has been hijacked by pro-business apologists

You need to know: Economics has, in general, been hijacked by pro-business apologists.

Why do you need to know this? Because when economic reporting, economic predictions and economic measures of well-being are skewed toward corporate business, your welfare and the society’s are discounted.

Economics has reverted to a pre-Depression confidence in markets, it operates on a herd impulse and is far behind the curve. We’ll talk about the housing bubble in a later podcast, but here let’s use it for illustration of this point on the irrelevance of current economics.

The run-up in housing was well understood or should have been well understood by economists as a classic asset bubble.

The most prominent economist, Fed Chairman Alan Greenspan, was actually principle author of the bubble. When the economy began to flag in 1999 and 2000, Greenspan attempted to prop it up by bring interest rates down to historic lows. Later he extolled the virtues of adjustable rate mortgages, which kept the bubble rising.

This demonstrates two things.

• Business and finance sector interests trumped common sense and good economics.
• Common sense and good economics is in sufficiently short supply that economists of this sort are not hooted off the stage.

The herd.

It is said that if you have five economists in a room, you’ll get at least six different opinions. This joke is quite misleading. The differing opinions rise in large part from the economists need to explain why events are not doing what they ought to be doing. Virtually all economists see the world through the prism of their school’s theory.

The dominant theory in academics today is one or another version of free market knows best. When, for example, the housing debacle points to the fact that unregulated free markets produce chaos, there is among this group a frantic search for scapegoats, not a questioning of the premise.

The patent need for the government to come in and try to clean up the mess, including bailing out the financial sector and mitigating the suffering of millions of homebuyers, is ignored. These government clean-ups are not part of the market. They are “external” to the market. In fact, they are referred to as “externalities. These costs, nor the price of the bailout insurance, are not factored into the economy.

A better, if even more tragic, illustration of the market’s ineptness and the mass myopia of economists on account of pro-market bias is the complete absence of a market response to global warming. Oil, coal, and their attendant poisons are in greater demand than ever. The tidal wave of bad news looms above us, but the market ignores it, assuming perhaps the protection of an invisible force field, perhaps labeled "Free Market."

Chart for Angry Bear

The housing debacle

What are the lessons from the housing debacle that is now unwinding?

First and most important, we were right. We predicted the housing collapse. We'll dig up the links and enter them on the web site treatment on Friday.

We predicted that the low interest policy of the Fed would produce the bubble. Others have talked about how the leverage and corruption of the mortgage brokers was key, but the cycle begins at the beginning -- turning housing into an investment. Speculation fever follows as prices rise. Then the leverage and the corruption.

Too much congratulations and not enough corporal punishment are being dealt the Fed. Under Greenspan and Bernanke, there was low interest at the beginning and bailing out at the end, with absolutely no oversight in the middle (or anywhere, really).

Second, others predicted it as well. Dean Baker is foremost among these. Baker of CEPR and now the American Prospect used a simple historical trend analysis comparing housing rents to home prices over time. It worked. He should be on every talk show in the nation.

Third, the people who didn't see it coming are still the "experts." (Much like in another key blunder, when Thomas Friedman and even the Neocons blew the Iraq analysis, yet are still showing up as experts. Compare this to others -- George McGovern, Joseph Stiglitz -- who offered accurate analysis and peaceful, productive resolutions. They are still on the outside.)

So, fourth, the people who say, "Nobody saw it coming" were and still are listening only to each other.

This debacle continues the ballooning of the financial sector. Henry Kaufman, formerly of Salomon Brothers and now of Henry Kaufman & Co. and hardly a communist, reported that the Finance Sector is now bigger than Health Care and Energy combined. Why not? Too bad some homeowners can't get hold of that "liquidity" and out from under their ARMS. Now is the time to buy stocks in the financial sector, before everybody realizes that -- just like in 1987 and 1998 -- the Fed is bailing them out. They get a hundreds of billions of "too big to fail" insurance for free.

Upcoming we'll look closely at tool the world class analysis at the Fed is linked too. It looks a lot like a catapult. The Fed's single blunt instrument is its control over short-term interest rates. It doesn't matter how smart you are, the interest rate is (1) ineffective against inflation, (2) operates with a lag in producing growth and is wildly inferior to fiscal policy for jobs, but (3) is great at bailing out a financial sector.

Outlook for the economy as housing deflates? Which economy?

• The financial sector will likely bounce back with great new investment opportunities.


• The wealthiest 20 percent will no doubt wonder what everybody is complaining about.


• The middle class will watch their home values receding in front of them as they approach retirement.


• The multiplier will bring down wages.


• The collapse of housing could create more hysteria in the immigration discussion, as migrants move out of their niche in relatively low-skill residential construction and residential support and compete for other jobs.


• A huge burden of private debt has been created, for the purpose of building an immense stock of passive housing vs. productive assets. And very little of this building was green. Both the debt and the character of the housing stock will weigh us down.

What a mess.

Why listen to the Market when it is talking gibberish?

Steve Conover at the Skeptical Optimist displays the vagaries of jobs numbers today and wonders what the Market will make of it.

Any Market response to jobs numbers is unintelligible over the sound of investors trampling each other at the exit door of real estate and "alternative" investment vehicles.

As Michael Metz, chief investment strategist at Oppenheimer Holdings said yesterday, the Market has stopped sending rational or intelligible signals.

Rational investors and students ought to see current strength in the stock market as money with no other place to go.

Chaos reigns in currency markets as well.

Strength in stocks in the face of an impending downturn in the domestic economy is, at best, Pig Latin.

see previous Demand Side take: Strong Stock Market, Weak Economy

How to create a market for planetary survival

Public policy can establish markets for specific products and unlock the economics of innovation

The market in environmental poisons is booming. Oil is over $80 a barrel.

Approximately zero dollars of that eighty finances mitigation of or adaptation to the direct results of using that oil.

Why no accounting? The cost of the rapid deterioration of the planet as a habitation for people must have some dollar value. This is a puzzle free market apologists don't like. Global warming, they say, is something called an "externality." External to what? Long after the plastic toy is discarded, the gasoline burned and the automobile crushed to scrap, these greenhouse gases will continue to entertain us.

The environmental effects and their costs are external only to the purchase-sale transaction. This transaction is effective extent of the market into the real world. This market failure has driven governments to construct the highly imperfect remedies of carbon trading and carbon taxes, clumsy attempts to have the price include at least a fraction of the cost. It hasn't worked.

The right way to make a market for planetary survival was outlined recently by Dr. Jonathan "Jack" Frost of British fuel cell developer Johnson-Matthey. He spoke at a recent Tyndall Center conference on environmental finance.

In a completely unassuming manner, in twenty minutes of presentation and ten minutes of Q&A, Frost nailed the principles of an economics of innovation to the wall and pointed to it as the way to engage industry in innovation rather than obstruction.

The illustration that convinces is the historic clearing of the smog from the atmosphere, which was sponsored by California's emission-reduction mandates. Cut emissions by half? Technically impossible at any by the most ludicrous price. Can't be done. Then came the catalytic converter. A catalyst on a consumer device was almost unthinkable. But the catalytic converter, a subsequent modification to it, and other technology now leave emissions at .001 (one one-thousandth) of their former level. Normalizing for all factors, its cost in the price of a new car is zero.

Better to listen to the podcast with this link. (The Tyndall Center has a link to a videocast.)

Public policy acting for the public good can create the purchase-sale condition for products of all kinds, not just the power plants and vehicles. The major problem is not the politics. It doesn't cost a fraction of the subsidy programs currently favored. The problem is identifying what we want and enforcing it while being sensitive or at least aware of the supply chains of an industry.

We're getting it together to put up a more extensive discussion of the economics of innovation as outlined by Frost on the web site (demandside.net). Dr. Frost kindly provided some links to research when we prodded him after the conference. None of it is as cogent as the Tyndall presentation.

Prediction: Strong Stock Market, Weak Economy

The economy slips toward recession and stocks ignore it. Why? Courage from the average investor perhaps? Confidence in the underlying strength of the economy? Hardly.

Investors are in full flight, trampling each other to get out from under the collapse of the housing industry, just as they rushed out of stocks and into housing after the so-called dot.com bust. Now they are fleeing housing after creating a similar fiasco in that market. But the money has nowhere to go.

The Fed’s solution to every crisis since 1987 has been to pump low-cost money into the financial markets. That’s one reason Wall Street thinks strength over the past four decades while Main Street has turned into a row of double-wides.

The money pump rattled into action again on September 18, when Bernanke and the Fed cut rates by half a point. There was only one excuse: To give the financial markets "confidence" so they can “run smoothly.” Bailing out financial institutions is a central bank theme.

So we have plenty of money sloshing around at the top. But where to put it? Housing is deflating. (Pity the poor homeowner who was counting on that to finance his retirement.) Stocks? It IS rumored some companies have foreign presence. Bonds? Sure, but you’re going to lose real value if inflation kicks up.
The smart money is buying foreign securities. Even if they don’t appreciate in value, you can ride up with the underlying currency. Or at least avoid sliding down with the dollar.