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The Great Moderation...



January 23, 2008 – Comments (4)

I'm reading "Worries That the Good Times Were Mostly a Mirage" and the statement that got my attention:

The great moderation now seems to have depended — in part — on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.

 The artcile goes into why this time is different and part of it are the things that I have been harping about, as the one economist said "Part of the big uncertainty is where the bodies are buried."  They don't know how the complex investments will unwind.

I saw how serious the problems were about this time last year and I started making my exit plans and I increased my watch over the warning signs.  There is the saying, if you are gong to panic, panic first.  You might say by leaving the market last October, I panicked first.  And indeed, as it took my broker six weeks to transfer my funds, I was feeling extremely uncomfortable with the market.  Was my broker incompetent or are there serious problems hiding there?

I figured there would be bank runs before this mess cleared up and seeing Northern Rock in England have a depression era bank run way before I expected to see that kind of thing made me check out the security of money with a brokerage.  They have their own insurance, and it appears to be self regulated.  Well, I've hardly seen a business sector successfully self-regulate.  They are there for profit for themselves and generally these things are some kind of smoke screen to appease the public.  It works as long as the problems are small.  Well, wouldn't you know it, the day I am putting in transfers to get my money out of my brokerage account E-Trade shows how much trouble they are in and have to raise $2.5 billion in equity.  I don't want to be in a brokerage should they find they can't raise the new equity.  I think government insurance is better, although still a disaster if it is needed.

There were at my last reading on derivatives $681 trillion dollars of them.  You might call that a lot of dead bodies that you just don't know where they are buried.

 This Mr. Rajan guy is saying the situation is more severe than the crisis in the late 1990s because firms are facing real losses.

From my looking at stocks this is something I've seen all over the market and it is why I think the market is going to about half the value before the correction is over.  Many companies have borrowed to buy back their stocks.  Their earnings are going down.  There is no question there is going to be a squeeze.  Wholesale prices are already up 6.3% and by the time all of the currency devaluation works its way through I would expect that figure to be in the double digits.  Consumers are in debt to the hilt and they have reached their limit on being able to increase their spending or perhaps they will increase their spending, but there will be a significant contraction of the goods and services they get for their money as costs increase faster than wages.

Business will be hurt by having increased debt servicing costs, lower amortization of their fixed costs over the goods they sell because of less goods being sold.  They can cut jobs to reduce some their costs that are not fixed, but they still have buildings to pay for and leases and all that stuff.  It takes much longer to reduce those expenses.

I predict that many of these share buy back programs are going to prove to be grossly incompetent.  They are akin to driving and vehcile into the ground, never changing the oil, or doing anything to look after it.  The increased debt burden will in some cases push the companies into a spiraling negative earnings position.  They have negative earnings and tap into their credit facilities further and end up with even more negative earnings.  Ultimately they will have to issue more equity or go bankrupt.  Raising equity for marginal profit margins is difficult to do, and this is what some buinesses have done to themselves. And all the profits are gone because they were used to buy over priced shares and outrageous levels of stock options were issued to the executives so there is very little, if any, actual reduction in total number of shares.  This is the biggest conflict of interest activity that increased so out of proportion, will stupid investor cheering the share buy back programs, which allowed executive compensations to go from 40 times the average wage to 600 times the average wage.  If you cheered these things, go look in the mirror and look at a fool.  A very few of the buyback programs may end up proving to be a good thing, but I would bet history will show they were few and far between.




4 Comments – Post Your Own

#1) On January 23, 2008 at 10:26 AM, GS751 (26.83) wrote:

interesting post.  I think the real burden on the crisis we are in is consumers don't have the ability to create more debt and spend this cash to push our economy out of this one.  The purgeing will be good.

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#2) On January 23, 2008 at 11:58 AM, WillSurfForFood (72.23) wrote:

I've come to the same conclusion about share buyback programs, very few will turn out to be a good idea. A better thing to do with excess money is to return it to shareholders as dividends. The dividends reward people that hold onto the stock. The share buybacks reward the people that plan to get rid of their stocks which often turns out to be the officers that are compensated with too many options. If a stock price of a company was such a good value to justify a share buyback you would see the same officers buying shares with their own money on the open market. This rarely happens.

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#3) On January 23, 2008 at 11:59 AM, cubanstockpicker (20.74) wrote:

Greast post, I read with great detail, since thought that the selling off of the financials would not involve the rest of the economy.


Two things worry me about this silently announced recession.  

The soveregin funds of other countries will scoop up and buy America little by little. And all Americans will be doing is making the other countries rich once we figure out a way out of this.

There will be no oversight by the government will create huge shifts of Power including buying 5% or more to Military and security companies will start creating better military products for their new employers at faster rates and better prices. Since publicly held companies are following their best financial interests, not the United States. (Follow the money)

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#4) On January 23, 2008 at 2:26 PM, dwot (29.20) wrote:

Bingo cubanstockpicker, I doubt that analysts are pricing in the leakage of earnings from foreign ownership of stocks in their analysis, and that goes for government debt and ability to pay for social programs.

The economy is leveraged to the hilt so even small changes in income and ability to spend money will hit it hard. 

Think of a bubble as a great leveraged bubble going up and because of leverage, coming down is leveraged as well. 

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