bizzXceleration: Performance, Value and Profit

INTRO

Below you'll find a careful selection of stories we think you ought to pay some attention to, which we'll try and summarize briefly to start with after the break. Before that though let's cut to the bottomline. The economy's slowing severely but would pull thru in a year+ but is exposed to severe downside risks from the meltdown of the credit markets. Which began re-melting for the 4th time since last Aug 3-4 weeks ago and reached a crescendo last week with a run on Bear-Sterns that WAS NOT VISIBLE at the begining of the week. If it had gotten out of control we would have not had a metastatic outbreak or even the contagion I keep yammering about but a major outbreak of credit collapse. This was a Hail Mary except it was done with skill, hardwork, guts and forethought. AND it won't be the last time while we work thru all this crap.

The stories after the break include a great Fortune interview with Paul Krugman where he provides short, pithy assessments of many of these factors that align with our take AND put him the camp of Messiuers Feldstein and Summers. Followed by a WSJ article discussing the domino theory of credit market contagion and collapse which leads nicely to another story on why monetary policy is proving so ineffective, given these broken credit mechanisms. Which, pointing to another WSJ article, is going to lead to a massive re-examination of the regulatory and institutional framework of the markets and the industry. And, in a colum by Sean Tully of Fortune, the end of Wall street as we knew it. To which we say here, here. The question is what will replace it and there we become open to political gerry-mandering and special interest manipulations which could be more dangerous than the original de-regulation has proven.

BtW - in case anyone's wondering we'd translate "re-position your portfolio" as go heavy on cash and short-term bond funds but look at longer term funds such as Pimco's Total Return as well as gold, precious metals and commodities. Though the later are ripe for a correction as the economy slows. And if you're feeling aggressive and if there's a bounce that would be a good time to investigate inverse, or short, funds and ETFs. Ryder and ProFunds have excellent choices btw.

SUMMARY

First, the credit markets are in the beginnings of a possible meltdown which has resulted in severely contractionary monetary policy. Second the economy was headed into a slowdown anyway which WAS likely to be longer and deeper than the too-sanguine optimism of the street. Third the key engine, Housing, is at best about a 1/3 of the way thru it's contraction and that is spreading to Commercial Real Estate, which will expose the financials to more write-downs not factored onto their books. Which will in turn further contract credit. Fourth the Fed is doing everything in the books and investing new approaches as we go though traditional monetary policy is NOT working, as we've explained several times, and they're creating new instruments to intervene directly in the markets as we speak. Fifth - this wasn't really caused by the sub-prime crisis, though it was initially triggerred by it. It was caused by major structural flaws in the Finance industry where "new" business models emphasized trading using leverage and gambled with other people's money. Because the Industry shifted from a business model of making loans on quality assets and associated fees to originating loans and distributing them it created a set of perverse incentives to maximize the flow of bad deals. Which was further accelerated by immense liquidity created by leveraged synthetic debt, thereby creating a feedback loop of immense proportions which put more and more funds into the markets to chase fewer and fewer opportunities. This is now all going into reverse thru de-leveraging and risk re-pricing. We have to survive this and then we can anticipate a complete re-structuring of the Finance Industry and entirely new comprehensive, massive regulatory regimes because the Industry has established that it's not capable of adult self-supervision. That's it in a nutshell. Let's hope we all survive. The chances are better than 50% but the risks are mounting.

Current Readings

How bad is the mortgage crisis going to get? What started in subprime is likely to continue cascading into the markets and keep the economy down until 2010, economist Paul Krugman forecasts. Bottom line for homeowners: An average drop of 25%. You've been saying 2010 is when we get out of this recession. How did you arrive at that date? The last recession officially ended after eight months, but employment didn't start to recover until 30 months later, so I think we go at least that long this time. If the recession started in January 2008, then that would mean July 2010 is the first month we have anything that feels like a recovery. But I wouldn't be surprised if it goes longer than that - maybe into 2011. What's changed? There has been the realization that the increased nervousness about risk and deleveraging is going to hit a lot of markets a long way removed from subprime - like when people start to see auction-rate securities go. Something has finally tipped the balance. We've got Fannie Mae and Freddie Mac suddenly having to pay substantial spreads. It seems to me like every few weeks there's another $300 billion market I've never heard of that has just collapsed. And there's credit cards, auto loans - I don't know what's next. But it's clear we're going to have a commercial real estate crash not too far short of the severity of the housing crash.

News Analysis: A Wall Street Domino Theory The Federal Reserve’s unusual decision to provide emergency assistance to Bear Stearns underscores a long-building concern that one failure could spread across the financial system. Wall Street firms like Bear Stearns conduct business with many individuals, corporations, financial companies, pension funds and hedge funds. They also do billions of dollars of business with each other every day, borrowing and lending securities at a dizzying pace and fueling the wheels of capitalism. The sudden collapse of a major player could not only shake client confidence in the entire system, but also make it difficult for sound institutions to conduct business as usual. Hedge funds that rely on Bear to finance their trading and hold their securities would be stranded; investors who wrote financial contracts with Bear would be at risk; markets that depended on Bear to buy and sell securities would screech to a halt, if they were not already halted. 

Why the Fed can't put out the fire. Even many of those who believe Fed must make another big rate cut Tuesday concede it can't do much to calm troubled markets. With Wall Street hit by a crisis of confidence, many are hoping the nation's central bank can save the day. The Federal Reserve's main weapon: Cutting interest rates, and most economists expect a big slash of three-quarters of a percentage point on Tuesday. But even those economists in favor of such a move concede it will do little to calm investor fears. But Lyle Gramley, a Fed governor from 1980 to 1985 and now a senior economic advisor for the Stanford Washington Research Group, said that such a failure would have far broader implications for the economy and the financial markets and the Fed has to do what it can to avoid that. "If the Fed had sat aside and let Bear go down the tubes, the cascading effects would have been ghastly," he said. Gramley and some other experts believe the solution to the current credit crisis will have to come from Congress, not the Fed, and that the federal government will have to take steps to bail out both Wall Street firms holding mortgage-backed securities as well as homeowners who have mortgages with balances greater than the value of their homes. And no matter what the Fed does, market fears probably won't go away any time soon. After all, some investors will probably take more Fed cuts as a sign that the central bank sees more trouble ahead.

U.S. Mulls Next Steps in Crisis  The U.S. is likely to respond to the unfolding financial crisis with a heavier hand, in the form of corporate bailouts, fiscal incentives and regulation. The swiftness and virulence of the financial problems have been stunning. The problems are rooted in a bipartisan goal to figure out ways for lower-income Americans to buy homes, so that they could build financial wealth and plant deep stakes in their neighborhoods. But the instruments that mortgage companies devised included provisions -- interest resets after five years, no down payments -- that buyers didn't fully appreciate could backfire. When those subprime mortgages were bundled into packages of debt and sold to a daisy chain of interlocked financial institutions, the risks of those provisions eluded investors considered far more sophisticated than first-time home buyers. Essentially, the risks were hidden from view -- "a lack of transparency," financial types call it. The irony is that the U.S. and the International Monetary Fund have been lecturing developing countries since at least the 1980s of that very danger. If economic risks aren't transparent to investors, they're likely to blow up, and can drag down an economy. Barry Eichengreen, an economic historian at the University of California at Berkeley, says that institutions bailed out by the government can expect stricter government oversight. That includes investment-banking firms, now that they are able to borrow from the Fed, and could include hedge funds and private-equity firms if they get government bailouts. "If we're going to use public money to prevent the finance system from collapsing," he says, "the quid pro quo is more oversight during normal times." "This regimen of total deregulation has essentially allowed the economy to be held hostage to some financially irresponsible actions," says Rep. Frank. "There is no choice but to pay some ransom."

End of Wall Street as we know it Financial firms have relied on a highly flawed business model for years. The time has come to fix it. The standards that rule most businesses­­ - avoiding excessive leverage, reining in rampant pay and the massive dilution that goes with it­­ - didn't apply to Wall Street. So what if investors didn't understand all those arcane instruments and sophisticated hedging strategies? Wall Street was the black box on the Hudson that worked its own brand of magic. Today, the magic is fading fast. It's time to step back and analyze how financial firms actually operate.The truth is that they've been relying on a highly-flawed business model for years. Put simply, Wall Street firms used towering leverage to make tons of money in a long-running bull market that blatantly underpriced risk. At the same time, they handed a huge chunk of the gains to employees in the form of excessive pay. Now that run is over, and the price of risk is rising dramatically. That's driving down value of everything from junk bonds to mortgaged backed securities. Wall Street's addiction to leverage is cutting the wrong way.