The bears are on the rampage and time is quickly running out to rein them in, writes David Hirst.
WHEN the history of the dreadful saga afflicting Wall Street is finally documented, the inquiries completed, some - perhaps many - lesser figures jailed, the spotlight will enter the lairs of the bears and chronicle a co-ordinated wave of rumour-mongering that began in earnest with the sudden, perhaps wanton, destruction of Bear Stearns in mid-March.
Historians will be tempted to look at the reckless greed, and the structuring of an economy on a substance - oil - all knew was finite and controlled by people who were fair-weather friends.
And in about 200 days, and in the teeth of winter, a new US president will be inaugurated. But as Dr Norm Zada, a major funds manager and a former professor of applied mathematics at Stanford University, said "we don't have 200 days", the exact words used by the head of Institutional Risk Analytics, Christopher Whalen, in a interview a week before.
In the absence of political will and leadership, especially from the White House, the bears are making great fortunes.
This column warned last week that Freddie Mac and Fannie Mae would dominate the market as the spotlight moved to the two mortgage giants. Although, as I said, the very mention of the two was setting the bears up for a rampage, I cannot claim to have foreseen the extent of the carnage.
I should have, for two reasons. One is the extraordinarily prescient prediction in 2002 of Dean Baker, from the Centre for Economic and Policy Research, who said: "If housing prices fall back in line with the overall rate price level, as they have always done in the past, it will eliminate more than $US2trillion in paper wealth and considerably worsen the recession. The collapse of the housing bubble will also jeopardise the survival of Fannie Mae and Freddie Mac and numerous other financial institutions."
When Baker made his prediction in 2002, his was a lonely but not sole voice. But by 2005 it was well apparent to the smart money that "easy money" would bring eventual asset collapse and those in the know moved out of the markets for havens or started the scary but immensely profitable business of shorting housing and the financials. The riches that are accumulating in the bears' caves are greater and can be made in days on the way down, not like the years of the boring bull markets accumulating money over time.
All these fortunes come at a price and again it was Baker who explained the truth and the consequences during the insane moments of last week's turmoil.
But the contents of this study are more alarming than Baker's 2002 observation. He, as co-author of the CPRE statement last week, asserted that the "vast majority of Americans" facing retirement with near to or negative savings will be relying on social security and Medicare, systems already facing the same insolvency.
"This extraordinary destruction of wealth will have tremendous implications for millions of families," Baker said. "Coupled with a very low personal savings rate, this means that many people, especially those near retirement, will only have social security and Medicare to rely on once they leave the workforce."
The report was written before the latest near-panic swept the market, removing further billions from investors and transferring them to the bears and short traders, and greatly worsening the situation.
But I find myself disagreeing, for the first time, with mortgage-credit crisis authority Professor Nouriel Roubini of New York University, who wrote on Sunday that shareholders, bondholders and the companies "take a hair cut", lest we create "the mother of all moral authority" crises. But this approach, which basically means letting Freddie and Fannie fall, seems to forget the extent to which the world's economy is subject to the vagaries of a vast, complicated, interwoven financial system where another major failure will, in the minds of many, lead to catastrophic collapses. .
It is possible Professor Roubini and like-minded moral authorities have not envisaged subjecting soft, middle-class and ageing Americans to 10 hours of hard labour six days a week.
As for social security, it is not sufficiently funded to withstand the sort of demands outlined in the CPRE report. In the meantime, if the financial system is to be rescued by the Government, which is now apparently inevitable, the US is caught between a rock and a hard place. It must save the financial system from bankruptcy by bankrupting, in a broad sense, most of its people, while huge numbers of expensive houses become ghost towns. A most unpleasant prospect, as Zada forcefully reminded me, for a heavily armed people.
And an essential point that underlines the interconnectedness of the world's financial system was made yesterday by a colleague of Roubini's, Brad Setser, a recent admission to the Council on Foreign Relations. Last week, and it will be worse this week, we saw the housing crunch hit Irish banks. It's moving on England. But worse, far worse, is China's, Russia's and other nations' exposure to Freddie and Fannie, in particular, but also to a whole range of "agency" and treasury debt those nations have accrued with the US. So much so there is speculation of feverish but polite conversations over the 10% of Chinese reserves held in the US. The Russian figure is about the same, according to Setser. We are, in the case of China, talking about some $US1trillion, or 25%, of the nation's gross domestic product and the matter is not just economic but diplomatic. Peter Shiff, president of Euro Capital, makes more sense than Roubini by stating the bail-out will cost less because the central banks "will own dollars that are worth less due to inflation".
The White House has issued a motherhood statement of three paragraphs that attempts to handpass the matter to Congress. Leadership at last! But nothing can deflect the fact the US is facing the most important economic decision in modern history. This is the greatest game of chicken ever played.
It is inconceivable that Roubini is unaware of the foreign policy implications of the application of the moral imperative; but let us return the to the matter of the US. The other reason I might have foreseen greater carnage towards the end of last week is a matter that should be fully investigated by the authorities. - the rumour-mongering that began with the demise of Bear Stearns and the near destruction of Lehman Brothers during the ides of March. That, it seems, was co-ordinated by the short-sellers. No doubt the rumour-mongering will return to Lehman this week (though there is little left to short) or Merrill Lynch or any one of the "universal banks" exposed to the toxic sludge that accompanied the easy money. And while industry insiders still repeat the mantra "too big to fail", another expression has crept into the lingo - "too big to save". It is an enigma.
But oil prices have halted the move by the vultures to strip the remaining flesh. The oil problem could be solved by the White House this week. As top Israeli figures come knocking on the White House door, hoping for an attack on Iran, would it be possible for President Bush to inform them there will be no attack, that the US is to establish dialogue with Tehran, wind down the war in Iraq and concentrate on securing Afghanistan? That would knock perhaps $US40 off the price of oil, maybe more, and avert immediate FMAD - Financially Mutually Assured Destruction.
David Hirst is a journalist, documentary maker, financial consultant and investor. His column, Planet Wall Street, is syndicated by News Bites, a Melbourne-based sharemarket and business news publisher.