The Zombie Stock Market De-Mystified*Updated
Every once in awhile, somebody gets a hold of me and says "If the economy sucks so bad, why is the stock market going up?" That is a fair question but it's not a question with a simple answer. If I were forced to give a simple answer it would be, "Primary dealers and free money from the FED have driven it higher. Retail investors, guys like me, have left in the millions."
So I am writing this piece for my investing friend, Pat. I am writing this for everyone puzzled by a rapidly inflating and deteriorating economy and a zombie stock market that only goes up. Many people are puzzled by this anomaly. So I am going to try and keep this explanation very simple while touching on and defining a couple of critical elements that I only have a rudimentary understanding of.
During my lifetime, until the repeal of the Glass Steagall Act in 1999, the stock market behaved in a predictable fashion. Retail investors, hedge funds, mutual fund managers, public fund managers, all performed the predictive function of the stock market. They invested on behalf of clients and themselves. They bought bonds, equities, and other investments like real estate trusts as long as the economic outlook was good. They sold positions when the economy didn't look so good. They did this through investment banks, broker dealers like Smith Barney or when I first started investing, Lehman Brothers.
We cannot have a discussion about the zombie stock market until we stop and define the two types of banks. Commercial and investment bankers. Giant commercial lenders like Citibank were restricted to mundane, money making activities like home loan lending and credit cards because of the Glass Steagall Act which was enacted in 1933. It was a law designed to protect us from a repeat of the catastrophe and great depression of 1929. Thus, it was illegal for commercial banks to engage in high risk-high reward investing. That was the glamorous domain of the investment banks.
So the big boring banks lived on fixed income that was pretty predictable. Wall Street was not confined to that boring and predictable income stream. They were creating all kinds of exotic investments and making gobs of money and bonuses. The big boring banks lobbied members of Congress to relax or eliminate all of the laws that prevented them from trading sexy new investments like the investment bankers could. It would also allow them to speculate and invest in credit and equity markets. The repeal of Glass Stegall in 1999, I believe, was directly responsible for the boom and bust that signaled the end of a healthy stock market by 2001. In fact, our markets have really done very little since then. Sideways. Dead money.
Bottom line. Glass Steagall did what it was intended to do. Congress, Clinton and Robert Rubin got rid of it. There has been nothing to replace it since then and therefore no real banking reform and I am purposefully ignoring the Dodd-Frank legislation which does nothing and in effect- is a joke. http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act
One last pre-requisite piece of information. Primary dealers. Primary dealers are banks that are authorized to sell debt for the FED. One of the ways that commercial banks hide what they do- is that they use investment banking arms to sell treasuries, buy equities, etc. Primary dealers include all of the Too Big To Fail Banks. I notice that the newly bankrupt MF Global, the device Jon Corzine used to steal 1.6 billion from customer accounts, is no longer on the primary dealer list. Here is the list. http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act
SUMMARY
As the FED issues and sells treasuries, it is creating money which is a debt instrument. Primary dealers sell those debt instruments. Primary dealers get the principal from the buyers. They turn around and use that newly created money to buy equities, or short precious metals, or manipulate commodities, because there are no other investment vehicles offering any kind of return. They don't need to pay the FED back necessarily since the FED is loaning the primary dealers money at essentially no cost right now. It's all funny money.
All that newly minted money has found it's way into the markets and inflated them. The primary dealers and the Federal Reserve are broke. Bankrupt. The world is disposing of and refusing to buy newly created U.S. Federal Reserve debt. So who is buying all of that new debt that we issue? You guessed it. Our own Federal Reserve. They call it monetizing the debt. I call it fraud. Whatever you call it, you cannot make this shit up. Primary dealers are desperately trying to repair their bankrupt balance sheets. They hide all of their losses, commercial and residential real estate, derivative exposure, through some of the most magnificent accounting gimmickry on the planet. Who allows that gimmickry? Our complicit and paid for Congress.
How long can this continue? I am in complete amazement that the masters of the universe have been able to manipulate markets this long. Going on four years. They are desperately trying to funnel everything and everybody they can into the stock market for one last giant catastrophe. Retirement accounts, the wealth of this country, is going to get stolen. It has to. That is the only wealth available to shore up the trillions in debt and losses that bankers truly owe. Time will run out before they can inflate away their losses with new and free money. It is that bad.
In the meantime, anyone getting into markets now, better be prepared to get fleeced. Obamacare is the last nail in the coffin. A CBO report has stated that Obama and the Democrats under estimated the cost of Obamacare (ON PURPOSE) by at least 1.2 trillion (incl. admin. costs) bringing the true costs of Obamacare to over 2 trillion in it's first ten years. Before it's even implemented. Who's gonna pay that? Apparently nobody gives a shit. http://campaign2012.washingtonexaminer.com/blogs/beltway-confidential/yes-obamacares-cost-have-almost-doubled/435111
On a personal level, I would love to get back in the market only to short it. This simply cannot go on much longer. This is the greatest battle ever waged by the elite against the hoi polloi. It is almost over. When this debt bubble eventually pops, it's going to make 2008 look like a birthday party.
* I had Dave in Denver look over this piece. He has solid credentials and asked him to see where I might be inaccurate- particularly I don't understand all of the transactions between Primary Dealers and the Fed. This is what Dave had to say.
So I am writing this piece for my investing friend, Pat. I am writing this for everyone puzzled by a rapidly inflating and deteriorating economy and a zombie stock market that only goes up. Many people are puzzled by this anomaly. So I am going to try and keep this explanation very simple while touching on and defining a couple of critical elements that I only have a rudimentary understanding of.
During my lifetime, until the repeal of the Glass Steagall Act in 1999, the stock market behaved in a predictable fashion. Retail investors, hedge funds, mutual fund managers, public fund managers, all performed the predictive function of the stock market. They invested on behalf of clients and themselves. They bought bonds, equities, and other investments like real estate trusts as long as the economic outlook was good. They sold positions when the economy didn't look so good. They did this through investment banks, broker dealers like Smith Barney or when I first started investing, Lehman Brothers.
We cannot have a discussion about the zombie stock market until we stop and define the two types of banks. Commercial and investment bankers. Giant commercial lenders like Citibank were restricted to mundane, money making activities like home loan lending and credit cards because of the Glass Steagall Act which was enacted in 1933. It was a law designed to protect us from a repeat of the catastrophe and great depression of 1929. Thus, it was illegal for commercial banks to engage in high risk-high reward investing. That was the glamorous domain of the investment banks.
So the big boring banks lived on fixed income that was pretty predictable. Wall Street was not confined to that boring and predictable income stream. They were creating all kinds of exotic investments and making gobs of money and bonuses. The big boring banks lobbied members of Congress to relax or eliminate all of the laws that prevented them from trading sexy new investments like the investment bankers could. It would also allow them to speculate and invest in credit and equity markets. The repeal of Glass Stegall in 1999, I believe, was directly responsible for the boom and bust that signaled the end of a healthy stock market by 2001. In fact, our markets have really done very little since then. Sideways. Dead money.
Bottom line. Glass Steagall did what it was intended to do. Congress, Clinton and Robert Rubin got rid of it. There has been nothing to replace it since then and therefore no real banking reform and I am purposefully ignoring the Dodd-Frank legislation which does nothing and in effect- is a joke. http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act
One last pre-requisite piece of information. Primary dealers. Primary dealers are banks that are authorized to sell debt for the FED. One of the ways that commercial banks hide what they do- is that they use investment banking arms to sell treasuries, buy equities, etc. Primary dealers include all of the Too Big To Fail Banks. I notice that the newly bankrupt MF Global, the device Jon Corzine used to steal 1.6 billion from customer accounts, is no longer on the primary dealer list. Here is the list. http://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act
SUMMARY
As the FED issues and sells treasuries, it is creating money which is a debt instrument. Primary dealers sell those debt instruments. Primary dealers get the principal from the buyers. They turn around and use that newly created money to buy equities, or short precious metals, or manipulate commodities, because there are no other investment vehicles offering any kind of return. They don't need to pay the FED back necessarily since the FED is loaning the primary dealers money at essentially no cost right now. It's all funny money.
All that newly minted money has found it's way into the markets and inflated them. The primary dealers and the Federal Reserve are broke. Bankrupt. The world is disposing of and refusing to buy newly created U.S. Federal Reserve debt. So who is buying all of that new debt that we issue? You guessed it. Our own Federal Reserve. They call it monetizing the debt. I call it fraud. Whatever you call it, you cannot make this shit up. Primary dealers are desperately trying to repair their bankrupt balance sheets. They hide all of their losses, commercial and residential real estate, derivative exposure, through some of the most magnificent accounting gimmickry on the planet. Who allows that gimmickry? Our complicit and paid for Congress.
How long can this continue? I am in complete amazement that the masters of the universe have been able to manipulate markets this long. Going on four years. They are desperately trying to funnel everything and everybody they can into the stock market for one last giant catastrophe. Retirement accounts, the wealth of this country, is going to get stolen. It has to. That is the only wealth available to shore up the trillions in debt and losses that bankers truly owe. Time will run out before they can inflate away their losses with new and free money. It is that bad.
In the meantime, anyone getting into markets now, better be prepared to get fleeced. Obamacare is the last nail in the coffin. A CBO report has stated that Obama and the Democrats under estimated the cost of Obamacare (ON PURPOSE) by at least 1.2 trillion (incl. admin. costs) bringing the true costs of Obamacare to over 2 trillion in it's first ten years. Before it's even implemented. Who's gonna pay that? Apparently nobody gives a shit. http://campaign2012.washingtonexaminer.com/blogs/beltway-confidential/yes-obamacares-cost-have-almost-doubled/435111
On a personal level, I would love to get back in the market only to short it. This simply cannot go on much longer. This is the greatest battle ever waged by the elite against the hoi polloi. It is almost over. When this debt bubble eventually pops, it's going to make 2008 look like a birthday party.
* I had Dave in Denver look over this piece. He has solid credentials and asked him to see where I might be inaccurate- particularly I don't understand all of the transactions between Primary Dealers and the Fed. This is what Dave had to say.
Dave in DenverMar 21, 2012 05:25 AM
http://thecivillibertarian.blogspot.com
Couple of nuances you should change. 1) Primary dealers are the designated market-makers of Government debt. They are also designated trading counter-parties of the Fed.
2) Money is created (printed) when the Fed uses its balance sheet to buy Treasuries and hold them through the PD's. In this case, the Fed prints money and buys the Treasuries, increasing the size of its balance sheet. This is different than a Repo transaction, in which the money is "sterilized" because the Fed doesn't print up extra and the Treasury is used a "collateral" to borrow the money. In Europe, the LTRO "repos" are becoming more like a surrogate for printed money because the maturity is 3 years.
3) Here's a nuance most don't realize about injecting funds into the system. And it's more powerful than outright QE because it's not acknowledged as printing, per se. The Fed decreases its reserve requirements for banks - all banks - thereby INCREASING the leverage of bank balance sheets. This means banks can borrow MORE money from the Fed against less equity. This was done in a big way in 2004. The reserve ratio at banks went from like 10:1 to nearly 40:1. That's what all the b.s. about level 1, 2 and 3 assets was about. It was a bullshit way to enable banks to borrow more money from the Fed. This has flooded the system with liquidity that's considered "printed" money or QE.
And you are right, all this liquidity has flooded into the stock market. In fact, as money has flowed OUT of the housing stock, it has shifted in a big way into stocks and Treasuries. We have a big bubble in Treasuries and brewing bubble in stocks.
By the way, your piece is very good!
Couple of nuances you should change. 1) Primary dealers are the designated market-makers of Government debt. They are also designated trading counter-parties of the Fed.
2) Money is created (printed) when the Fed uses its balance sheet to buy Treasuries and hold them through the PD's. In this case, the Fed prints money and buys the Treasuries, increasing the size of its balance sheet. This is different than a Repo transaction, in which the money is "sterilized" because the Fed doesn't print up extra and the Treasury is used a "collateral" to borrow the money. In Europe, the LTRO "repos" are becoming more like a surrogate for printed money because the maturity is 3 years.
3) Here's a nuance most don't realize about injecting funds into the system. And it's more powerful than outright QE because it's not acknowledged as printing, per se. The Fed decreases its reserve requirements for banks - all banks - thereby INCREASING the leverage of bank balance sheets. This means banks can borrow MORE money from the Fed against less equity. This was done in a big way in 2004. The reserve ratio at banks went from like 10:1 to nearly 40:1. That's what all the b.s. about level 1, 2 and 3 assets was about. It was a bullshit way to enable banks to borrow more money from the Fed. This has flooded the system with liquidity that's considered "printed" money or QE.
And you are right, all this liquidity has flooded into the stock market. In fact, as money has flowed OUT of the housing stock, it has shifted in a big way into stocks and Treasuries. We have a big bubble in Treasuries and brewing bubble in stocks.
By the way, your piece is very good!
