Post card from the edge

Futures, Aug 2008 by McMahon, Chris

While those foreign buyers are doing us a favor by helping to stabilize large financial companies, Wiggin says that optimism is misplaced.

"They are expecting the U.S. economy will rebound and they will end up owning a big chunk of it." However, he also says that it is a bet that assumes other economies won't supersede that of the United States, that non-U.S. exchanges will continue to be subordinate to U.S. exchanges and the world will continue to price things in dollars. "They are making a big mistake. They should be investing in their own. Saudi Arabia, Abu Dhabi, they should be investing in their own infrastructure," Wiggin says. "Maybe they just have so much money they can afford to do both!" he laughs.

Even as the beleaguered investment banks invite foreign buyers to shore up the books, Waldock says the process will be long and painful.

"The United States is finding itself the road kill rather than the vulture. We made a killing off the suffering of others for a long time and payback is a bitch," he says, adding that the financial sector will be among the last to recover and that the dilution of stock, through capital raising and deleveraging near market lows, will draw out their recovery.

The inflation of the housing bubble by low cost and easily available credit and the resulting devastation of the housing market, which is ongoing, continue to have negative implications for credit conditions (see "Recession hurts," Futures, June 2008).

Wiggin refers to the current situation as a "balance sheet recession," and notes that the recent spate of Fed fund rate cuts have not filtered down to home buyers. Banks are simply applying the spread to heal their balance sheets and credit conditions for individuals are not likely to ease any time soon. "The number of resets on mortgages, which is a root cause, doesn't finish until the end of 2008. And the Option Arms, another class of exotic mortgages, will begin resetting in equal numbers in 2009 and go through 2010," (see "Hell to pay," left). "If you just look at the numbers, we are not going to be out of this for a couple years."

But it appears the credit situation is improving for business. "We are starting to see the spread yields between corporate bonds and Treasuries have narrowed since the crisis in March," Zarembski says. He believes that while write downs will continue, the worst is over as far as the institutions are concerned but that conditions will remain tight for homeowners.

"A lot will depend on what the market believes the Fed will do the rest of the year," Zarembski says, adding rates are likely to remain at 2% for the rest of the year. "No one wants to get in the position of raising rates as we get into an election."

OUTLOOK

In the next 90 days, Levine expects the Dow to test below 11,000, and for the S&P 500 to test 1257. "All the volume is on the downside. When we move on the upside, it's short covering and short lived," Levine says. "The Nasdaq has a little better chance of hanging in there," he adds, although much rides on the success of Apple's new high-speed internet enabled iPhone.