A slow, agonizing bear market trap?

Click on the above image to enlarge.

It's another great graph from Doug Short comparing the 1970's bear market with our current market - after adjusting for inflation.

And it's poignant when you consider that economist after economist is expressing concerns that the stock market is not properly reflecting the state of the economy. Most long-time observers are convinced that we will see another market pullback to the March market lows.

A lot of it has to do with the fact that a year after Washington rescued the big names of American finance, it’s still hard to get a loan.

The problem, it seems, isn’t just tight-fisted banks... but paralysis in the debt markets. It's deepening the credit drought.

The debt-securitization markets have been the source of roughly 60% of all credit in the United States in the past. Continued disarray is making loans scarce and threatening to scuttle any economic recovery.

Those debt-securitization markets that are operating, are only functioning because the government is propping them up.

But the Federal Reserve has put these markets on notice that it plans to withdraw its support for them, policy makers hoping private investors will return to fill the void.

And their return is critical.

The debt-securitization markets are crucial to the American economy. They financed corporate loans, home mortgages, student loans and more. In good times, they enabled banks to package their loans into securities and resell them to investors. That process, known as securitization, freed banks to lend even more money.

But many investors have lost trust in securitization after losing huge sums on packages of subprime mortgages that had high default rates.

The government has since spent more than $1 trillion trying to restore the markets, with mixed success. And with Americans moving into the highest personal savings mode in decades, the outlook isn't promising.

Until more of the securitization market revives, or some new form of financing takes its place, a wide range of loans needed to secure a lasting economic recovery will remain elusive, experts say.

"Given the imperative for securitization markets to fuel bank lending, we won’t have meaningful economic growth until securitization markets are re-established," said Joseph R. Mason, a professor of banking at Louisiana State University. Lee Sachs, a counselor to the Treasury secretary, Timothy F. Geithner. agrees. "It’s very important these markets come back to get credit to businesses and families who need it, and also as a sign of confidence."

But enormous swaths of this so-called shadow banking system remain paralyzed.

Depending on the type of loan, certain securitization markets have fallen 40% to 100%.

A once-thriving private market in securities backed by home mortgages has collapsed. It's gone from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.

The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years.

"The securitization markets are dead," said Robert J. Shiller, the Yale University economist and housing expert who predicted the subprime collapse. The government is supporting them, he said, but it’s unclear what will happen when it extricates itself. "We’re stuck," he said.

Many bearish economists have recognized this and have been calling for the bear market trap to snap shut on investors due to an irrational run up in stock prices from government stimulus.

But as Doug Short's chart above shows, the current market appears that it could be tracking the pattern of the 1970s.

Instead of another sharp drop, we could simply drift lazily back down to the March low over the next four and a half years as the North American economy fails to find the grease to make the machinery of business function.

That, by the way, is the same way things played out in the 1930s.

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