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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More on Wells Fargo, yesterday's market rally and an update on a previous post

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Faithful readers know that I have beaten up on Wells Fargo in the past because of it's dramatic financial balance sheet turnaround.

Critics have raised concerns that the stunning improvement in their financial situation has more to do with bookkeeping manoeuvres than the fundamental improvements.

Enter the infamous 'stress tests' of the 19 largest financial firms in the US. These 'tests' are a centerpiece of the Obama administration's plan to stabilize the banks. Some critics have decried the process as weak and ineffective, an artificial attempt to instill confidence in America's financial system.

Regulators have said they will not allow any of the 19 firms to fail because it would be too dangerous for the rest of the financial system. Wells Fargo holds billions of dollars in mortgage, construction and credit card loans.

And based on the results of their 'supposedly sound' quartly balance sheet released last month, Fargo stock has almost doubled in value.

Which make the latest leaked results of the 'stress tests' even more disturbing.

Wells Fargo is one of several banks that regulators will force to hold larger buffers to protect them against possible future losses, according to two people familiar with the matter who spoke on condition of anonymity because of the sensitivity of the process.

Apparently regulators have told Wells Fargo to shore up its finances after the stress tests showed the bank would have trouble surviving a deeper recession.

What happened to the outstanding quarterly results that had Wells Fargo on an excellent financial footing?

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In the Markets yesterday...

Yesterday, at about 11:05am, the Canadian Business News Network declared that different conditions were driving the market upward for the day. The BNN host stated that "gains appear to be driven by investors who are jumping into the market for fear of missing out on the rally".

Hmmm...

'Green shoots' that are nothing more than signs the economy is doing less worse, instead of getting better & impulse stock buying because investors fear they are missing out on the rally.

Perhaps you recall yesterday's post about the three stages of a bear market trap?

Don't look now, but I think the canary in that cage over there is dead.
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Update Post

You will recall that on Saturday April 25, 2009 I made the following post titled "Deja Vu - all over again". On that day the phrase that pays was 'corporate-style subprime loans'.

I cautioned that the next big financial disaster looming on the horizon in the United States was commerical mortgages structured just like the subprime housing loans.

Today the Miami Hearld published a story sounding a warning over this exact issue. Quoting the article, "Thousands of commercial mortgages valued at hundreds of billions of dollars are approaching a renewal date. By some estimates, two out of every three will no longer meet the original loan conditions and won't be able to refinance. And with prices for commercial properties expected to plunge, a vicious cycle may unfold much as it has in the nation's housing market.

A commercial mortgage meltdown is likely to prolong the nation's economic recovery. The falling prices in commercial real estate will lead to additional bank losses at a time when banks are sapped by home mortgage defaults and soaring credit card defaults. This could lead to future additional taxpayer assistance for the banks."

Hmmm... make that TWO dead canary's in that cage.

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Email: village_whisperer@live.ca