No, I haven't been inhaling any of that whacky Oregon Smoke.
Those three words in the post title sum up what is happening to the stock markets now.
In the past 2 weeks, I have watched almost 100 hours of CNBC, which, despite being part of the politically twisted NBC empire, is actually just a technical money-and-banking network, for the most part.
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UPDATE:101008: 1910 PDT: On CNBC, a talking head, referring to a Newsweek poll that said that Americans are still against the bailout(s), cross-referenced the stock market collapse by saying "they've voted with their dollars because they couldn't vote with their votes" (against the bailout).
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Everyone on the channel agrees, and I believe them, that the huge sell-off in the markets is due to the freezing of inter-bank and inter-corporation credit systems. With no money moving around the system, commerce in the global economy is grinding to a halt.
Today is the day that the bastardized system of inter-institutional credit known as Credit Default Swaps gets tested. The CDS' of the bankrupt Lehman Bros investment and brokerage house are auctioned today to the Federal Government, but they are being bid on in an open process. So far, no one has even bid a dime on the dollar for these insurance policies which guaranteed the "leverage" or margin of credit upon which Lehman Bros. operated.
So, the Treasury Dept, which will own what used to be Lehman Bros, will get less than a dime on the dollar for whatever that formerly-huge investment empire owned. That means you and I just got stuck with the proverbial pig in a poke.
That's what I refer to as the "plastic economy". Leverage, plastic, all the same to me and to the rest of the Joe Sixpacks who are watching the trillions in plastic money melt down as the days go by.
Either today or Monday, Wall Street will pass a negative milestone: the Dow Jones Industrial Average (of 30 selected stocks) will have fallen in value by 50%. Half of that index is gone, and YOU AND I ARE BEING BLAMED BY THE "ELVES"ON WALL STREET FOR THE DEBACLE !
How could it be our fault, you and I ask?
It isn't, but those elves (and the tycoons who hire them) know that it is the individual investor, not the institution, who is best positioned to survive this crash. We have simply pulled our dollars out of the game, and with shotguns across our laps, are just sitting it all out. We have passed up some mighty tempting opportunities to jump back in to the markets, and we are getting to be hated for our decision.
WE KNOW WHAT THE BIG MONEY BOYS CAN'T EVEN GUESS AT: the "leverage" is the culprit, and until the crash wipes most or all of it out, we're not going to play the game again.
Let's look at the numbers. Lehman played the game at 25-to-30 to one leverage. The Dow was about 14,500 a year ago when they were in. They're gone, and the Dow dropped below 8,000 for a while today, which means that the leverage rates are almost cut in half.
I studied the Crash of '29 just like Ben Bernanke did. We probably read the same reports. He got a PhD out of his studies, while I only wrote a 40-page Senior Thesis in high school for mine (got an "A", though!). Before the Crash of '29, ANYONE could use "leverage". You could play the stock market on "ten percent margin", which means you were leveraged ten-to-one. Now the brokerages which took your leveraged order (by Western Union telegram) then ALSO leveraged THAT business out at ten-to-one, making the final leverage one hundred to one. With that leverage, the market went away QUICK when it went away. BTW, guess what company ran most of that empire?
Goldman Sachs.
OK, so after the Crash of '29, it was decided that no one could leverage any worse than two-to-one again, but that rule has been watered down by the invention of the sleight-of-hand Derivatives Market, which instruments are nothing but leveraged bets on movements of the price of real equities and commodities. When the Commodities Contracts seemed to do alright with their large leverages, the idea of those futures contracts spread to futures on actual equities, so when "spiders" and Hedge Funds were developed, the huge levels of leverage came back with them.
With today's auction of the Lehman Bros CDS', the free market has decided that it will pay for leverage at a rate no higher than ten-to-one.
The free market is limiting leverage, but until the entire market corrects to the free market indications, the slide in value will continue.
So, in answer to my question of "where's the bottom", I propose that the bottom is when the leverage is mostly gone, when the plastic is mostly melted, and when a dollar invested buys ONLY a dollar of value in a company.
I'll do the math for you. If the Dow companies were leveraged at twenty-five to one, their par value at no leverage would be 580 (based on their aggregate high of 14,500). If leverage at ten to one is OK, then the "bottom" for the Dow is 5,800.
If the free market is going to accept ten to one leverage (and that number is traditional both here and abroad, BTW), then it must understand that the TOTAL leverage in chain transactions must only be ten-to one, not as in 1929, ten to one, then leveraged AGAIN at ten to one.
Oh, and watch Goldman Sachs like a hawk. That outfit did it to us once, 79 years ago, and their proteges sit atop our government regulatory agencies now (that would be Paulson and Bernanke).
So, if you will excuse this untrained, under-educated blogger for making such a technical prediction, the Dow has another two thousand to drop before the little guys get back in. For me, and I suspect a lot of others, it's a cash economy until then.
If investment were to resume soon at high leverage rates, any "recovery" we see will not last, and the markets will fall off the table again, only the next time, the cash economy might not hold the fort as it's doing now.
If the government regulators ARE going to tinker with the "free" markets, they need to tinker on the side of getting the plastic swept out the door of the Temple. If they encourage resumption of the Plastic Economy, they have failed us, and themselves. So far, they have done very little to discourage the use of high leverage. That must change.