Indexes Closely Slightly Higher, Week Lower

Tanking Stocks

And volatility is spiking at the same time!

Dow down about 140 at this moment.

Is This What a Taper Tantrum Looks Like?

Dow down 100 points now! These are the most distorted markets I've seen!

Unconvinced by Budget Deal

Running for the exits before end of 2013

More taper rumors. Is this the beginning of another taper tantrum?

The beginning of a taper tantrum?

What? Wall St Suddenly Doesn't Like Spending MORE?

Isn't "easing spending cuts", as shown in this Bloomberg headline this morning, just another way of saying that they are going to spend MORE? Why the parsing of words? Why the games of semantics, just to tell us that they're kicking the can down the road again?

Key points in this budget "deal":
They restore $65 billion in spending cuts NOW!
They cut spending by $23 billion over ten YEARS!

Meanwhile, the US Treasury issued $409 billion of new debt in October alone -- in ONE MONTH!
Are these people insane? What kind of "grand deal" is that? It sounds like more of the same insane to me!

A Growing Cacophony of Voices Calling for a Fed Taper

Is this the reason stocks are showing weakness again, just two days after a 200-point Dow rally? There are more and more voices, even on Wall St, calling for the Fed to begin tapering it's debt monetization scheme at the Fed's meeting next week.

Inventory! The Dirty Little Devil in the GDP Details!

Stocks came to within a hair's breadth of another new all-time record high yesterday and throughout the night, but what Wall St seems to be shrugging off is that the recent stronger-than-expected GDP contains a real devil in the details. The recent GDP growth has been based all on inventory builds.

"...of the $534 billion rise in nominal GDP in the past year, a whopping 56% of this is due to nothing else but inventory hoarding.

"The problem with inventory hoarding, however, is that at some point it will have to be "unhoarded." Which is why expect many downward revisions to future GDP as this inventory overhang has to be destocked."

And when that "destocking" takes place in future quarters, it must be accomplished with REDUCED profit margins and REDUCED payroll. This means that we are robbing the future's GDP Peter, to pay today's GDP Paul. In other words, unless the American people suddenly find a strong and compelling urge to buy, buy, BUY, future quarters will be weak and there will be lay-offs in jobs.

So that dirty little devil in those GDP details forebodes disappointment ahead.

What's worse, economists over the past few days have now assessed that last Friday's surge in consumer confidence wasn't really an IMPROVEMENT at all. It was just a return to a more normal level following the the temporary shutting down of part of the government in October. It wasn't a surge in sentiment. It was just a return to the same level of malaise that has dominated for the past few years.

And there is a growing cacophony of voices -- even on Wall St -- calling for the Fed to begin tapering its debt monetization scheme NOW! The Fed board meets next Tues and Wed, and will release a policy statement at the end of their Wed meeting.

Stocks Extend Climb

No more worries of a taper? Friday's jobs report was calculated to be just high enough to suggest growth, but not enough for the Fed to begin a taper of asset purchases.

Dow Up 200 on Better-Than-Expected Jobs Report

The US created 204,000 jobs in November. This used to be a number that represented malaise. Now, it sends stocks 200 points higher.

What George Soros Says About Asset Bubbles

EXCERPT FROM THE GEORGE SOROS ‘ACT II OF THE DRAMA’ SPEECH, JUNE 2010 (emphasis added)
Let me briefly recapitulate my theory for those who are not familiar with it. It can be summed up in two propositions. First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. This is the principle of fallibility. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality I speak of far from equilibrium conditions. That is where we are now.
Second, financial markets do not play a purely passive role; they can also affect the so-called fundamentals they are supposed to reflect. These two functions that financial markets perform work in opposite directions. In the passive or cognitive function, the fundamentals are supposed to determine market prices. In the active or manipulative function market, prices find ways of influencing the fundamentals. When both functions operate at the same time, they interfere with each other. The supposedly independent variable of one function is the dependent variable of the other, so that neither function has a truly independent variable. As a result, neither market prices nor the underlying reality is fully determined. Both suffer from an element of uncertainty that cannot be quantified. I call the interaction between the two functions reflexivity. Frank Knight recognized and explicated this element of unquantifiable uncertainty in a book published in 1921, but the Efficient Market Hypothesis and Rational Expectation Theory have deliberately ignored it. That is what made them so misleading.
Reflexivity sets up a feedback loop between market valuations and the so-called fundamentals which are being valued. The feedback can be either positive or negative. Negative feedback brings market prices and the underlying reality closer together. In other words, negative feedback is self-correcting. It can go on forever, and if the underlying reality remains unchanged, it may eventually lead to an equilibrium in which market prices accurately reflect the fundamentals. By contrast, a positive feedback is self-reinforcing. It cannot go on forever because eventually, market prices would become so far removed from reality that market participants would have to recognize them as unrealistic. When that tipping point is reached, the process becomes self-reinforcing in the opposite direction. That is how financial markets produce boom-bust phenomena or bubbles. Bubbles are not the only manifestations of reflexivity, but they are the most spectacular.

In my interpretation equilibrium, which is the central case in economic theory, turns out to be a limiting case where negative feedback is carried to its ultimate limit. Positive feedback has been largely assumed away by the prevailing dogma, and it deserves a lot more attention.
I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, “As long as the music is playing, you’ve got to get up and dance. We are still dancing.” Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions.

Mixed Headlines for 12-5-2013

 GDP this morning reported to be 3.6% for Q3. But it was all inventory build-ups, not organic or consumer-fed growth.

 Another dose of cold water for Obamacare.

 Durable goods orders drop:

Roller Coaster Day!

It's down! It's up! It's down! No, it's up! This kind of turmoil can only exist when central bankers are out of control!

Stocks Collapse More!

Wow! What a reversal!
Dow down 118!

A Retail Dose of Cold Water

Today's elation has suddenly turned to despair.

ADP Reports Better Jobs, ISM Reports Worse Jobs

Is it any wonder that the stock market is all over the place today?

More Good News Sends Stocks Into Red, Near Opening Prices

Lower home prices caused home sales to surge, and stock prices have reacted by dropping. Stocks are now in the red, and are close to the price at this morning's open. What a twisted world!

The Warped World of Wall St

Only in the Fed-warped world of Wall St! This chart is from this morning. A private jobs report (called ADP) that is released each month two days before the government report, was better than expected this morning. It wasn't stellar, but it was better than was anticipated. At first, stocks fell, anticipating that the Fed is more likely to "taper" off it's debt monetization. But then, shortly after the stock exchanges, stocks, took off, leaping higher instead. So now, I guess we are to assume that ALL news is good news. Bad news would signal the Fed's intentions to continue to print money as a free gift to Wall St. So buy stocks! And good news is a sign of economic prosperity to come. So buy stocks!

When stocks go higher without regard for ANY news, it sounds like a classic bubble to me!

For perspective, in order to bring the economy back to the state it was in before Obama was elected president, it would require about 500,000 jobs be created every month until his presidency ends. This morning's "good" jobs report indicated that 215,000 jobs were created last month. And on THAT news, stocks leaped this morning!

Only in the Fed-warped world of Wall St!

Der Spiegel Gets It

Why doesn't the Fed?

Now That Is Some Divergence

A divergence of expectations... from reality.

John Hussman Describes What Causes Bubbles to Crash

"Keep in mind how investment bubbles work. A bubble always starts with some real factor that takes on increasingly exaggerated importance in the eyes of investors. The bubble expands not on facts but on untethered imagination. People imagine that X will result in ever-increasing prices, and assume that an endless crowd of buyers is still behind them – dot-com stocks, technology, housing, “tronics” stocks in the 60’s, the Nifty Fifty in the 70’s, quantitative easing, tulip bulbs. Regardless of whether the mechanism underlying that concept is fictional, and regardless of how tenuously it is linked to reality, a bubble advances as long as the adherents it gains are more eager than those it loses. What stops the bubble is not the concept itself hitting a brick wall, but pool of new adherents being exhausted. Once everyone is in, who’s left to buy from all those holders with their fingers hovering over the sell button? The question, once the moment arrives, is always the same: Sell to whom? And that’s why markets crash." -- John Hussman, Ph.D. Dec. 2, 2013

I see bubbles!

Stocks Close Down, But Maintain Key Levels

The Dow closed down 77 points today, but barely held the key 16,000 level. The S&P 500 scarcely managed to hold onto the 1,800 level also -- for now!

My, Dems Costly Cows!

Dairy futures are breaking records.

Stock Market Reality Bomb From Bob Shiller

Recent Nobel Prize winner Bob Shiller just unloaded a reality bomb.

from Zero Hedge:
On the heels of his recent appearance pouring cold water on Jim Cramer's housing recovery exuberance, recent Nobel Prize winner Bob Shiller unloads another round of uncomfortable truthiness (presumably on the basis of his future-proofing tenure guaranteed by the Nobel). "Bubbles look like this," Shiller tells Der Spiegel, adding that he is, "most worried about the boom in US stock prices." As Reuters reports, Shiller is concerned since "the world is still very vulnerable to a bubble," and with stock exchanges around the world at record highs despite an economy that is "still weak," the Nobel winner proclaimed, "this could end badly."

Via Reuters,

[Bob Shiller] believes sharp rises in equity and property prices could lead to a dangerous financial bubble and may end badly, he told a German magazine.

...

"I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets," Shiller told Sunday's Der Spiegel magazine. "That could end badly," he said.

"I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable," he said, describing the financial and technology sectors as overvalued.

...

"Bubbles look like this. And the world is still very vulnerable to a bubble," he said.

Bubbles are created when investors do not recognize when rising asset prices get detached from underlying fundamentals.

We tend to agree - bubbles do look like this...
...we observe a variety of other features typically associated with dangerous extremes:

• unusually rich valuations on a wide variety of metrics that actually have a reliable correlation with subsequent market returns; margin debt at the highest level in history and representing 2.2% of GDP (eclipsed only briefly at the 2000 and 2007 market extremes);
• a blistering pace of initial public offerings - back to volumes last seen at the 2000 peak - featuring “shooters” that double on the first day of issue;
• confidence in the narrative that “this time is different” (in this case, the presumption of a fail-safe speculative backstop or “put option” from the Federal Reserve); lopsided bullish sentiment as the number of bearish advisors has plunged to just 15% and bulls rush to one side of the boat;
• record issuance of covenant-lite debt in the leveraged loan market (which is now spreading to Europe);
• and a well-defined syndrome of “overvalued, overbought, overbullish, rising-yield” conditions that has appeared exclusively at speculative market peaks – including (exhaustively) 1929, 1972, 1987, 2000, 2007, 2011 (before a market loss of nearly 20% that was truncated by investor faith in a new round of monetary easing), and at three points in 2013: February, May, and today (see A Textbook Pre-Crash Bubble).

Many of us in the financial world know these to be classic features of speculative peaks, but there is career risk in responding to them, so even those who view the situation with revulsion can't seem to tear themselves away.

While I have no belief that markets follow any mathematical trajectory, the log-periodic pattern is interesting because it coincides with a kind of “signature” of increasing speculative urgency, seen in other market bubbles across history. The chart above spans the period from 2010 to the present. What’s equally unsettling is that this speculative behavior is beginning to appear “fractal” – that is, self-similar at diminishing time-scales. The chart below spans from April 2013 to the present. On this shorter time-scale, Sornette’s “finite time singularity” pulls a bit closer – to December 2013 rather than January 2014, but the fidelity to this pattern is almost creepy. The point of this exercise is emphatically not to lay out an explicit time path for prices, but rather to demonstrate the pattern of increasingly urgent speculation – the willingness to aggressively buy every dip in prices – that the Federal Reserve has provoked.

Black Friday Sales Down 13%, Stocks Higher

According to ShopperTrak, total Black Friday traffic plunged 11% and total sales fell 13.2%, the second consecutive year of declines following last year's 1.8%.

Lessons Lost: The Lessons of Long-Term Capital Management

By Roger Lowenstein, author of When Genius Failed: The Rise and Fall of Long-Term Capital Management

from the New York Times

A financial firm borrows billions of dollars to make big bets on esoteric securities. Markets turn and the bets go sour. Overnight, the firm loses most of its money, and Wall Street suddenly shuns it. Fearing that its collapse could set off a full-scale market meltdown, the U.S. government intervenes and encourages private interests to bail it out.
The firm isn't Bear Stearns — it was Long-Term Capital Management, the hedge fund based in Greenwich, Connecticut, and the rescue occurred 10 years ago this month.
The Long-Term Capital fiasco momentarily shocked Wall Street out of its complacent trust in financial models, and was replete with lessons, for Washington as well as for Wall Street. But the lessons were ignored, and in this decade, the mistakes were repeated with far more harmful consequences. Instead of learning from the past, Wall Street has re-enacted it in larger form, in the mortgage debacle cum credit crisis.
In the wake of Long-Term Capital's failure, Wall Street professed to have learned that even models designed by "geniuses" were subject to error and to the uncertainties that inevitably afflict human forecasts. It also professed a newfound respect for the perils of borrowing. Whether this wisdom endured may be judged by events of the past year, when not only Bear Stearns but also scores of banks and financial institutions have written off hundreds of billions of dollars — a result of blithe faith in models of the housing industry, not to mention a voracious hunger to do business on credit.
Regulators, too, have seemed to replay the past without gaining from the experience. What of the warning that obscure derivatives needed to be better regulated and understood? What of the evident risk that intervention from Washington would foster yet more speculative behavior — and possibly lead to a string of bailouts?
Indeed, through the lens of today's more widespread failure, the Long-Term Capital collapse looks like a small dress rehearsal. But at the time, it sent tremors of fear through the corridors of Wall Street, along the electronic byways of finance and around the globe. Somehow, a geeky band of bond traders was able to throw the financial world off kilter.
In its first four years, Long-Term Capital achieved phenomenal profits with virtually no downside. Thanks to its seemingly flawless computer models, as well as its formidable arbitrageurs — including two Nobel laureates and a former vice chairman of the U.S. Federal Reserve Board — it quadrupled its capital without having a single losing quarter.
But in the summer of '98, its fortunes took a frightful downturn. With terrifying suddenness, bond markets turned skittish and all the fund's gambits ran into trouble.
As Long-Term Capital teetered, Wall Street feared that its unraveling could set off a systemic meltdown, and William McDonough, president of the Federal Reserve Bank of New York, agreed. On Sept. 22 and 23 — by which time Long-Term had lost almost $4.5 billion — he summoned the heads of the major Wall Street firms, along with senior bankers from Europe, to a conference at the Fed. Fearing chaos, 14 banks — Bear Stearns, ironically, was the lone naysayer — agreed to rescue Long-Term by investing $3.65 billion. Within a few weeks, calm returned and the crisis passed.
No firm had a closer view of Long-Term Capital than Bear Stearns, the broker that cleared its trades. And it was Bear that sounded the first shot in the current mortgage crisis. In summer 2007, amid a sharp rise in delinquencies on subprime mortgages, two hedge funds sponsored by Bear that invested in high-rated mortgage securities imploded. As foreclosures kept rising, other institutions suffered losses and the crisis spread.
Bear was warned to raise more capital by selling stock, but its senior executives, led by James Cayne, the chief executive, thought the company's stock was cheap and refused. Cayne, who was an original investor in Long-Term Capital, should have remembered that the hedge fund's most obvious flaw was its excessive borrowing, or leverage. Before its annus horribilis, Long-Term Capital had intentionally reduced its equity to a mere 3 percent of assets. It was a fatal mistake.
This time around, Bear gambled that it could survive with a weak balance sheet — its equity-to-assets ratio was an identical 3 percent. By March, worries that Bear was overleveraged prompted a run on its stock and pushed it to the brink of bankruptcy. Again, Wall Street feared that a chaotic collapse could jeopardize the financial system, and the Fed orchestrated a rescue.
AS striking as the parallel is to Bear, Long-Term Capital's echo is far more profound. Its strategy was grounded in the notion that markets could be modeled. Thus, in August 1998, the hedge fund calculated that its daily "value at risk" — meaning the total it could lose — was only $35 million. Later that month, it dropped $550 million in a day.
How could the fund have been so far off? Such "risk management" calculations were and are a central tenet of modern finance. "Risk" is said to be a function of potential market movement, based on historical market data. But this conceit is false, since history is at best an imprecise guide.
Risk — say, in a card game — can be quantified, but financial markets are subject to uncertainty, which is far less precise. We can calculate that the odds of drawing the queen of spades are 1 in 52, because we know that each deck offers 52 choices. But the number of historical possibilities keeps changing.
Before 1929, a computer would have calculated very slim odds of a Great Depression; after it, considerably greater odds. Just so, before August 1998, Russia had never defaulted on its debt — or not since 1917, at any rate. When it did, credit markets behaved in ways that Long-Term didn't predict and wasn't prepared for.
This was the same mistake that scores of lenders would make in the U.S. housing industry. The United States had never suffered a nationwide contraction in housing prices; they assumed that the pattern would hold.
Modern finance is an antiseptic discipline; it eschews anecdotes and examples, which are messy and possibly misleading — but nonetheless real. It favors abstraction, which is perfect but theoretical. Rather than evaluate financial assets case by case, financial models rely on the notion of randomness, which has huge implications for diversification. It means two investments are safer than one, three safer than two.
The theory of option pricing, the Black-Scholes formula, is the cornerstone of modern finance and was devised by two Long-Term Capital partners, Robert Merton and Myron Scholes, along with one other scholar. It is based on the idea that each new price is random, like a coin flip.
Long-Term Capital's partners were shocked that their trades, spanning multiple asset classes, crashed in unison. But markets aren't so random. In times of stress, the correlations rise. People in a panic sell stocks — all stocks. Lenders who are under pressure tighten credit to all.
And Long-Term Capital's investments were far more correlated than it realized. In different markets, it made essentially the same bet: that risk premiums — the amount lenders charge for riskier assets — would fall. Was it so surprising that when Russia defaulted, risk premiums everywhere rose?
More recently, housing lenders — and the rating agencies who put triple-A seals on mortgage securities — similarly misjudged the correlations. The housing market of California was said to be distinct from Florida's; Arizona's was not like Michigan's. And though one subprime holder might default, the odds that three or six would default were exponentially less. Randomness ensured (or so it was believed) a diverse performance; diversity guaranteed safety.
After Long-Term Capital's fall, many commentators blamed a lack of liquidity. They said panic selling in thin markets pushed its assets below their economic value. That's why leverage is dangerous; if you operate with borrowed money, you lack the luxury of waiting until prices correct.
The fund's partners likened their disaster to a "100-year flood"— a freak event like Katrina or the Chicago Cubs baseball team winning the World Series. (The Cubs last won in 1908; right on schedule, they are in contention to repeat.) But their strategies would have lost big money this year, too.
John Meriwether, the fund's founder, later organized a new fund, which suffered big losses early this year, according to press reports.
If 100-year floods visit markets every decade or so, it is because our knowledge of the cards in history's deck keeps expanding. When perceptions change, liquidity evaporates quickly. Indeed, the belief that one can safely get out of a "liquid" market is one of the great fallacies of investing.
This lesson went unlearned. Banks like Citigroup and Merrill Lynch felt comfortable owning mortgage securities not because they knew anything about the underlying properties, but because the market for mortgages was supposedly "liquid." Each firm would write down the value of its mortgage investments by more than $40 billion.
Such stupefying losses suggest the biggest difference between 1998 and today. In '98, though credit markets froze and stocks plunged, they recovered quickly. Long-Term Capital was wholly a financial episode; it left no scar on Main Street. The current crisis has its roots in housing, a mainstay of the economy, and with the bubble's bursting the damage has been enduring and severe.
But Long-Term Capital's influence on regulatory practice is anything but forgotten. Alan Greenspan conceded at the time that the fund's rescue could lead to "moral hazard," meaning it could tempt financial players to take excessive risk. The warning was ignored. And the notion that a private hedge fund with but 16 partners and fewer than 200 employees could cause lasting harm was never truly examined. It was simply accepted.
The concept of too-big-to-fail, exceptional in 1998, is now a staple in the regulators' playbook. Bear Stearns and, by implication, other troubled investment banks have been taken under Washington's protective skirts; Fannie Mae and Freddie Mac, too. The Federal Deposit Insurance Corporation is pushing for easier terms for millions of homeowners; auto companies are demanding loan guarantees.
Where does it end? If individual responsibility is to be fully excised from American capitalism, the free-market enthusiasts who founded Long-Term Capital deserve no little credit.
The shock of their failure was such that hedge funds have been regarded as especially suspect ever since. This, too, is a misbegotten lesson; an investment bank (Bear Stearns) could and did wreak similar havoc. Long-Term Capital's woes had less to do with who was trading than with the kind of assets they were playing with, namely that potent tinder of modern finance: derivatives. (These are off-balance sheet agreements whose value "derives" from that of underlying assets like stocks or bonds.)
In traditional finance, borrowers borrow and lenders lend. The only firms exposed to, say, home mortgages, are the banks that issue them. Thanks to derivatives, a firm with exposure can pass it off, and a firm with no exposure can assume it.
Markets thus have less information about where risk lies. This results in periodic market shocks. Put differently, derivatives, which allow individual firms to manage risk, may accentuate risk for the group. Markets were stunned to discover that Long-Term Capital owned outsized portions of obscure derivatives. They dealt with that shock in typical fashion: they panicked.
Incredibly, six months after the Long-Term Capital affair, Greenspan called for less burdensome derivatives regulation, arguing that banks could police themselves. In the last year, he has been disproved to a fault.
Investors have no confidence in banks or in their disclosures. How much will each downward tick in housing prices hurt the bottom line? No one knows. Failing to inspire confidence, banks cannot raise (enough) capital; thus, they do not lend.
Bear Stearns had on its books $2.5 trillion of a derivative known as a credit default swap. Perplexed and alarmed, investors dumped the stock. And Bear was party to a hopelessly complex web of such derivative deals. Rather than let its contracts fail, regulators forced it to merge.
What we need from Washington now is not a promise of help after the next bust, but a show of wisdom before it. Requiring full, meaningful derivatives disclosure would be a good start. Investors, meanwhile, could help themselves by preparing for the next 100-year flood. Rest assured, it will arrive before then.

from About.com:

Question: What Was the Long-Term Capital Management Hedge Fund and the LTCM Crisis?

Answer: Long-Term Capital Management (LTCM) was a very large hedge fund ($126 billion in assets) that nearly collapsed in late 1998. It reached that size thanks to the stellar reputation of its owners. The founder was a Salomon Brothers trader, John Meriwether, and the principal shareholders were Nobel prize-winning economists Myron Scholes and Robert Merton. These were all experts in investing in derivatives to make above-average returns and outperform the market. Investors paid $10 million to get into the fund. They were not allowed to take the money out for three years, or even ask about the types of investments LTCM used. Despite these restrictions, investors clamored to get in, thanks to LTCM's spectacular annual returns of 42.8% in 1995 and 40.8% in 1996. This was after management took 27% off the top in fees. LTCM successfully hedged most of the risk from the 1997 Asian currency crisis, giving its investors a 17.1% return that year.
However, by September 1998, the company's risky trades brought it close to bankruptcy. Its size meant it was too big to fail, and so the Federal Reserve took steps to bail it out. (Source: Le Monde, LTCM, a Hedge Fund Above Suspicion, November 1998)

What Caused the LTCM Crisis?

Like many hedge funds, LTCM's investment strategies were based upon hedging against a fairly regular range of volatility in foreign currencies and bonds. When Russia declared it was devaluing its currency and basically defaulting on its bonds, this event was beyond the regular range that LTCM had counted on. The U.S. stock market dropped 20%, while European markets fell 35%. Investors sought refuge in Treasury bonds, causing long-term interest rates to drop by more than a full point. As a result, LTCM's highly leveraged investments started to crumble. By the end of August 1998, it lost 50% of the value of its capital investments. Since so many banks and pension funds were invested in LTCM, its problems threatened to push most of them to near bankruptcy. In September, Bear Stearns dealt the final death blow. The investment bank, which managed all of LTCM's bond and derivatives settlements, called in a $500 million payment. Bear Stearns was afraid it would lose all of its investments, which were considerable since LTCM had been out of compliance with its banking agreements for three months. (Source: The Independent, Bear Stearns Call Triggered LTCM Crisis, September 26, 1998)

How Did the Federal Reserve Intervene?

To save the U.S. banking system, the Federal Reserve Bank of New York President William McDonough William J. McDonough convinced 15 banks to bail out LTCM with $3.5 billion, in return for a 90% owernship of the fund. In addition, the Fed started lowering the Fed funds rate as a reassurance to investors that the Fed would do whatever it took to support the U.S. economy. Without such direct intervention, the entire financial system was threatened with a collapse. (Source: IMF, World Economic Outlook, Interim Assessment, "Chapter III: Turbulence in Mature Financial Markets December 1998; IMF Report: International Contagion Effects from the Russian Crisis and the LTCM Near-Collapse, April 2002; European Central Bank, Financial Stability Report December, 2006.)

Should the Fed Have Intervened?

A CATO Institute study says the Federal Reserve didn't need to rescue LTCM because it would not have failed. An investment group led by Warren Buffett offered to buy out the shareholders for just $250 million and kept the fund running. The shareholders and management would have been replaced.However, the Fed intervened and brokered a better deal for the LTCM shareholders and managers. This was the precedent for the Federal Reserve's bailout role with Bear Stearns, AIG, Fannie Mae and Freddie Mac during the 2008 financial crisis. Once financial firms realized that the Fed would bail them out, they were more willing to take risks.
The Cleveland Federal Reserve countered by saying the Buffett deal was only for LTCM's assets, not its portfolio. The failure of the portfolio, which consisted of derivatives, would have damaged the global economy. Furthermore, the Fed didn't actually bail out LTCM, since no federal funds were used. It merely brokered a better deal than the one Buffett was offering.
As much as $100 billion worth of derivative positions throughout global financial markets could have unraveled, according to The Independent. Large banks throughout the world would have lost billions, forcing them to cut back on loans to save money to write down those losses. Small banks would have gone bankrupt. The Fed stepped in to soften the blow.
Unfortunately, economic leaders did not learn from this mistake. The LTCM crisis was just an early warning symptom of the same disease that reoccurred with an vengeance in the 2008 global financial crisis. (Source: CATO Institute,Too Big to Fail?, Kevin Dowd; Federal Reserve of Cleveland, Some Lessons on the Rescue of Long Term Capital Management, April 2007) 

Stock Market Status

One characteristic of a bubble is that as it approaches its zenith, it ACCELERATES, because market participants no longer perceive ANY risk! They begin to think it's a "sure deal" and that they "can't lose". This phenom can been seen in this chart and in data that shows that stocks have been higher eight weeks in a row. No one even cares about the macroeconomic data any more!

Another sign of a bubble is that market participants are so sure that the market will continue to rise that they BORROW more and more money to pile in. Margin debt is now in record territory.

Still another bubble characteristic is that central bankers remain in denial throughout the ordeal! Just last week, Alan Greenspan wrote an article in which he still denies any responsibility or influence that was a causational factor in the housing bubble.

Still another characteristic of a bubble is that the media become cheerleaders for it! They have no desire to see reality return to the market, so instead they beat the drums for it to go even higher.

In fact, media people often ATTACK anyone who raises alarm bells. It may even become a death knell for the careers of people who wave the red flag. They are viciously attacked as "perma-bears" and treated with opprobrium.

Perhaps one of the best descriptions I've heard lately was from an analyst on Wall St that admitted that the stock market is now a "game of musical chairs". Everyone on Wall St is playing, just hoping that when the music stops and the bubble pops, THEY will individually survive the panic when it ensues. But unlike the real game of musical chairs, in the financial markets, there are only HALF as many chairs as market participants. That's because for every person wanting to SELL in a panic, there must also be a willing BUYER of those same stock shares or futures contracts.

What makes it even worse is that there is also something called "counter-party risk" or "third party risk". That's the risk that even if you CAN find a willing (but foolish) buyer in a collapsing market, that buyer might not be able to complete the purchase if they are losing money. Even if you sell at a profit, the counter-party to that transaction might not be able to complete it! This is one reason why derivatives are so risky. They escalate the counter-party risk geometrically. It even causes risks to other people that had nothing to do with the transaction at all.

In THIS game of musical chairs, when the alarm sounds and EVERYONE is running for the chairs, there is NO ONE willing to BUY during the panic. That means that chairs become mighty scarce when that moment comes. Then the risk increases geometrically like a tidal wave through the financial markets.

Stocks Plunge Into the Close

The Real World Vs. The Central Banker Fantasy World

Bill Gross, Marc Faber, Warn of Bubbles Everywhere

This was tweeted this morning:

And this from CNBC:
Faber, editor and publisher of The Gloom, Boom & Doom Report, told CNBC on Friday he believes a "massive speculative bubble" has encroached on everything from stocks and bonds to bitcoin and farmland. He attributed the vast bubble to "symptoms of excess liquidity."
Faber said the markets, which have reached record highs, could still rise before the bubble bursts, if stimulus programs such as the Federal Reserve's massive monthly bond purchases and super-low interest rates continue.

See? Surge!

Stock Market Doldrums

I expect that stocks will surge. Since all bad news is dismissed on Wall St, all it will take is a kernel of good news (or another Fed POMO) to send stocks higher again.

Stocks Turn Red

This is surprising, because near the close of the day, stocks tend to revert to the overall trend, which is higher. Stocks have already hit fresh new all-time record highs today. Today, however, stocks have sold off into the close. Even still, stocks are down only marginally, so perhaps this means very little. Is this a sign that stocks are near a peak? Only time will tell!

Building Bubbles -- One Puff At a Time

This shows the current stock market, shown in blue, overlaid by a textbook Sornett-style log-periodic bubble. They are virtually indistinguishable! This chart is from Dr. John Hussman's weekly market commentary.

Stocks Post New Records Despite Disappointing Housing Data

Stock Market Stratosphere

Both the S&P 500 and Dow closed in new record territory today. This looks more and more like a bubble with each day that passes.

If This Isn't a Bubble, What Is?

Listless!

More Bubble Proof

The stock market vs. macroeconomic data! The great divergence!

Stocks Rocket 109 Points Even As Goldman GLI Slows

Another sign of a bubble!

Bubbles Abound!

Fox Business headline today:

This headline on Fox Business today. Despite this, stocks are UP 100+ points today! I ran across an interesting quote the other day. A Wall St analyst said that all of Wall St now knows that they are "playing a game of musical chairs". He admitted that they acknowledge that when the next financial crisis trigger occurs, and the music stops, there will be a panic and a mad rush for the exits. But only the lucky first few will get through the theater exit doors safely when the shout of "Fire!" is heard. Everyone else will get burned. But on Wall St, EVERYONE believes that THEY will be one of the lucky few.

Philly Fed, Bad; Stocks Rise Faster

Stocks Leap Still More

A mixed bag of economic news has sent stocks scrambling even higher during the overnight hours. Improved news on unemployment claims would suggest a QE taper sooner rather than later, but weaker wholesale inflation gives the Fed room to do even more QE. Here is the result:

Stocks Leap Overnight

Bernanke Doubles Down on Debt Roulette

Stocks Stall

Holiday Shopping to Disappoint

Foreign Investors -- Running For the Exits

This chart shows the 12-month moving average of TIC (Treasury International Capital) flows. This is a troubling sign, because it suggests that foreign investors don't feel their money is safe in the United States. What writing do they see on the wall, that Wall St doesn't?

The US Economy In One Simple Cartoon