Sad to say, America is acting more like an immature emerging market than a mature financial power in its handling of the credit crisis... and in result, the rally in financials looks dubious at best.

In the midst of the froth and excitement of a bubble economy, there is always a boisterous and delusional group declaring an end to gravity and logic.
– Walter Shorenstein, 94-year-old real estate tycoon

If you have a few extra minutes, there is an excellent piece from The Atlantic magazine you might want to read. It’s called “The Quiet Coup” by Simon Johnson. You can find it here.

To give you the Cliffs Notes version, Simon Johnson spent two years as the chief economist at the IMF (International Monetary Fund). During his time in that post, Johnson noticed a disturbing pattern that seemed to repeat itself over and over again.

As emerging market countries saw their economies grow and prosper, inside business interests would get extra chummy with the government. An insider “oligarchy” would then form, to the mutual benefit of politicians and connected businessmen, in order to best exploit the budding prosperity on both sides of the aisle.

Not long after the point of maximum entanglement, the age-old domino chain of events would come tumbling down. The proverbial waste matter would hit the proverbial oscillating device... a financial crisis would unfold... and the government’s knee-jerk instinct would be to first and foremost save the oligarchs, i.e., the connected business insiders who had the most to lose in a potential meltdown.

The depressing thing is, this instinct to protect insiders always winds up making the crisis worse. In addition to being grossly unfair – taking blood and treasure from the general populace and using it to prop up a small group of greedy failures – the pattern tends to delay solutions, greatly draw out the pain, and overall make the IMF’s rescue job a lot harder. Most of the time, the proposed solutions to the crisis are simple. The challenge is that cutting off the insiders is usually step one – and that’s where the politicians fail.

Simon Johnson’s sad conclusion in “The Quiet Coup” is that, in protecting our own connected oligarchs and insiders, America is acting exactly like an immature emerging market country, slip-sliding on its way to banana republic status and quasi-fiscal dictatorship.

Still Rotten to the Core

I’m not good at sugarcoating things, so I’ll just tell you what I think.

I think Simon Johnson is more or less on the money. I think he is further correct that, until we muster up the political will to toss the whole lot of failed financial oligarchs out on their ear, any attempt to draw out the situation – to throw ungodly sums of money at the banks and try to wish our problems away – will only make things worse.

I think America’s banks are still rotten to the core. I think the measures that have been taken by Washington, initiated under Bush and continued by Obama – a pox on both their houses – are even more rotten still.

I further find it more than telling that Tim Geithner is a signed-and-sealed product of Wall Street (bought and paid for by the banks he once worked for)... that top economic adviser Larry Summers has received literally millions upon millions in speaking fees and consultation fees from the very fat cats who caused all these problems... and worst of all that Paul Volcker, one of the few plain-spoken and honest men left in Washington, has reportedly not even been able to get an audience with President Obama for over a month. (The mind boggles. Did I say that already? Let me say it again...)

The hidden trading implication here is that this mega-rally in the financials could be one big giant “gotcha.” The government’s attempt to juice the fortunes of hopelessly compromised and corrupt institutions via the channeling of hundreds of billions worth of taxpayer funds – some of it legally appropriated and some of it flat-out looted – could still fail spectacularly.

There are many reasons why I think failure (and possibly spectacular failure) remains a distinct possibility. Were I to delve into deep detail here, this missive would be many thousands of words.

The Wells Fargo Rally Stinks to High Heaven

The above gives some flavor as to why I hated the rally that ignited last Thursday. As I told Macro Trader members, the Wells Fargo surprise announcement – a deliberate goose, timed to a light pre-holiday trading day, aimed at burning short sellers – looked to me like a TARP/TALF gamed piece of cheese.

Just to clarify, I’m no perma-bear. I want our markets to heal as much as anyone does. But rallies come about for different reasons. Some are based on logic, some are based on blind hope, and some are based on pure deceit. I think the Wells Fargo rally was a combination of the last two, with a good helping of behind-the-scenes gaming thrown in.

Some media outlets are drinking the “hooray for banks” Kool-Aid with gusto. I almost couldn’t believe it when I found this Time Magazine piece titled, “More Quickly Than It Began, The Banking Crisis Is Over.” I almost shouted at my laptop screen, “TIMEMAGAZINE, ARE YOU INSANE!?!”

Nope, not insane. Just clueless cheerleaders who don’t understand what’s happening and can’t be bothered to look more than two inches deep below the surface.

The Long and Short of It

Again, I must resist the temptation to go into further detail here for the sake of length. But oh, the things we could discuss! The vaporization of the shadow banking system... the further pain ahead for U.S. consumers... the looming debacle in commercial real estate... the lunacy of thinking we can snap our fingers and solve a once-in-a-generation crisis “just like that”... resist, must resist...

Instead, I’ll give you a few brief “snapshots” of some of the items on my radar screen just now:

• Good news from the banks should be taken with not just a grain of salt, but half a ton of salt at this point, given their ability to play coy with their balance sheets and use the government’s tens of billions worth of bailout largesse as perfume to cover the stench of still-rotting toxic garbage.
• In regards to commercial real estate loans, homeowner mortgage resets, pension fund liabilities, and nosebleed tax hikes on the docket for 10 or more states, there are some VERY large shoes left to drop.
• In addition to playing games with the numbers to exploit an optimism jag, much of this recent rally has evidently been driven by short-covering – bears getting the stuffing squeezed out of them – and, even more frighteningly, by large “quant” hedge funds forced to adjust their trading books in a relatively illiquid market, thus slamming the markets higher via computer-generated bulk orders. As general liquidity falls, the violence of random moves increases in both directions as program-driven trading strategies run wild.
• As noted by Bespoke Investment Group, the S&P 500 recently hit its most overbought levels in almost eight years (since May of 2001). Healthy markets breathe in and out. They move and consolidate, move and consolidate. As the old saying goes, bull markets roll and bear markets spike. Fiery screaming rocket jags are far more typical of bear market rallies, not new bull market underpinnings.
• Some of the improvement we are seeing now in areas like emerging market equities and commodities could well be real... or at least driven by genuine “real” investor sentiment of positive fundamental change. But we need to remain careful here as any long-term investment decisions based on hope for the U.S. consumer are prone to dramatic reversal.
• What do I mean? I mean those who are buying emerging markets today because they believe in the internal fundamentals of emerging domestic demand may well stick around. Those buying because they think the U.S. consumer is going to execute a quick bounce back with wallet intact – that the old glory days of major trade imbalance will soon return – are setting themselves up for a frying pan to the face.
• A very important question is whether the rally in copper is real. Because “Dr. Copper” is known as the metal with a PhD in economics, a lot of people look to copper as a global barometer of economic activity. I am coming around to the view that Dr. Copper’s message may well indeed be for real... but that the good doctor is more likely predicting the imminent return of inflation as opposed to renewed economic prosperity.

Those are just a few of the here-and-now factors shaping the “market script” as it plays out in my head in real time. I am laser-focused on how best to aggressively exploit this market, with an eye for capturing some of the truly dramatic moves ahead. (If you want lots more analysis like this, and a steady stream of trading ideas to go with it, check out Macro Trader.)

Tomorrow I will reveal to you a very simple, yet powerful, way to bet against the government... and potentially earn a tenfold return in doing so. Stay tuned.

Other Related Topics: Government Issues , Justice Litle , Macro Trader , Market Analysis

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