The new movie “Zombieland” fittingly stormed the box office this past weekend, even as undead financial institutions walk among the living (and eat the brains of Wall Street).

“If you pump enough liquidity into a corpse, it will get up and walk – pump in more still, and it will dance; that does not mean that it has Fred Astaire’s career before it.”
– Eric Kraus, Moscow-based hedge fund manager

The horror-comedy flick Zombieland took top movie honors this past weekend, raking in a cool $24.7 million at the box office. Meanwhile, as a cheery Woody Harrelson makes use of one-liners and shotguns to blow away the undead, the real-life “Zombieland” continues to frighten and disgust with precious little comedy relief in sight.

Consider, for example, the ghoulish remarks coming from Japan’s minister of financial services, Shizuka Kamei, who took up his post just last month:

“When lenders are in trouble, we rescue them using taxpayer money. When borrowers are in trouble, we give them respite from debt repayments. Plain and simple.”

Such thinking would not have been remarkable, say, 15 or 20 years ago, when Japan had only just first encountered its post-bubble financial apocalypse landscape. The forever propped-up banks, the endless gushers of wasted capital, the years of unshakeable malaise and corrupt construction projects... none of that had yet come to pass.

But for the same type of “mass rescue” thinking to prevail even now, in 2009, after the slow-moving nightmare Japan has lived through for nearly 20 years straight... the mind boggles.

Even in the face of sweeping political change – Shizuka-san is the new finance minister, mind you – the “Land of the Rising Sun” seems to have well and truly become “the Land of the Living Dead.”

America, too, is looking green around the gills. As Bill Bonner predicted in his book Financial Reckoning Day some years back, we are “turning Japanese” with disconcerting speed. The banks are rotting from the inside out, even as Wall Street’s cheerleaders try hard to convince us otherwise (and Washington looks on with approval).

Sharp observers like Chris Whalen of Institutional Risk Analytics believe U.S. banks have only taken 60% of their total write-offs thus far (with European banks in even worse shape at only 40%), implying plenty more carnage to come. (Whalen expects the banking crisis to continue on through 2010 and well into 2011.)

What’s more, the fallout from soured commercial real estate loans has not yet pinged the Geiger counter, and unemployment trends paint an increasingly dark picture of consumer credit defaults. Personal bankruptcy filings soared past the 1 million mark as of Sept. 30 – a whopping 41% increase year-on-year – and the waves of “strategic defaulters” are surging, even as banks hold back a growing “shadow inventory” of foreclosed homes for the sake of keeping losses off the books.

Of Lags and V’s

If that sounds like bad news, just wait. It turns out there is evidence that the official statistics sharply underestimated the true level of job loss in this crisis. As Bloombergreported last week, “The U.S. economic slump earlier this year was so severe it short-circuited the government’s model for calculating payrolls, raising the risk that today’s jobs report may be too optimistic.”

Given that September’s official unemployment numbers were anything but optimistic – in point of fact they were horrible – that means the unvarnished state of things is likely even more gruesome to behold.

All this helps explain why Mohamed El-Erian, the compatriot of “bond king” Bill Gross and chief executive officer of PIMCO, thinks that unemployment has morphed into a leading, rather than lagging, indicator.

In past recessions (i.e. more “normal” recessions), unemployment levels were something to be considered in the rearview mirror. They were signs of hardship left behind, not hardship still to come. But in the midst of this “new normal,” as El-Erian describes it, the unemployment rate “is much more than a lagging indicator... it is also a signal of future pressures on consumption, housing and the country’s social safety net.” (Not to mention rotten news for revenue-crunched small businesses and struggling regional banks.)

By some accounts, there are upwards of 26 million U.S. men and women unemployed – some, mostly older, who may never work again for the rest their lives. The youth unemployment rate is off the charts. Small businesses are gasping for breath. Wage levels are on the ropes. And the vast majority of banks, scrambling to pull through themselves, are mostly sitting on their government-backed cash hoards and investing in low-risk government securities.

With this kind of backdrop, one could imagine stocks having a hard time of it. But no... stocks are more or less priced for a V-shaped recovery! As William Hester of the Hussman Funds writes, “At these levels it seems that a full-blown V-shaped recovery is being priced in. There's no better example of a V-shaped forecast than for what is expected for the recovery in earnings over the next couple of years.”

Better Off Dead

The irony here is that the dire state of the U.S. economy may, in fact, be helping the stock market stay strong.

Things are so well and truly ugly, the Fed is likely to keep stimulating and pumping the market full of “funny money” for some time to come. The stiff liquidity medicine required to keep zombies walking and talking is also courage tonic for the dip-buyers. If the economy were actually on the mend, that would make it easier for the Fed to take its foot off the accelerator – which, in turn, would take the magic liquidity potion away and leave stocks unsupported.

All this makes the Fed Chairman akin to a zombie-baiting mad scientist, like the one in the 1980s howlfest Re-Animator. Janet Tavakoli, an ex-Wall Street derivatives expert with 22 years of experience in structured finance, describes the situation as follows:

No one has any confidence. We’re masking the problem. And they’re treating the global taxpayers as if we’re infants. Human infants, in the early months of their life, figure out that when you throw a blanket over something, that something hasn’t disappeared. And yet they’re trying to tell us that by covering up the problem, the problem will disappear.

Not quite infants, we would argue, but zombies... mindless investors and portfolio managers who are hungry for “gains” in lieu of brains, blind to the terrible hidden costs, glomming onto any hare-brained explanation that soothes the pain of being dead.

For the record, those of us who object to the orgy of liquidity-fueled cheerleading now taking place are not party poopers. We merely find the idea of getting into bed with corpses a distasteful one...

Dazed and Confused

In discounting the future, the stock market is supposed to have something intelligent to say about the future of the economy too. But the flood of Re-animator-style liquidity provided by governments has so distorted that historic function, the economy and the market can now run in polar opposite directions for extended lengths of time. Asset prices can rise (and rise some more) even as wages, revenues and profits go into sharp decline.

Some observers, like oil analyst Gregor MacDonald, believe that this “disconnect” between the liquidity-driven market and the reality-constrained real economy will keep getting ever more twilight-zone-like until something finally snaps.

“You can think of the US economy as a kind of defunct amusement park,” MacDonald writes, “over which the FED has poured trillions of dollars of syrupy goo. The caramel candy is there for tasting, but it doesn’t turn the machines back on. The ferris wheel is silent.”

Those of us who haven’t been turned into zombies are thus destined to watch things get weirder and weirder, as we head into what MacDonald describes as “an inflationary depression.” MacDonald further argues that “the divergence between the economy and asset prices apparently has to become even more grotesque before people will understand.”

Red Team Versus Blue Team

So let’s step back and take quick stock of the situation. We have a living dead U.S. economy overrun with zombie financial institutions (thanks to a government “rescue” mindset uncannily like Japan’s). We have investors making big bets on tap-dancing corpses like AIG, Fannie and Freddie.

And we also have a number of wide-awake observers doing their best to sound the alarm, blasting the zombies with round after round of logic ammo and preparing for the economic aftermath.

The two zombie-fighting camps – those with eyes wide open, waiting for a climax – could be dubbed “Red Team” and “Blue Team” based on their expectations.

The “Red Team” sees deflation as the inevitable outcome. (In fact, many of them argue deflation is already here.) They expect the dollar to rally sharply, or otherwise slowly rise, as risk-related assets succumb to the irresistible gravitational pull of falling wages and revenues across the globe. To be a Red Team member is to be short risky assets and long government bonds, in the contrarian expectation that Uncle Sam’s debt will look better and better as everything else starts to look worse.

The “Blue Team,” in contrast, sees runaway inflation as the final climax to a financial horror flick that has already run too long. To be a Blue Team member is to be selectively long hard assets – gold, crude oil, base metals and the like – in the expectation that the great pump-priming machine will spin out of control sooner rather than later.

As for your humble editor’s stance... he is keeping a close eye on Treasury bonds, an even closer eye on gold, and a metaphorical loaded shotgun at the ready.

Other Related Topics: Bankruptcy , Justice Litle , Macro Trader , Real Estate , Unemployment Rate

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