The Bank Credit Analyst did not perfectly time, but it predicted the October 1987 crash. It wrote in its October 1987 issue, before the month’s action,

“The stock market is in the process of forming a significant, possibly major top; severe downward pressure is likely to be delayed until liquidity contracts more rapidly.” A bullet point later it wrote “Investors should continue their program of gradually reducing exposure to conservative levels.”

That was as close as anyone I know of who got to predicting the ’87 crash. BCA knew the conditions were there for one. It had been writing about them. It did not know when the crash would be, and it did not know how deep it would be. But it noted an “unprecedented growth of liquidity, which has been the driving force behind the revaluation of assets in the 1980’s”. It noted as well that this growth had been slowing since late 1986.

This was the first time in BCA’s memory that liquidity had driven market prices quite this way. It had been writing about financial matters since 1949. For it, 1987 was a time that was unprecedented. It had published a monograph entitled, The Escalation in Debt and Disinflation: Prelude to Financial Mania and Crash? Senator Bill Bradley had written the lead article of the monograph. Opinions varied as to the gravity of the debt situation.

It seemed to Mr. Boeckh, the editor-in-chief who had written the introduction, that debt burdens had become much heavier because credit expansion had risen much faster than GNP(today we call it GDP) at a time when price inflation had been falling. It seemed to Mr. Smith, a senior editor, that financial asset prices had a good deal more to rise in the long term.

Both turned out to be right. BCA overestimated the gravity of the crash in its immediate publications. Soon the debt expansion continued, making Mr. Smith’s call ultimately the correct one. Indeed the Debt to GDP ratio rose past the 2.1 that the publication bemoaned in 1987. It went to roughly 3.5 in our time. This exceeded the ratio experienced in the Great Depression which was over 2.6, but at a time when GDP imploded faster than debt deleveraged.

We as yet await a serious decline in GDP.


http://www.bcaresearch.com/

The article below writes of what I am very afraid of: that the volatility we are seeing is indicative of something coming that is far worse than 1932-no market at all.

Minyanville
The New Stock Market
Tuesday November 25, 10:00 am ET
By Mr. Practical

First, as my trader friends point out, there no longer really is a stock market. Liquidity is so bad that prices do not really reflect new information. Rather is(sic) reflects volatility due to buying and selling by fewer and fewer participants as either people neither have the money or desire to trade. The stock indexes have moved more in the last 50 days than they have for the last 50 years.

Secondly, stock prices are being driven more and more by currency movements. Why is this? As governments take on more and more risk, as they price more and more assets for the market, and as they transfer debt from private to public, the common denominator, or release valve, becomes the currency.

When a government that can create its own money becomes insolvent, it is manifest in a much lower currency. Ironically it is manifest in a higher currency in the first stages as debt is destroyed. But as government take on more and more assets financed by printed dollars it becomes weaker. We are seeing that struggle play out each day. When the dollar goes up due to deflationary pressures, stocks go down. When the government replaces debt with its own by printing currency and takes the risk as it did with the Citigroup (C)bailout (a huge amount for one company), the amount of dollars printed to finance the bailout causes the dollar to drop and stocks to go up.

Why do stocks go up when the dollar goes down? Imagine one person owning all the shares of a company who is willing to sell the stock for $50 a share. If the dollar drops 50% over-night and you go to that person to give them $50 for a share of stock they will say 'no, no, today I need twice as many dollars for a share of stock because the dollar is worth half as much so the stock price rises to $100.

So you say let's just devalue the dollar fully and watch stocks go soaring. Well be careful what you wish for as I have explained the consequences of that: total debasement of a currency will lead ultimately to a deflationary collapse. Study your history. A total debasement of currency creates no wealth and the stockholder is no better off, it just looks that way for awhile. But if all confidence is lost, the fiat currency system fails altogether.

The point is nothing really matters anymore besides currency, so watch them closely. Governments are systematically destroying stock markets and changing how they work. They are being replaced with socialism and determined pricing.

Risk is very high.
http://biz.yahoo.com/minyanville/081125/20081125newstock_id.html

There have been two times, 1929-1931 and 1987-1988, when the market(the Dow Jones Industrial average) experienced the volatility and derivatives of volatility at the levels seen today. In the first case, the market ground much lower after futile attempts to save it. Sometime in 1932 it reached bottom, lower by 90% or so from its 1929 high. In the second case, the market went sideways for a while and then drifted past its ‘87 highs into 1990. Then there was the Gulf War and a serious recession. It then fell, but not to its 1987 lows.

There would seem to be no reason, looking at these two cases, to expect a bodacious rally anytime soon. All of the talking aside, the prior time series don’t tell you that there is any urgency to buy into the time series today. You had a year or so for a free look at the market from late 1987 to late 1988. You needed a very long look from 1929-32.

But let us look a few features of the two periods and the period today. The ’29 period had bank failures with no deposit insurance. The ‘87 period was the beginning of the S&L crisis. But depositors in ’87 were insured. Today depositors are insured. The 1929 period seems inappropriate for comparison to today, just because of the deposit guarantees. There should be no loss of one’s savings in the banks. Nor should commercial accounts be impeded in the way they were in the 1929 period.
.
http://en.wikipedia.org/wiki/Savings_and_loan_crisis

However, in 1987, the savings rate was 3%. It rose to 4% in 1988. But there was savings. Today there is little savings on a national level. It may be moot that the banks are insured for the purpose of current savings. Thus, the conditions of 1987 were better than today from the aspect of savings.

http://www.bea.gov/briefrm/saving.htm

Moreover, in 1987 rates had risen, long term treasuries to 10%. Rising rates had created a liquidity crisis. There was room for rates to come down. Today there is less room for rates to come down as treasuries are already at depression levels. Short term interest rates, those of T-Bills, have approached zero. Today we don’t have a liquidity crisis. We have a crisis of quality in lending.

http://www.bloomberg.com/apps/news?pid=20601009&sid=awWwvVRUrmho&refer=bond

In addition, in 1987-1988 there was neither recession nor any quarterly contraction. We have already experienced two quarterly contractions in the past year, despite a deep compression in rates.

Looking at matters from these perspectives, we are better off than in 1929-31, but we are worse off than in 1987. More comparisons may turn out to be helpful for consideration of our current time.

I'll see what I can come up with over the next few weeks.

It may be important to distinguish between what the government is putting up as capital and what it is lending to institutions. We can say that the government is more likely to lose on one and less likely to lose on the other. But it may not be. The capital could be lost, although that is unlikely. Look at the case of AIG which bears the possibility of perpetual government ownership.

With AIG, the government owns approximately 80% of what could be an avenue to convert private insurance into some kind of public program. We don’t need to ask how this will come about yet. It depends on how deep is the crisis. The state of other insurers is not yet clear.One cannot tell the state of their mortgage portfolios from their financial statements. At least, I certainly cannot, and I have looked..

If a large number of life insurance policies turns out to have no backing, there is one way to deal with some of them, for example, those which are bought for estate tax purposes. Simply keep the estate tax, but raise the exemption so the policies are unnecessary. Gene Sperling already has suggested the larger examption(see the report cited 11/17/08). There will be ways for the government to take over a good deal of this business, especially if it is largely insolvent.

In the case of the banks, there is plenty of control now that the government is lending trillions for collateral. If the government is the ultimate backstop for lending against all of these assets, it won’t lose anything; instead it will gain everything in power that the original market has given up. Banks that behaved themselves, which are not lending in these markets because of counterparty default risk, lose opportunity while those that misbehaved have the government backing for continuing their books. If the latter begin to fail, then a Citicorp-like rescue will follow. The government controls who defaults and changes the market mechanism.

The government also looks as though it is in position to control future public capital formation in that all prior large investment banking firms will be U.S. banks, some of which are already government funded(Citi), some government backed(Citi, JPM for its Bear Stearns takeover, Wells for its takeover of Wachovia, Bof A, for its takeover of Merrill). Goldman and Morgan are becoming banks to seek deposits and will be governed as well. They are on FBR’s list of financial entities that need capital. Goldman today raised money with FDIC guaranteed bonds. See the Financial Times below:

Tuesday Nov 25 2008 18:05
Goldman Sachs (NYSE:GS) on Tuesday became the first US bank to issue debt backed by the Federal Deposit Insurance Corp under one of several government plans designed to bolster financial companies and stimulate lending.

Fellow US banks were quick to follow Goldman in what could be a $300bn market. JPMorgan and Morgan Stanley (AMEX:MWD) pitched similar deals to investors while other banks and financial entities such as GE Capital, the financing arm of General Electric, are expected to participate in the new asset class. A flourishing market for such debt already exists in Europe after deals from UK banks such as Lloyds TSB, Royal Bank of Scotland and Barclays (NYSE:BCS) .


http://us.ft.com/ftgateway/superpage.ft?news_id=fto112520081814404437&referrer_id=yahoofinance

If the FDIC backs your debt, you give up reins. But you also give up reins if Treasury injects capital . The distinction between debt and capital at the level discussed here seems to blur in the issues of control. The government owns you one way or the other. If the new government is not kind to free markets, you will have no emancipation.

A better way to have done this was to do what was planned originally: get the troubled assets off the books of the institutions. But there is this change: take them at cost. Put them into an RTC-like structure and sell them off over time. The RTC does not have to mark the assets to market. The counterparties have to stand pat. They cannot recognize gains or losses, either.

No capital is necessary for the institutions. Nor is there need to lend trillions for collateral. The trillions are invested instead in the bad assets which are sold off later. Those who created the bad assets can be sued, for they will still have some capital to pay damages. Some capital eventually will go to the counterparties.

In the meantime the troubled institutions will have been delevered and will have a business that can function.

The Chinese have done this to some extent, without the lawsuits. They have asset management companies for each of their large banks. These take the troubled assets and sell them to investors at a steep discount.

From Wikipedia:

The Ministry of Finance of the People's Republic of China has established four financial asset management companies (AMCs), one for each of the four commercial state-owned banks.
They are:
Great Wall AMC - for the Agricultural Bank of China
Orient AMC - for the Bank of China
Huarong AMC - for the Industrial and Commercial Bank of China
Xinda AMC - for the China Construction Bank


http://en.wikipedia.org/wiki/List_of_asset_management_companies_of_the_People

Of course, the Chinese have been somewhat corrupt in their banking. They just continue to cook the books of their large banks, then shuffle off bad assets to the management companies. No where near enough fraud is prosecuted. Although there is a rather nice case below.

http://www.iht.com/articles/2006/11/21/bloomberg/sxfraud.php

Lately, we are turning out to accept their model, in that we are not countenancing large bank failures. Or very many prosecutions.

Here is what we would have done some short years ago:

For those who created the bad assets, there are criminal provisions. Fraud is prosecuted. Management is replaced in the case of FDIC takeovers. New owners with capital are found. Old management and boards are sued. People are forced into bankruptcy with civil actions as was done in the days of the old Resolution Trust Corporation. Former bankers can find lean-tos in Georgia in which to house. They can be subpoenaed there.

Assets ultimately are sold. The taxpayer takes a hit, but the right people get punished. Moreover, there is not the issue of losing the capital markets in their prior form. Freedom still rings. It does not in China.

For some reason, Treasury and the Fed changed their minds about the original plan. They are now having to do what they should have done earlier by taking the troubled assets off Citi’s books by guaranteeing them. But in the interim they opened the door to what may prove to be total government control of the financial industry. By then prosecutions will seem few and far between.

Going back to the Reuters article cited last Thursday, FBR noted that “Eight financial companies -- Citigroup Inc, Morgan Stanley, Goldman Sachs Group Inc, Wells Fargo & Co, JPMorgan Chase & Co, American International Group Inc, Bank of America Corp and GE Financial -- are in greatest need of capital.”

It further noted that “Combined, these eight companies have roughly $12.2 trillion of assets and only $406 billion of tangible common capital, or just 3.4 percent.”

Citigroup was bailed out this morning. The government is helping to guarantee $306 billion of troubled assets.

From this morning’s AP article:

“As part of the plan, Treasury and the FDIC will guarantee against the "possibility of unusually large losses" on up to $306 billion of risky loans and securities backed by commercial and residential mortgages.

"Under the loss-sharing arrangement, Citigroup Inc. will assume the first $29 billion in losses on the risky pool of assets. Beyond that amount, the government would absorb 90 percent of the remaining losses, and Citigroup 10 percent. Money from the $700 billion bailout and funds from the FDIC would cover the government's portion of potential losses. The Federal Reserve would finance the remaining assets with a loan to Citigroup.

"In exchange for the guarantees, the government will get $7 billion in preferred shares of Citigroup. In addition, Citi said it will issue warrants to the U.S. Treasury and the FDIC for approximately 254 million shares of the company's common stock at a strike price of $10.61.”

http://biz.yahoo.com/ap/081124/citigroup.html.

So what are Citicorp’s total assets? Ans: $2050 trillion, taken from its 9/30/08 Balance Sheet. Its troubled assets are close to 15%.

What is 15% of 12.2 trillion? The big number is the number which all of the eight banks are said to have. The answer is $1.8 trillion.

So just in the seven remaining banks and other institutions there could be another $1.5 trillion in problem assets.

What else has filtered through the system to smaller banks is not yet clear. However, the order of magnitude is beginning to dawn.

Note some of the analysis of the situation below:

Nov. 21 (Bloomberg) -- Argentina’s stock market is fading as the state seizure of the nation’s biggest shareholders undermines investor confidence and threatens an equity sell-off.

The Argentine Senate last night approved President Cristina Fernandez de Kirchner’s plan to nationalize about $24 billion in private pensions, a move opposition parties called a cash grab and the government said is a way to protect retirees from the worst financial crisis since the Great Depression.

For the Buenos Aires Stock Exchange, the government’s decision underscores the growing irrelevance of a market whose listed stocks dropped to 82 from a record 669 four decades ago and is discouraging outside investment because of capital restrictions.

“It’s a substantial blow to the capital markets,” said Eduardo Costantini, the 62-year-old chairman of Buenos Aires- based real-estate and asset management group Consultatio, the sole Argentine company to go public this year. “The only long- term investor with characteristics of the pension fund industry disappears with this.”

The funds, known by their Spanish acronym AFJPs, hold about a quarter of shares available for public trading in Argentina, data compiled by the companies show. They were net buyers of shares for a third month in September as the benchmark Merval index tumbled 10 percent and emerging-market funds pulled out.

The Merval is down 60 percent this year, compared with the 48 percent decline in Brazil’s Bovespa index and 38 percent slide in the Mexican Bolsa. Argentina’s economy, which slipped into a recession after the government defaulted on $95 billion of debt in 2001 before recovering, is headed for a slowdown. That may lower tax revenue and hurt its ability to meet debt payments, according to Goldman Sachs Group Inc. economist Pablo Morra.

Possible Downgrade
The government is taking over pension funds as MSCI Inc., whose stock indexes are tracked by investors with $3 trillion in funds, prepares to remove the biggest stock, Tenaris SA, from its Argentine measure and considers downgrading the nation to frontier from emerging-market status.

“Put all those together and it really spells the death knell of the Argentine equity market as a place where foreigners want to invest,” said Citigroup Inc. strategist Geoffrey Dennis. Citigroup this week cut its recommendation for Argentina to “zero” from “underweight.”
In 1995, a year after the AFJPs were set up to help bolster capital markets, Argentina’s share of emerging market equity fund investments was 4 percent, making it the third most invested Latin American market after Brazil and Mexico, according to fund flow tracker EPFR Global in Cambridge, Massachusetts. That shrank to 0.5 percent at the end of September, putting it in fifth spot among regional peers.

Stock Assets
The pension funds’ assets include 6.8 billion pesos ($2 billion) held in local stocks, according to Argentine regulators. They will be transferred to the state-run social security agency as part of the government’s decision.

The funds invested about $144 million in domestic equities in September, according to Deutsche Bank AG. Foreigners have been selling at the fastest pace in eight years. Emerging-market funds sold about $340 million in Argentine stocks through September in the biggest outflow since 2000, according to EPFR.

The government forced the pension funds to sell more than $500 million in Brazilian stocks in a three-day fire sale last month, as Amado Boudou, the head of the social security agency Anses, said pension accounts shouldn’t hold any foreign assets.

In an Oct. 28 speech to lawmakers, Boudou vowed to “protect the value” of the AFJPs’ domestic equity holdings and said the government won’t “rush out and sell at any price.”

http://www.bloomberg.com/apps/news?pid=20601086&sid=ajuNcpt6m_N0&refer=latin_america



While there is no evidence that this will happen here, a pension takeover by the government has far reaching effects. Some of the proposals noted on Monday involve changing the 401(k), putting a percentage of current payroll income into a government sponsored account with a fixed yield. The current year’s long term investment component would be lost to the capital markets. The old 401(k) investment would stay as it is. With no deduction given for an annual contribution, there would be little incentive to continue building the account.

I don’t know how Mr. Sperling intends to sell his notions to CALPERS and others in equivalent positions.

http://en.wikipedia.org/wiki/CalPERS

If he sells them broadly, the Argentine situation may prove relevant.

It is pretty clear from this article that the government will own the big banks when this crisis is over.

(Reuters) - The U.S. financial system still needs at least $1 trillion to $1.2 trillion of tangible common equity to restore confidence and improve liquidity in the credit markets, Friedman Billings Ramsey analyst Paul Miller said.

Eight financial companies -- Citigroup Inc, Morgan Stanley, Goldman Sachs Group Inc, Wells Fargo & Co, JPMorgan Chase & Co, American International Group Inc, Bank of America Corp and GE Financial -- are in greatest need of capital, he said.

"Debt or TARP capital is not true capital. Long-term debt financing is not the solution. Only injections of true tangible common equity will solve the current crisis," he said in a note dated November 19.

Currently, the U.S. financial system has $37 trillion of debt outstanding, he noted.

Combined, these eight companies have roughly $12.2 trillion of assets and only $406 billion of tangible common capital, or just 3.4 percent, the analyst said in his note to clients.

Miller said these institutions need somewhere between $1 trillion and $1.2trillion of capital to put their balance sheets back on solid ground and begin to extend credit again, given their dependence on short-term funding and the illiquid nature of their asset bases.

Since the summer of 2007, Wall Street has been hammered by a sharp pullback in debt markets, which began with mortgage woes and escalated into a credit crisis, slowing economic activity around the world.

RECAPITALIZATION NEEDS

The bulk of the capital will have to come from the U.S. government, Miller said. The government needs to take the initial steps to begin the process, and private capital and earnings can finish the job.

"The quicker the government acts, the sooner the financial system can work through its current problems and begin to supply credit again to the economy," he said.

The U.S. government must declare a bank-dividend holiday and convert the TARP funding into pure tangible common equity to get the credit markets functioning.

Also, the government should support a centralized CDS clearinghouse that backstops all transactions and eliminates the cross-default problem, the analyst said.

Top U.S. financial regulators said on Friday they were working on developing a centralized clearinghouse for credit default swaps, the exotic instruments that have exacerbated the financial crisis of recent months.

The weakened economy and global credit crisis had pushed the U.S. government into bailing out companies including insurer AIG, investment bank Bear Stearns, and mortgage companies Fannie Mae and Freddie Mac.

Regulators have also shown a willingness this year to intervene when banks appeared to struggle. They pushed Wachovia Corp into finding a buyer and arranged for JPMorgan to buy Washington Mutual Inc's banking assets after worried customers began to yank deposits.

Miller, however, said it could take three to five years for the financial system to fix itself completely, with adequate capital and appropriately priced interest rate and credit risk.

http://www.reuters.com/article/ousiv/idUSTRE4AJ1GV20081120


This means that for these major banks the government will be able to dictate lending standards, just as they now dictate dividend policy.

It was the lowering of such standards that got the banks in trouble in the first place. Much of this lowering was political. That was much of the problem; it was a political goal to make lower quality loans.

Soon, as a matter of principle, the standards will become political in government-run institutions. The recapitalization will allow us to run amok again.

Still business.

Most of what I do is look at what is in front of me. I do not model it. I rather look at it for what it reveals. In that way I am a little like Heidegger. I look for a disclosure.

But not one that is metaphysical.

What I saw today is that after all the government’s work with the banks and the financial system, it has not induced new lending of a material amount. The automakers told me so. Maxine Waters, of all people, told me so.

If I look at triple B versus 30 year treasury spreads, there is little money going out to business in the form of operating capital. In fact, that spread has been over 300 basis points for some 65 days. That is over 1/6 of the year. It is over 500 basis points now. While there may be interbank lending, commercial lending has ground to a halt. With this kind of lending, people are going to be in deep trouble soon, if not already. Letters of credit are not available for shipping, and the Baltic Dry shipping index is off 90%.

Just listening to the congressional hearings confirmed that today.

There have been some proposals for and discussions of retirement savings:

http://news.aol.com/political-machine/2008/10/24/obama-dems-seek-to-end-401-k-plans/

Here is Gene Sperling of the Center for American Progress:

http://www.nytimes.com/2005/01/05/opinion/05sperling.html

Sperling is mentioned here in 2006:

http://www.nytimes.com/2006/12/28/business/28scene.html?_r=1&oref=slogin

Below is a summary link of Sperling’s thought:

http://www.americanprogress.org/issues/2004/01/b289151.html

Here is Sperling’s entire report:

http://www.americanprogress.org/kf/social%20security%20-%20sperling%20web%20final.pdf

Then here is a summary article at the AICPA website.

http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2008/Tax/ConcernsAndIdeas.jsp



What is striking about these proposals is the change that will result for the financial industry. There will be less need for brokers, advisors or pension consultants. The annual funds that traditionally fuel the market will be gone. The question of return on investment, not dealt with by Sperling, has been set aside for a stipulated return in the package below:

“Professor Teresa Ghilarducci of The New School for Social Research in New York proposes the GRA plan under which workers not covered by a DB plan would have an account established by the government. Each year, the government would deposit $600 into the account with that amount adjusted annually for inflation. Workers would also have five percent of their earnings deposited into their GRA. The government would pay a guaranteed return that would be adjusted for inflation.

“Professor Ghilarducci posits that this five percent contribution and three percent inflation-adjusted return would enable workers to supplement their Social Security benefit such that they would “achieve a 70 percent replacement rate at retirement.” (October 2008 testimony (PDF) before the Committee on Education and Labor.)”

As we lean toward proposals of this nature, we lean toward a very different financial industry.

Medieval literature occasionally used the metaphorical apothegm: ‘you need a long spoon to sup with the devil.’

Barry Ritholtz discusses the bailout today at this link.

http://www.ritholtz.com/blog/2008/11/why-bailouts-attract-handout-seekers/

He ends with:

“Unregulated, Free market capitalism, anyone?”

There is none here, clearly, but what is not adumbrated is: what happens if the new administration decides to run the banking system in perpetuity? It will have a controlling interest in quite a bit of it(who knows how much?) if it ponies up the numbers Ritholtz suggests are possible.

And so it may be in other industries that are lining up at the trough. If the US left is Marxist, when it comes to power this January, we could witness the beginning of a revolution that leaves no private capital and takes its victims willingly and bloodlessly.

The devil is clearly in the details here, not clear to anyone at the moment and to be fashioned to suit the next in power.

Thoughts on the dialogue form(18)

I have an additional number of thoughts on the form, but the current situation in the US has dampened my ability to write. I am seeing configurations in my time series research which have not been seen since prior to WW2. I am quite concerned about the future of the economy.

At the beginning of the year, on the Agonist, I said that the market would go below 11,000. I also thought that gold would go lower, below $750. I also thought that the dollar would trade at over ¾ Euros, and that oil would fall below $75. All turned out to be right. However, the unfolding of a serious recession is now in view.

I am now trying to figure out what is next, despite the intervention of all the financial powers. So my mind is on that at the moment and on shepherding the miniscule that I own after some 30 years of work.

God bless us all in this current disharmony.

http://agonist.org/mauberly/20081020/four_out_of_four

Thoughts on the dialogue form(17)

“So that’s why you don’t like Derrida.”
“Yes. He tries to take the voice(you might say ‘the heart’) out of literature, and I’ve made my literature multivocal, so he cannot deconstruct it. There is not one way to go in mine. There are all these people, and they all have voices(hearts).”
“Hmm.”
“And so may God bless or brimstone ‘em.”

(I might add that generally you don’t pray without a voice.)

Thoughts on the dialogue form(16)

“If you hold your position, how do you account for language?”
“I don’t hold a position, so I don’t account for it. I just try to write talk as I hear it, and I marvel at it, among other things.”