While the Getting is Good

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That Ben Bernanke. What a tease. His Friday remarks gave investors just enough hope that the Federal Reserve will soon pull the trigger on massive purchases of U.S. bonds (otherwise known as quantitative easing). Investors, speculators, doormen, taxi drivers, and the dog across the alley have all been buying stocks, bonds, and commodities ahead of this planned “queasing.”

But Ben was just coy enough to keep us guessing until the Fed’s November 2nd meeting. In a speech Friday he said, “Given the committee’s objectives, there would appear – all else being equal – to be a case for further action.” Exactly what the real objectives of the Federal Reserve are – price stability and full employment or engineering a giant wealth transfer from the Middle Class to Wall Street – is another matter.

However it’s not hard to characterise the market’s reaction to Friday’s cryptic speech. It was a resounding, “Meh!”

Stocks were down. Gold sold off a bit. If anything, Bernanke’s boring and pedantic speech put everyone to sleep, which is another way of calming things down, if you think about it.

Calm is good. Complacent is not. Keep this in mind: since the “robo signing” mortgage foreclosure scandal began to gather steam last week, shares in Bank of America (NYSE:BAC) have fallen almost 10%. The more people understand this story, the scarier it gets.

Lest we be accused of fear mongering, though, let’s just put it out where what’s at stake here: the rule of law in the American housing market. That’s all. Nothing too important.

Or is it?

Our view is that there are three parts to this crisis, the legal, the political, and the sociological. The legal side part revolves around the trail of documents that establish ownership of mortgage. If the banks securitised and sold mortgages they can’t prove they owned, the investors in those securities will put them back to the banks and the banks will have to pay. More capital will be needed. A lot. Expect class action lawsuits by investors who claim the banks made false representations.

The political aspect – being all about a bunch of elected cowards – is easy. The politicians will not reverse engineer a legislative solution that allows banks to more easily foreclose on millions of homeowners when the banks are clearly guilty of at least some level of fraud in the documentation process.

No elected official worth his own vanity is going to cast a vote to save the banks’ bacon again. Even a deadbeat Congress returning to Washington after the November elections but before the new Congress is sworn in is unlikely to take up the cause of the banks. If anything, a still-Democratic lame-duck Congress may push for the to-big-to-fail firms to be nationalised in GM-style.

That brings us to the sociological. A growing number of American homeowners – those in good standing on their mortgage and those underwater – will begin considering sticking it to the bank (strategic default) as a legitimate non-compliance strategy. The lawyers and the community organisers will be keen to surf this rising tide of popular rebellion. Imagine millions of Americans – en masse – simply refusing to pay their mortgages or leave their foreclosed homes.

What do you think happens in a market where title can’t be transferred? Where prices don’t communicate any information because buyers and sellers don’t trust anyone? That’s not a market. That’s chaos; chaos which threatens all the securities whose value is derived from mortgages.

Neither the financial press nor Wall Street seem are looking at this issue with much imagination. They see it mainly as a matter of establishing the paper trail. But for millions of homeowners, this is emotional confirmation of what they’ve suspected all along: somehow they got screwed. The drive to right this perceived wrong by stiffing the banks is going to be very strong and politically irresistible.

We’ll see how it plays out. The worst case scenario is quite plain: this is the undoing of one or two major banks in America. They never cleaned up their mortgage act. They are not adequately capitalised. They will be nationalised. And the whole affair feels very Lehman-like.

Whether it has the same consequences for the global financial system is yet to be seen. On the “uh oh” side of the ledger are soaring commodity prices and rising stocks. Markets are at the same heady highs as they were pre-Lehman.

On the “not so fast” side of the ledger is the fact that this would appear to be largely a problem with the collateral/capital structure of the American banking system. Australia, like the rest of the world, must be hoping that it can decouple from the American housing train wreck. Capital flows already indicate a strong desire by investors to exit the dining car, find a platform, jump from the train, wave to Chief Engineer Ben Bernanke, and get well clear of the tracks.

Meanwhile, all the rest of the central bankers, central planners, bureaucrats, free loaders, and zombies on the train are shouting, “Stop the train!” Too late people. This train left the station in 1971. It ain’t coming back.

But where is it going? Probably the total destruction of the U.S. dollar. This sounds radical. But it is usually the fate of fiat currencies. And this is the trouble with the current global financial system.

The U.S. dollar is the world’s reserve currency. The drivers of the dollar are taking it down on purpose. Like an air show tricks team where each pilot follows a fixed spot on the plane ahead of him, the rest of the world’s central bankers are driving their money into the ground too.

If there is any decoupling ahead, it may come in the equity markets between developed debtor country markers and emerging creditor country markets. If stocks beat inflation – and that’ a big if – the better bet may be emerging market equities over the S&P 500.

Keep in mind that at the micro level, independent of inflationary monetary policy, each commodity market has its own supply/demand dynamic. That dynamic contributes to the general outlook for that commodity. The outlook is, at least to some extent, independent of the monetary realm.

One example is the current rare earths mania. We began covering the story a few years ago, when it sounded mostly like crackpot/cranky fear mongering about obscure modern metals in your television and iPod. Now, investors/speculators can’t get enough of the story.

One share we’d never even heard of went up by 105% in the first five minutes of trading last Thursday because it said it had discovered rare earths mineralisation in the Northern Territory. No details on the characteristics of the deposit or even any plans for production.

Meanwhile, the one Aussie company that is actually already mining rare earths ore – and which Kris Sayce told you about in late July – is up 133% since then. The point? You can make money in this market. But you’ll have to do it as a speculator. And you’ll have to be early on the best stories to make the most money.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Excellent article Dan, but I do have one small quibble: you call politicians cowards…. because “The politicians will not reverse engineer a legislative solution that allows banks to more easily foreclose on millions of homeowners”???
    Of course they are cowards – because they have bent over repeatedly to the big banks, and voted for the repeal of the Glass-Steagall act which allowed the banksters to pull off this heist in the first place.
    But now you accuse them of cowardice for being forced by popular outrage to finally do their duty as representatives of the people, as they are supposed to do?
    In any case…. I for one do not think you can be accused of fear mongering here, in fact I think you have understated things a fair bit. Add to the list of those who will be lining up to sue the banks those who were induced to take out ARM’s who were deliberately lured and pressured into signing, and who were actively decieved about the terms of the mortgage, those who have bought re-possessed forclosed homes who will learn that the banks, once again, did not actually have title to the home, investors in bank stocks who will show that the banks engaged in various types of fraudulent book keeping tricks to make them appear to be proffitable, investors in mortage backed securities who will sue the banks for fraud because the securities they bought, being told they were told were low risk, were actually filled with mortgages deliberately cherry picked BECAUSE they were deemed as likely to default(!)…. so that the banks could bet against them on the derivatives market and cash in when they went belly up. How about lawsuits by investors who claim that the banks conspired with ratings agencies to misrepresent the risk level of the products they were selling? can anyone guess what sort of rats nest of suits and counter-suits that will likely ensue when banks (and others like AIG) are unable to pay up on (and/or receive payment on)the credit default tab when that will come due as this train wreck continues for the next ten years or so?

    Stuart Davies
    October 19, 2010
    Reply
  2. Looks as though gold and AUD have given bearish warning signs…surely they need pullbacks here. Crumbs they’ve both had a huge run.

    Reply
  3. Comment by Lachlan on 19 October 2010:

    Looks as though gold and AUD have given bearish warning signs…surely they need pullbacks here. Crumbs they’ve both had a huge run.

    Any pullback will be short lived I feel Lachlan. The mess is a long way from being sorted.

    Stillgotshoeson
    October 19, 2010
    Reply
  4. I agree with you Shoes and for the same fundamental reason.
    I gave my CFD trading away because it was too much hard work (short term trades) and due to the rain I’m just about to start a long period of outdoor work with the seeds. I need sleep. But if gold does pull back to support somewhere further down then a swing trade will be what I’m hoping for. No I dont see the end of the gold bull market or of the worlds monetary problems anytime soon either.
    Owning shares suits me fine too. I bought some very speculative shares (GMR)quite a while back. They found some very promising gold recently and the share price just started to break away. I count myself lucky because an ex geo I know told me he viewed their prospects as poor. Only own a tiny amount.
    I’m car..less and kid..less also today so will take some time and do some research.

    Reply
  5. Comment by Lachlan on 19 October 2010:

    I agree with you Shoes and for the same fundamental reason.

    I’m car..less and kid..less also today so will take some time and do some research.

    AVB
    FML
    ERJ
    RAU
    RCP

    These are on my watch list or now in my portfolio
    Only a nibble or a look at this stage.

    Stillgotshoeson
    October 19, 2010
    Reply
  6. Ta Shoes. Just reading about that Bolivian geology (RAU). Owned some Focus once for a small profit but know a bloke who spent a fortune on them. Have not looked at them for a long time.

    Reply
  7. Stuart,

    If we could identify a US Listed Law firm that specialises in class actions against banks and the finance industry, they could be the trade of the decade.
    Think of the fees!

    Reply
  8. Boston Legal, Davo!~ :D

    Reply

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