Why the Market Needs to Accept the Pain Now

Well that crisis didn’t last long did it?

More on that in a moment. But first, we’ve decided to run an irregular Preposterous Property Spruiking section in Money Morning. We’ll dump it towards the bottom [Reader's voice: Where it belongs!] of the newsletter so that if you couldn’t give a stuff about property spruikers you don’t have to read it, but if you could give a stuff then you know where to find it.

Today we’ve three beautiful examples of rampant spruiking from The Northern Star newspaper. As we understand it, it’s a regional rag covering the northern coast of New South Wales.

But until then, this…

Crises, and solutions to crises seem to be getting shorter and shorter. Is it because the crisis isn’t as bad as it first appeared? Or is it that the majority of market participants have absolutely no idea what the real crisis was in the first place?

No prizes for guessing our opinion. It’s clearly the latter.

You can tell that simply by looking at the market reaction to the Citigroup Inc., quarterly results:

The above chart is a five-day chart. On Friday you can see the stock took a tumble, as did all financial stocks in the US.

But overnight, following the results announcement of a USD$4.4 billion profit, the stock was up. Closing the day’s trading 7% higher than the Friday close.

Yippee! Everything’s OK again. Move along, there’s nothing to see.

But that hasn’t stopped the pollies from tut-tutting at the banks for their “moral bankruptcy.” That was UK Prime Minister Gordon Brown’s words to describe Goldman Sachs.

It’s just a shame that Brown felt the need to give billions of dollars of UK taxpayer money to these morally bankrupt institutions rather than letting them become actually bankrupt.

Although we’re not surprised he’s a little miffed, because the stink surrounding Goldman’s has shown further what fools the politicians and central bankers were for bailing out the banks.

It turns out that of the billions of dollars the UK taxpayer gave to Royal Bank of Scotland, USD$841 million of it went to Goldman Sachs to pay for the losses incurred by the bank from its investment in the collateralised debt obligation (CDO) structured by… the “fabulous” Fabrice Tourre.

That’s what happens my friend, when you give someone a blank cheque with no questions asked.

But more importantly, what this episode proves, without any doubt is that the mainstream has no idea what’s going on. And it’s this that ensures there will be a repeat of the financial meltdown that occurred through 2008.

Today, as we write, the Aussie banks are moving upwards, regaining some of the lost ground from yesterday.

Mainstream commentators here and overseas continue to spruik how wonderful and important the banking system is. That it’s recovered from the meltdown to be stronger and more responsible than it was before.

We know that’s baloney. And we think they do too, not that there’s any chance of them admitting it.

But the banks really are a sideshow. The most worrying aspect of it all is the urging of the vested interests in the finance industry for interest rates to be kept low. It’s worrying because even a five-year old could figure out that it just doesn’t make sense.

The argument put forward by those pushing for interest rates to remain low is that increasing them could ruin the recovery. Newsflash dudes, there is no recovery.

The very fact that the so-called recovery is only possible if interest rates are kept abnormally low is proof of that. If the economy really was recovering and really had overcome the past problems then it would signify the recovery is real.

Unfortunately, these dimwits just can’t see that it was abnormally low interest rates and excessive credit creation that caused the whole stinking mess to begin with. Keeping interest rates low now won’t solve anything, it merely adds more manure to the dung heap.

We’ve been asked several times by readers why we’re advocating higher interest rates. Our simple answer is that we’re not doing anything of the sort. Hang on, isn’t that contradictory?

No, it isn’t your editor that’s advocating higher interest rates, it’s the market that’s advocating them. Or rather, the free market would be if it wasn’t for the presence of central bankers manipulating the rates to keep them low.

What the market needs right now is to be purged. Admittedly it won’t be pleasant, but guess what, denying that it needs to be done won’t make it go away. It will happen sooner or later, overtly or covertly.

The market needs to be purged of all the excessive debt obligations. Debtors need to be punished for borrowing more than they can afford. And creditors need to be punished for lending more than they should.

That will inevitably mean that savers will take it where it hurts too. That won’t be good for them. But the reality is, as long as you have a financial system with central bankers manipulating the market and interest rates, and as long as you have governments giving implicit or explicit guarantees for savers, then there is little incentive for savers to be cautious about where they put their money.

The many investors who bought into mortgage funds have probably learned their lesson. They learned the hard way.

But what happened to mortgage fund investors is exactly what should have happened to bank savers. The banks should have been allowed to collapse rather than having the government and central bank prop them up.

In a free market, the result would have been another firm taking over the banking operations and assuming the ownership of the assets on the banks books, ie. Mortgages. Savers would then have had to wait for their savings to be paid back over time, just like the mortgage funds.

Obviously, for those that couldn’t wait, there would be the opportunity to sell their savings accounts at a discount to someone who is prepared to wait.

The result? Those with a mortgage would have to pay higher interest rates, as the new banks would need to offer higher interest rates to attract savers. Some of those mortgages would default because the borrowers would be unable to service the loan at a higher interest rate.

The revelation that there isn’t an undersupply of housing would soon drive the price of housing down to a much lower level. Granted, that doesn’t necessarily mean that more people will be able to buy, especially if they’ve lost savings, but odds are they would.

And if they didn’t then entrepreneurial property investors who didn’t get killed in the property crash would be able to buy property on the cheap and lease it out to renters.

I know this won’t be a popular if you have “done the right thing” by saving. And we’re certainly not going to echo Ben Bernanke and the Keynesians who blame the economic meltdown on the excessive savings by Asians.

Rather, what we will say is that savers have been duped and mislead – fraudulently perhaps – by central bankers and governments into believing that keeping money in the bank is the safest thing to do.

The reality is that all that has done is serve the cause of the corrupt banks who are able to use your savings as capital in order to create money to lend out and pump up unsustainable credit bubbles.

The credit bubble has provided the illusion of gains. Now it’s time for the illusion to be blasted away and for the pain to be felt before it’s made even more painful.

Preposterous Property Spruiking

The Northern Star journalist Alex Easton must have been working overtime on April 17th. We hope his endeavours have been amply rewarded because he produced the following items.

The first two stories were sent to us from Money Morning reader, A. Nonny-Mouse:

“Future demand inflates home market”

“Million reasons to buy”

The third came from Money Morning reader Jim:

“House prices soon out of reach”

Jim claims that in the print version of this article the headline was, “We will all be rich.”

He’s offered to scan and email a copy of the article so we can confirm it. But whatever, even without the fabulous “We will all be rich” headline, these three articles have gone to enormous lengths in the effort to keep pumping that property bubble.

All three articles are worthy of a Walkley Award. I suggest you read them for yourself, but we can’t help but point out a couple quote-worthy quotes:

“By the time they’re 36, Gavin Calnan and Olivia King will be millionaires.”

Not ‘could be’ or ‘may be’, but “will be.”

How are they going to do it? Starting a business perhaps? Working hard? Or even saving up a few dollars a week? We’re sure they work hard. And that they’ll save as much as they can. But that’s not where The Northern Star sees their fortune being made:

“By the time the final brick has been put in place, Mr Calnan said the couple expected to have spent about $460,000 – just under last year’s median price for Ballina of $475,000.

However, projections from Australian Property Monitors suggest if the couple can stay in their new house for a decade, their home will be worth nearly $1.25 million.”

According to our Canan TX-220TS calculator (we dumped the Canon LS-100TS after it made a mistake by not multiplying a number when we told it to) that gives Mr. Calnan and Ms. King a $790,000 gross profit.

Minus say $250,000 in interest payments, that’ll still leave them with a profit of around $510,000, or about $51,000 per year.

That’s the equivalent of about $65,000 in pre-tax income. All they have to do is go to the bank each year, get the house revalued, extract the “equity” and they’ll never have to work again.

After ten years they can sell the house and walk away owing nothing. Or they can just keep on getting the house revalued and withdrawing “equity.” What could be easier than that?

It’s easy money this property lark.

The other quote we liked was from the “Future demand inflates home market” article. According to Easton:

“Mr Shay [of LJ Hooker in Ballina] said property prices in Ballina had doubled or trebled every decade since he moved to the town from Lismore 10 years ago.”

Do you spot the oddity there? Correct us if we’re wrong, but isn’t a decade 10 years. So “every decade” within a 10 year period is, erm, one decade. We suppose technically he’s correct, but seriously.

As we said above, these are beautiful examples of property spruiking by the mainstream press. Feel free to send more property spruiking stories to moneymorning@moneymorning.com.au

Cheers,
Kris.

Why the Market Needs to Accept the Pain Now, 8.7 out of 10 based on 14 ratings

Tagged as: CDO, Fabrice Tourre, Goldman Sachs, Gordon Brown, interest rates, mortgage fund investors, property spruiker, Royal Bank of Scotland, The Northern Star, UK taxpayer money