Fed Bailout: impossible this time around

"Earlier, Alan Greenspan and many others thought that the CDO's and derivatives in general were wonderful because they spread risks broadly. But these debt instruments also encouraged risk-taking, especially among subprime mortgage brokers and lenders whose attitude was, "I originate this garbage, securitize it, I sell it -- and then I forget it. Also, the reality is that risks can be transferred, but never eliminated. Someone ends up holding the bag, and it will probably be well beyond the usual highly-leveraged and unregulated hedge fund suspects. We expect many trustees of conservative pension funds as well as mutual fund investors to be shocked!. Shocked! when they learn about the trash that's in their portfolios.

"Finally, when the risks are spread so widely, it's nearly impossible for regulators to organize bailouts. They could with the S&L collapse in the late 1980s-early-1990s because those lenders were regulated and largely retained their mortgage loans. Similarly, the bailout of Long-Term Capital Management in 1998 was possible because it was a single institution. Not so with today's highly leveraged, opaque and widely distributed derivatives."

Gary and his organization do extensive research, and as usual Gary's latest mailing is loaded with great charts. One chart in particular caught my attention. It's the ratio of the coincident to the lagging indicators. The ratio has an outstanding record of predicting recessions. This ratio hit a high in 2005 and it has been declining ever since. The latest reading (June, 2007) shows the ratio at new lows, in the area where many previous recessions have started. The ratio of coincident to lagging indicators appears to be hinting that a recession lies ahead. The intensity of the stock market decline may be saying the same thing. From: Gary Schiling