Indeed, who are all these crazy people buying stocks at a time like this? Are they insane? Don't they know there is a global crisis underway?
They are indeed aware of the crisis--but it is a crisis of confidence, not of fundamentals. This doesn't make the current issues less real or more dangerous, but serious people are obviously making serious bets that this will pass. They are the people who track the Chinese and Indian GDP as carefully as they track the U.S. GDP. The people who watch Chinese consumer spending with the same interest as European consumer spending.
There are other things going on besides long-term bets. Short-term, there are some serious short squeezes that have developed. New shorts are reportedly harder to get--short rates are skyrocketing, according to traders I have heard from--and there is little capacity in single stock names and even some secondary ETFs.
This morning: markets stable as bank interventions appear to have calmed nerves. Retail sales were higher than expected giving a brief boost to markets. Japanese Economic and Fiscal policy minister Ota said the economy will keep expanding driven by corporate and consumer spending.
China July CPI up 5.6%, stronger than expected vs. previous up 4.4%.
Banks generally higher this morning; J.P. Morgan, Comerica, and US Bancorp upgraded at Deutsche Bank on valuation.
2) the credit markets.
Once this liquidity crunch subsides, watch for the fallout. In the short term, traders are calling for a rate cut from the Fed, but more interesting to watch is the call to allow Fannie Mae and Freddie Mac to increase its investments in home loans and mortgage bonds. This would go a long way toward easing the concerns, but the conservative elements in Washington are wary of allowing these two to expand their domain. This is a HOT political topic right now.
Long-term, there will definitely be changes in the way the securitization business operates. Global investors will develop better methods for more clearly sorting out their exposure to different risk levels.
They will start with this question: how did this stuff get rated so highly to begin with?
Recall how all this started: investors have been buying and selling Mortgage Backed Securities (MBS, pools of securitized mortgages) for 30 years. The problem came when investment bankers took the MBS debt and repackaged them into Collateralized Debt Obligations (CDOs). These CDOs split the debt into different risk levels--called traunches. The riskiest traunches received the lowest ratings and had the highest yields. Those deemed "safest" (i.e. those investors would be the last to take the hit) got very high ratings (sometimes AAA--as good as government debt) and lower yields.
Here's where the problem came: once the initial losses from subprime defaults wiped out the riskiest traunches, the market for the less risky traunches seized up as well. How did that happen? The main problem was there was little liquidity in this paper to start with. The market for CDOs were often created for specific clients and much of this paper has rarely--if ever--traded.
OK, so it rarely traded and so it wasn't easy to price in a normal market, and impossible to price in a panicky market. But a lot of very smart people--including Bear Stearns CEO Jimmy Cayne--have voiced doubts about the rating methods used for this paper, implying much of it should never have been rated as high as it was.
There will be big fallout over this, with the result that there will be greater spreads between the highest and lowest rated traunches. This has already happened, but more changes will occur after all this is over and, if history is any guide, will be little noticed by general market observers.