Opinion: Market farces strike again- Dow reflects lack of investors and traders understanding

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The latest charity auction on the Dow created another big 7.33% drop. Hard to say what’s so appealing about 7% drops, but that seems to be the magic number. Perhaps the turkeys are selling their futures before Thanksgiving.

Just to put this in perspective, there’s a new buzzword floating around the economics profession: “Recapitalization”.

“Capitalization” means the creation of capital, by trade, banking, loans, business, investment, etc. Every profitable trade generates capital. Capital of the kind that has been running the US economy since the big postwar boom is an example. The US economy grew by multiples in that period, and so did its capital.

That capital base was the state of the US financial sector’s capital prior to the subprimes/housing crash. It consisted of all forms of capital, including bank loans, derivatives, etc. There was a big component of these forms of trade, thanks to chronic overpricing and asset inflation which made the financial market look invincible.

Added to which, full automation of transactions created a lot more business. The growth of capital was now a matter of pushing a button, doing a transaction on a spreadsheet, and saying how great your figures looked.

It was only a matter of time before business lost contact with reality. It also looks as if reality wasn't the first choice of options, when confronted with the meltdown.

There’s a lot of perfectly logical business and economic theory which says “Don’t get in over your head”, but everybody went right on trading until debts were multiples of actual assets. So when something went wrong, people preferred to believe numbers, not defaults. That was the serious mistake which killed so many big names. Solvent one week, a government handout the next.

The unthinkable was now a fact. All that capital, the product of generations, went straight down the tube. “Recapitalization” means rebuilding the capital base of America. It just so happens that the US had 60% of the world’s capital.

That’s how big this has been. The tsunami has already hit, now the backwash is playing havoc as people flounder around in the surf.

The markets themselves took long enough to realize what was happening. They still don’t understand it, to some degree, if the drop on the Dow is any indication. Investors at the lower end obviously don't get it at all.

The New York Times:

The sell-off suggests investors are pricing in a much deeper recession than the markets had previously thought was likely. New data released on Thursday also showed that retail investors were withdrawing tens of billions of dollars from stock mutual funds — a sign that the panic on Wall Street was spreading.

Thursday’s decline came after the Treasury Department signaled that it would move quickly to inject money directly into big financial firms in addition to buying up to $700 billion in troubled loans and securities from the companies.

“There is a downward spiral of fear still about whether the measures put in place will be enough,” Richard Sparks, senior equities analyst at Schaeffer’s Investment Research, said. “You continue to see selling into any strength.”

There’s a misconception here, but it’s an understandable one. It’s no longer a question of “enough”. The banks have been put on life support by the central banks. They’ll be on it until they’re able to trade on their own, which will be quite a while. Availability of money has been made a lot easier, and the interest rates are so low a child should be able to make money out of them.

The bailouts aren’t charity. If the banks and credit systems go, the economy collapses. There isn’t, and wasn’t, any choice. Because all of these loans and transactions are across the entire financial system, there was a need for the US government to be legally able to intervene, hence the need to legislate the big bailout. The previous bailouts and buyouts were relatively ad hoc, emergency measures.

The bill itself, which is riddled with earmarks, also indicated that Congress didn't really understand the nature of the mess. They've added a lot of cost to revenue, when revenue is doing all the work.

It's a bit like telling a lifesaver removing people from a sinking ship to carry a piano at all times during the rescue. Dumb, but it also reflects the fact that the US Congress has a habit of hitting the Fed like a kid asking for money on Friday night, regardless of the state of the family budget.

Really, you guys, a bit of reading of things can give you a lot of information. It can even explain what you're doing with these bills. Try it some time.

I can promise you there wouldn’t have been any great joy in the US Treasury, which is working with a massive deficit of its own, in having to provide $1.6 trillion to a dysfunctional financial sector.

It makes revenue an even tougher thing to manage. All the talk of tax cuts has to be seen in relation to the fact that tax cuts seem to be the only trick in the political textbook. The US taxation system is an antique, and until it’s modernized, it’s a liability, and can’t generate revenue efficiently anyway. So this is another straw for a camel which already has enough problems.

The markets, however, are still doing sums, not business. They’re also getting the wrong answers. That $700 billion doesn’t represent some sort of attempt to bailout the entire mess at once. It’s a control mechanism for things that get out of control.

Rather worse, they’re misinterpreting their own position.

Unless everybody in the various markets is intending to commit suicide tomorrow, they’ll have to get up, go to work, and try to do business.

To do that, it might be nice if they have something to do business with, instead of dropping a fortune every day on principle. Holding assets of some defined value does have its uses.

Life doesn’t stop just because you’re not feeling too good after reading the financials. This is like jumping out a window by proxy.

Recapitalization is going to take a while, and the sooner people start doing real business, with real capital, the sooner that’s going to happen.