East For Income, West For Wealth (and Dow 100.000)

Fed Chairman Bernanke just re-iterated that the Fed is "prepared to act" and urged Fannie Mae and Freddie Mac to step in and help resolve the mortgage difficulties "if able". All these stern words of market succor while S&P 500 is a mere 6% off its all time highs and after being up an almost uninterrupted 100% in the past 5 years. Why? Is the Federal Reserve now a Guardian of The Dow, as well as the sleepless watchdog of US commercial banking?

In a word, yes. This what the once proud institution has succumbed to: being a carnival barker for the hedge fund and private equity interests that now dominate markets, not only in the US but the whole world. But, once again, why? Because asset prices, shares in particular, are now the "be all" and "end all" of the global economy. Income generation as a way to prosperity has been savaged in the West by the pittance wages of the 1.2 billion Chinese ex-peasants, not to mention the mere hundreds of millions of other assorted Asians and near Asians. And let's not forget another 1 billion Indians...

The die has been cast: The Economy of The East is based on labor income and The Economy of The West is asset wealth. And just as it was unthinkable in years past for incomes to go down in any given year, it is now absolute anathema for asset prices to drop. It is not only a reason of national importance, but of global balance: we in the West buy lots of their cheap goods, they buy our expensive assets. This is a balance resting on the knife edge of market performance, a global financial accord that is rapidly overtaking entrenched perceptions established decades ago in Bretton Woods.

How is it maintained? By a series of algorithms that are pushed, stretched and if need be kicked into constantly spewing out buy orders for all manner of securities, regardless of fundamentals and it all boils down to one simple parameter: momentum. Buy because the market is up and going higher, period. All the rest is fancy footwork pour epater les bourgeois. Roughly eighty percent of all transactions in US equities are now done by hedge funds, 15 percent by other institutions and a minute 5% by individuals. The name "hedge fund" has long become an oxymoron because they no longer "hedge" anything and they merely follow the latest fashion in trading, which right now is "quantitative strategies". There are exceptions, of course, but the great majority just follow the exact same fake rabbit around the dog track.

It all became exceedingly clear in the recent market drop, when hedge funds reported incredible losses (some lost 30% in one month), from a mere correction, however sudden. Everyone was on the same side: long risk, short volatility, short yen and all leveraged to the maximum.

So the Fed promptly pushed the "panic" button, though it did not wish to appear doing so. First it cut the Discount Rate to show resolve and then (very, very quietly) permitted the large banks with brokerage subs (Citi, JP Morgan, et al) to lend an astonishing $25 billion each of what is clearly depositor money to their said subsidiaries, so that they could in turn provide it to their customers in trouble (i.e. hedge funds). Not only that, but as we have already seen, those "customers" were often nothing more than in-house hedge funds and SIV's.

Does anyone recall that this is exactly how large banks got into the deepest possible trouble in 1929? They kept lending depositor funds to the broker call loan market (i.e. margin), which then simply evaporated within two days. Just like today's margin loans, ABCP's, the yen carry and all other types of financial leverage bets, they did it because the rates were higher than regular loans and could be demanded back within a day or two. Safe until proven poisonous.

Mr. Bernanke surely knows all this - he is, after all, a professor who has written two books on the subject of Fed operations during that period. He is apparently resolved that unlike 1929 no "liquidity need" shall go unmet on his watch to cause anything approaching a significant correction, no matter what the eventual consequences. And what may those consequences be?

Well, if Ben's Balloon Emporium keeps pumping more and more helium into the market it will certainly levitate. And there will be no ill effects, save perhaps a shrilly voice from gulping too much He, because...let's see... if each Chinee were to buy just $10.000 worth of US stocks...(gulp, gulp) by golly mate, that's twelvvve treeeellion dzollarz worth! And why stop there? The oil sheikhdoms are good for another 10 trillion, at least, and then you have the Indians and the Russians (gulp, gulp) - holy cow, Dow 100.000 heeeere vve come!