A great pretender of a rally

By Bill Fleckenstein

Over the last couple of weeks, the stock-market action has been remarkable. The bulls have enjoyed a nice rally. It was precipitated by the anticipation that the monoline insurers would be bailed out. Then anticipation turned into reality: The bailout was nothing more than an agreement by the ratings agencies to pretend that the monolines were still worthy of AAA ratings.

Parenthetically, I would just note that the rating agencies continue to be a farce. How could MBIA (MBI, news, msgs) -- which recently had to pay 14% to borrow money, and whose debt still yields over 13.5% -- ever possibly be considered AAA?

If the ratings agencies are to have one shred of credibility again, ever, they might as well start now. But of course, just like every other aspect of the sanity that some of us might like to see break out, it seems to be politically unacceptable for anyone in a position of real responsibility to act like an honest adult.

Oversight? Say what?

A few days later, the bulls decided that ugly economic news and a new all-time low in the dollar index was no impediment to higher stock prices. No doubt they were buoyed by the Office of Federal Housing Enterprise Oversight. That agency, entrusted to regulate Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs), said it was considering a proposal to make it possible for them to lose even more money (by removing caps on their mortgage-acquisition growth).

So, once again we are right smack in the middle of a full-blown Wall Street fantasy, whereby more of what got us into this mess is supposed to get us out of it. Nothing has been learned, and the game of price suppression continues apace. Unsupervised price discovery (as pertains to securitized assets) continues to be avoided at all cost.

Eyes on the pox, not the pimple

Having said that, the bulls, the banks and the government won't succeed in putting the genie back into the bottle. Our problems are not a function of potential downgrades for some municipal bonds (raising the chance that those financial institutions that own them could take a hit to their balance sheets). If that were the extent of it, an effective solution would be found rather quickly.

The specter of municipal-bond downgrades is a function of a much larger problem: the unwinding of the credit bubble, which had the housing bubble at its epicenter. The credit bubble that has burst is going to continue to shrink the availability of credit, and the housing bubble that has burst is going to continue to unwind. The United States is not going to escape without a serious recession, which is the outcome preordained by the housing/credit bubble.

As to when folks will confront that reality, let me say this: It takes many years for a certain psychological mindset to take root, and resistance to change is always formidable. Yet when the dominant trend finally changes, that new trend remains in place for a long time.

But it does appear that psychology regarding inflation has changed and that a new trend has been accepted. I've been struck by the media's belated recognition that we have an inflation problem and that the Fed is clearly in a box, destined to ease interest rates in an attempt to stave off economic weakness while continuing to honor the Greenspan put as far as equities go.

Thus, folks who follow the news are now beginning to realize that the Fed's predicament will only increase inflationary pressures.

Of course, expect the Fed to say economic weakness is relieving some of those pressures. But a serious amount of economic weakness would be needed to counteract the money-printing that's chased the price of almost everything higher, and even a recession may not relieve all the pricing pressures.

Capitalists pray for socialism

In any case, the determination to suppress the destructive downside of capitalism and ensure permanent prosperity is a terrible idea that will not work. Permanent prosperity, after all, is what socialism was supposed to be about, and we've all learned that theory doesn't work. I continue to find it a sad irony that Wall Street -- the alleged bastion of capitalism -- would cling so dearly to the hope of socialism.

That's exactly what the Fed is all about. Its central planners think they can pick the right interest rate with which to run the world, even as the evidence indicates that their efforts over the last 20 years have produced two epic bubbles. This story would strike any sane person as the stuff of nightmare. Sadly, it's our waking reality.

At the time of publication, Bill Fleckenstein did not own or control shares of any of the equities mentioned in this column.