Don't worry about the Fed getting tough

By Bill Fleckenstein

Despite the July heat, there was lots of tough-Fed shivering last Wednesday, at least initially. That's because the supposed "core" consumer price index (excluding optionals known as food and energy) printed a tick higher than expected. Apparently, those terrified folks do not understand that this is the same Fed whose easy-money policies made them rich in the first place.

In any case, their fears were soon forgotten, as Fed Boss Ben Bernanke told Congress:

• The Fed must be mindful of past rate increases.

• "Moderation" in economic growth now seems to be under way.

• The Fed must be "flexible" and "ready to adjust."

Clearly, the fixed-income market got the hint, as it reduced the odds of an August rate hike from the current 5.25% for the federal funds rate from 90% earlier that day to just 50%-ish. So, shades of my comment a few weeks ago: "We must remember that the Fed is run on the applause meter. Fed members just want to be loved."

Worrying about the wrong thing

Notwithstanding the alleviation of angst, I continue to believe that worrying about the Fed being tough is exactly the wrong thing to worry about. This, after all, is the Fed that precipitated a stock bubble -- and then a housing bubble to address what ensued. The Fed only knows how to do one thing -- which is to print money and bail out whatever problem it previously created.

Thus, if one wants to worry, one should worry about the consequences of Fed recklessness: The fact that our economy is entering a post-housing-bubble recession, given (a) how levered up the consumer is, and (b) the fact that our financial system is held together with baling wire, in the form of derivatives, credit-default swaps and other sorts of financial "dark matter." It is this beneath-the-surface reality that comprises the real threat.

Lenders in line for more than fender benders

Perhaps as a sign that folks are starting to care, the shares of mortgage-insurance underwriter MGIC Investment (MTG, news, msgs) sank 5% on July 18, despite its win at "beat the number." This is a bit of the linkage I've been looking for, in terms of potential rot from the housing sector spilling into the financial sector.

In other words, some folks are beginning to rethink the notion of loans against homes as impregnable assets. In my opinion, any company that has profited by aiding and abetting the housing ATM is in trouble -- and at serious risk, if it has a leveraged balance sheet with its assets being loans to houses.

I make those comments based on what I can see has gone on, and I'm sure that lots of unusual business practices have gone on that we have no knowledge of. Just as we didn't find out about Enron, WorldCom, options-backdating, etc. until the tide went out, we have yet to discover what borderline, if not outright criminal, behavior occurred in the housing mania.

When the stock market begins to connect the dots and that recession looms, all hell is going to break loose. Exactly when that occurs, I do not know, but it's coming.

Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. At the time of publication, Fleckenstein was short MGIC and long MGIC puts.