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If you hadn't realized that credit isn't improving, it's because the mainstream financial media has been snookered into reporting that the commercial paper market, for instance, is better because sales volume has increased by $200 billion in the past two weeks. Reporters don't seem to care it's all being bought by the Fed now, which means that all real-money holders are dumping their paper as fast as possible on the new sap that just hit the block.
"Sold to you, Mr. Bernanke!" is the only sound of action on commercial paper desks these days. And you can already see why, as Genworth Financial (GNW, news, msgs) paper bought by the Fed last week has already been downgraded to non-investment grade.
The money pit
Indeed, the Fed, which now already owns 15% of all U.S. commercial paper in addition to Fannie Mae (FNM, news, msgs), Freddie Mac (FRE, news, msgs)and American International Group (AIG, news, msgs), and stakes in several fast-faltering banks such as Goldman Sachs Group (GS, news, msgs), is increasingly looking like the classic dope who keeps averaging down on bad investments until he's got no money left.New demands for $75 billion in additional bailout money from AIG, for a total of $150 billion, and at least $30 billion from Fannie Mae, in addition to $100 billion already spent, have already led the government to postpone its vaunted guarantee of money market funds. And we haven't even begun to count the money that's headed for Detroit's crashing automakers.
Another credit market signal that's been misinterpreted lately is the apparent rise in commercial and industrial loans being made by banks. Brian Reynolds, analyst at WJB Capital, points out that non-investment grade companies that are shut out of the commercial paper market are drawing down bank lines of credit set up a few years ago for emergencies only. These loans were contracted by banks during the bull market at interest rates that are currently uneconomic -- so the more they lend out involuntarily on these lines, the worse the banks' financial condition becomes.
The New Ickonomy has created all sorts of distortions in the way that money normally flows, creating hidden dangers that threaten to boomerang on policymakers' good intentions. Congress members are now complaining, for instance, that banks aren't making enough loans to small businesses with their bailout money. Do they ever stop to think that bad loans in boom times got us into this mess, so politically correct loans in bad times are only likely to make everything worse?
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Instead of rejuvenating markets, Reynolds points out, bailouts have only created a bigger rush to dump assets onto the government. Yet there is a limit even to what a spendthrift Congress and Treasury can accept, so this means the bailouts will have to be enlarged or frozen, and either outcome will be met with hostility by investors.
Thus the crisis will end only when private fund managers replace the government as the market's top credit buyers. Don't hold your breath, though, as that will require a large appetite for risk, which is painfully missing on Wall Street today at a time of shrinking balance sheets.
This new economic paradigm has already slaughtered many hedge fund and mutual fund pros who have gotten it wrong, so it's going to take unusual foresight and patience for individual investors to survive. My recommendation is to avoid getting sucked into rallies in seemingly cheap stocks and high-yielding bonds except for brief trades, and just guard your cash patiently while awaiting the next bull market that's bound eventually to emerge after a lot more sideways action, or worse.
For now, the only all-clear sign that risk-averse private investors should accept would be a close of the S&P 500 Index ($INX) above its 12-month average for at least one month, and preferably two straight months. That's currently 1,260, but it's moving lower all the time. If you want to take more risk and try to jump the gun at some point, wait for a one or two weekly closes above 1,010.
At the time of publication, Jon Markman did not own or control shares of any company mentioned in this column.
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