This is one of those moments of existential choice in which one wonders whether the world is a very different place than one believed just days ago. I still believe that this is a liquidity event driven by a global redemption call on hedge funds. The result will be a lot of cheap securities that will fall into the hands of pension funds, life insurers, and individuals, that is, a redistribution of wealth away from hedge funds to middle-income households.
Of course, I could be wrong. The market could be telling us that the American political system is broken, that Democrats and Republicans never can achieve a consensus, and that a political catastrophe is only a matter of time. As I wrote in Asia Times Online last week, neither the traditional constituency of the Republicans–the upwardly-mobile middle class–nor the traditional constituency of the Democrats–the public-sector unions and the entitlement-receiving poor–can win in the current environment. That could spell a political disaster. And the market could be discounting the dysfunctionality of the American political system.
I do not think that this is happening. I continue to believe that this is a popping of the last bubble in the system, namely the hedge funds.
Nonetheless, it’s scary out there.
With Bank of America trading at an intraday low of $6.32, not only the common but also the preferred of America’s biggest bank has collapsed:
As I pointed out in March 2009 at the height of the bank crisis, turning off the bank preferred securities would have cataclysmic consequences for the financial system:
A number of commentators (including this blog) have pointed to the exposure of insurers to bank capital paper: historically the insurance industry is the largest investor in commercial bank Tier I capital securities, preferred shares, and so forth, such that a nationalization of the banking system and a repeat of the Fannie Mae/Freddie Mac conservatorship would have fatal consequences for the insurers. They already are beset by huge problems in their commercial mortgage portfolios.
If the Bank of America preferred go the way of Fannie and Freddie preferred, we are in a full-tilt crisis. I do not think this will happen: the banks have already had massive losses wrung out of them and have reduced risk on their books across the board. They cannot make money in this environment but it would be hard for them to lose even a fraction of the losses they sustained in 2009.
Investors appear to selling what they can, not necessarily what they want to. Why should electric utilities like Con Ed and Duke Power track the market down? These are the most boring bond-like equities in the universe.
CNBC right now is warning of reports that major head funds are taking massive losses, quoting the reports I cited earlier that the $1.25 trillion in equity hedge funds was massively bulled up in May. Now the hedge funds are all trying to exit through the same keyhole.
Stocks are stupid cheap by any valuation criteria. I’m not selling. I hope I’m right.