The following editorial was published in Price Perceptions issue #1443A on October 15, 2011

End of an Era ?

Following the 1987 stock market collapse, the Federal Reserve began pumping money into the economy at a record pace. Following that experience, the Fed made it policy to come to the rescue every time the stock market fell or the economy stalled. Investors became so confident the Fed would come to the rescue, the policy became known as The Greenspan Put.

With confidence the Fed would always come to the rescue, Wall Street designed new and exotic investment vehicles to bolster profits and attract even more investors. Exchange Traded Funds (ETF’s), Credit Default Swaps (CDS) and a multitude of new derivative products were designed to draw more speculative investors into the marketplace. Bubbles began to occur in the late Nineties from one area to another. Each time a bubble burst, the Fed came to the rescue, pumping more liquidity into the system and assuring Wall Street they stood ready to meet any potential downturn. In fact, the Fed began to preempt potential problems. They pumped billions into the system prior to the millennium in case computers were unable to handle the change from the 1900’s to 2000’s.

The problem with Fed liquidity injections was they never took them back. Speculative fever continued to spread from equity and commodity markets to real estate. Individuals bought homes and condos for little money down in anticipation of “flipping” them to the next buyer willing to pay a higher price. Major stock and commodity exchanges shifted ownership from members to public companies. Because they were now publicly held, the corporation opened new markets and methods of trading to attract more volume and increase profits. When the bubble burst in real estate, Wall Street found they held more debt than equity and the speculative game came to a halt.

However, the Federal Reserve again came to the rescue, buying an unprecedented $1.2 trillion in mortgages and loans from Wall Street. The government also provided $700 billion in bailout funds to help Wall Street overcome their problems. Wall Street utilized the bailouts and came back with a roar. They generated record profits and paid record bonuses. High Frequency computer trading spread rapidly as exchanges provided facilities for large hedge funds and Wall Street banks to trade instantaneously, generating fast profits and greater volume for the exchanges.

Now, Wall Street profits are beginning to dwindle as government bailouts and Fed funding have run their course. In addition, implementation of the Dodd-Frank Act, containing the Volcker Rule, will curb Wall Street’s propriety trading and force more transparency in the $600 trillion derivatives market. Also, new banking rules by the Basel Committee on Banking Supervision will double capital requirements for banks. As a result, Wall Street bankers are becoming disillusioned and reducing their risk appetite.

Global instability and implementation of new banking rules should mark the end of an era. Risk appetite should dwindle in months and years ahead. This will limit the number and extent of big bull markets in stocks and commodities as the new era unfolds.

Bill Gary
CIS, Inc.


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