Wednesday, April 16, 2008

The Libor Lies: Smoke and Mirror Games Continue

Well it was rally time today as the market continues to try to convince itself that the worst is behind us.

I find Wall St. fascinating because so much of it is a game of psychology. Dr. Robert Shiller from Yale describes financial bubbles as mainly being a psychological event. Bubbles tend to start with excitement and profits, are fueled by manias, and then crash in a panic. In between the cycles you will see moments of denial as the people who got in too late refuse to accept that they were the last sucker at the top. Today's housing market and tech are good examples of this.

I view the stock market right now as being more psychological in how it reacts to news versus your old school technical market. There was a time in the markets where earnings were what mattered and markets were much more predictable as a result.

Today we have a much different market. You have financial TV news networks influencing investment decisions with 100 talking heads that have 100 different opinions. Today's market also has a much larger pool of short sellers which can make the market move more violently up or down. Finally and most importantly in today's market you have the the "financial innovation" of Wall St.

This new environment makes things very confusing for the average investor because there is so much information to digest. Its gotten to the point where its almost impossible for any investor(including myself) to predict where we are heading on a short term basis. However, in the long term, fundamentals ALWAYS come back to the market and stocks are then priced appropriately to earnings. Nasdaq 5000 ring a bell?

IMO, Financial innovation's have become the most dangerous change in the financial markets because it made the stock market more vague or "shady". Wall St.'s existance is based on trust and confidence. Without trust you would have no financial system. Would you give your money to a bank that you didn't trust would pay you back?

Because we have this new financial innovation, its easier for Wall St. to "keep the game" going because they can play with the books. Level 3 asset accounting is a good example of this. Goldman Sachs has $83 billion in level 3 assets which has risen significantly from 2007. This is more then the firm has in capital. Doesn't this make them technically insolvent? Why are they allowed to not be forced to price these assets?

This game of "smoke and mirrors" took a big blow today with an article that you probably didn't hear about today. CNBC "bubbleland" TV wouldn't dare bring this to your attention. The WSJ and Bloomberg reported today that the Libor rate is being misquoted by banks. The Libor is set on the marketplace based on what the banks tell them they paid to borrow. This rate is not set by regulators. The Libor rate is set on trust.

So the banks are lying and saying they are paying a lower rate when they really paid a higher lending rate. From Bloomberg:

"The British Bankers' Association will speed up the review of the process by which money-market rates are set daily amid concern that some contributors are providing misleading quotes.
The global credit squeeze has raised concern lenders have been manipulating the so-called fixing process to prevent their borrowing costs from escalating, the Bank for International Settlements said in March. Participants have complained about whether banks are submitting accurate information, said Angela Knight, chief executive of the London-based BBA.

The association, which held its annual board meeting today, said it will ban any member deliberately misquoting lending rates.

``At the heart of the problem is that this credit crisis has crystallized why we are referencing so many securities to an uncollateralized reference rate and not a market price,'' said Francesco Garzarelli, director of macro and markets research at Goldman Sachs Group Inc. in London. ``That is why the panel is being solicited to provide better quotes. Libor is a rate that has lost some of its reference value in the current crisis.''

``The most obvious explanation for Libor being set so low is the prevailing fear of being perceived as a weak hand in this fragile market environment,'' wrote Scott Peng, head of U.S. rates strategy at Citigroup in New York."

My Take:

Well well well Wall St. just took a big step back in the trust department. We are already in a credit crisis and this will just put more fear into the marketplace. Expect the Libor rate to rise as regulators stop these "smoke and mirror" games.

Some mortgage rates are based on Libor so expect them to go up as well.

Bottom line is there will be a point where this crisis of confidence will come to a peak and its going to be ugly when it does. The tough part is figuring out when the music stops. I have a strong feeling we are very close. Wall St. knows the debt bubble has to burst and the market needs to reset with affordable housing and low inflation.

Today they just lost one of their big "smoke and mirror" instruments. The question now becomes how many tools are left in the toolbox?


Avl said...

Jeff, I think the markets will engender recollections of the following:

"In her book “On Death and Dying”, Elisabeth K├╝bler-Ross described a type of emotional journey among people who are facing death. Since she wrote this book, the model has been found to apply as well, for many people, to other major losses.

Typically, the seven (7) stages of grief are described as:
- Shock or Disbelief
- Denial
- Anger
- Bargaining
- Guilt
- Depression
- Acceptance and Hope

Sometimes, people speak of five (5) stages of grieving, putting together:
- Shock/Disbelief and Denial
- Bargaining and Guilt"

'Nuff said.

Jeff said...


Yup. We are somewhere in the grieving stage.

I think in housing we are in the "oh **** I shouldn't have paid this much" stage heading towards the "Foreclosure" stage...

johndaniels said...

i appreciate your perspective, and i check it frequently and it is always intelligent...good things are happening though.... like coca cola, nike, ibm johnson johnson, etc earnings beating q1 estimates...

financials are still in bad shape. anything having to do with equity credit and financing is in deep trouble still: but more than 50% of other business sectors are actually doing above average.

have to think that the recession may not be full blown, and only financials are really effected.

inflation will benefit the stock market and create more buying and will inflate assets. we have deflationary trends now: i think you may be dreaming of a stock crash and housing dropping another 50% but the fed is steering us towards inflation and that will lead to inflation in prices for assets, in time.

in short, deflation will not last.

johndaniels said...

if anything there is a commodities bubble. tech in 2000, then real estate peak in 04 and 05, now commodities. inflation and deflation at the same time. what are your thoughts on this; how can both be happening at the same time? it seems like a commodity bubble. companies that meet or beat expectations wont crash. a great many are doing this. financials are crashing...not the entire market. its predictable commodities will burst as money reenters the stock market as people realize the recession is not full blown and the financials are the trouble spot. I was very bearish until the UCLA forcast in march: which appears to be on track. i dream of having cd's closing out and tons of cash while the stock market crashes to 7,500 and i can buy houses for 100,000. would be nice, be thats dreaming, its unrealistic.

Jeff said...


Thanks. I often think about the same issues. Either scenario takes down equities long term IMO.

Inflation will kill the consumer because wages simply aren't rising fast enough to cover the price increases we are seeing. If your raise is 2% and our inflation is running double this then how can you afford higher prices?

I think you are going to see deflation similiar to Japan in the '90's in the long run. Inflation willl subside as the recession deepens because demand for goods should decreasing inflationary pressures.

So you will see inflation now a lot of it is speculation similiar to the tech bebble. This could run a little while longer because of Chindia demand, but I think a lot of it is speculators chasing returns that they can no longer get in the stock market. Deflation is what is coming IMO.

As the debt bubble pops I see can't see inflation continuing because demand will be gone. Be careful with hard assets. Theree is a lot of speculation goig on.

Thanks for the feedback.

Anonymous said...

well, you all are eloquent, and luckily only some are ignorant at the same time! Congratulations to the enlightened masses! (minor though we may be as yet....) This is coming to pass as it must. Wow what a wealth transfer!!! So , uh, how did U do? Did the elite rape you before you got a clue? Wake up and smell the dollars! Ok, now I have to get politically incorrect.... McCain't and O'Bummer.... geeeez people are we sound thinking americans or not??? WTF???
RON PAUL will defend the constitution!!!! Its all we have left: To hell with the angry old white asshole.... to hell with the charismatic educated "in the biz" tinted guy... lets get together and run dis ting.... YES! We can! STOP divide-and-rule!!! Talk to people who dont look like you!!! Respect them and let them respect you... its the only way! YES WE CAN.... IF WE WANT TO!!!!!!!!!!!!

Jeff said...


I love Ron Paul! I will be voting for him in November. The other two knuckleheads are a joke.

I want to thank Jim Sinclair for sending you over to check out the blog.

I realize gold is getting crushed, but its hedgie liquidations and deflation.

Inflation is right around the corner. Gold will be back with a vengeance but it may be awhile.

Dollar cosr average into gold IMO. Deflation short term could hurt you here. I think you might see much better entry points for gold before inflation sends gold higher.

Mr. Sinclair has a much better gold perspective than I so I am sure he has some great advice.

Thats just my 2 cents.

Good luck and Go Ron Paul!