But What If The Worst Isn't Over?


The market seems to be operating under the assumption that the worst is over. We’re never going back to the old lows, the second derivative of unemployment and housing is all good, and with the stress test behind us, the banks are finally on a stable footing.


The market’s move has been powerful, and we’d hesitate to discount what it (might) be telling us.

But we continue to be nagged by a few things, namely some big macro problems that aren’t going away. Massive muni and pension shortfalls, for example. We still don’t see how California — which now has to borrow more just to pay off its borrowings — gets out of its budgetary crisis without massive structural changes. Mini Californias are everywhere.

We still don’t know what happens to New York when the Wall Street severance payments run out.

And is this crisis — ostensibly the worst since the 1930s — really going to go away without a fundamental shift in lifestyle? How could this be it?

And finally, where the heck are people going to go to work? We see tons of people with skills and experience designed for the last economy: real estate, finance, etc. Without real, non-public industries for these people to go to, the odds of a recovery seem slim.

Roger Ehrenberg is thinking along similar lines:

But what if, just what if, the economy hasn’t turned the corner? What if job losses continue apace, residental mortgage defaults continue to rise and corporate bankruptcies spike? As defaults ripple through the system, given the lack of transparency and granular, easily accessible data around mortgage-backed security vehicles (CMBS, RMBS) and credit default swap (CDS) positions, how are we to untangle the mess in a timely and efficient manner? How are investors supposed to accurately price risk in the absence of this data? The US Government can continue its posture of uber-borrower, but this game can only go on for so long. Let’s say the Chinese government gradually reduces its net purchases of US Treasuries, and also shortens the duration of its Treasury portfolio. As the US Treasury continues to run the printing presses, the Chinese would gradually build a compelling argument (and a powerful economic position) as to why the US Dollar should no longer be the global reserve currency and the basis of exchange in oil. Profligate spending coupled with fewer willing buyers will drive up US dollar long rates, debase the currency and set off a very unpleasant inflationary cycle. With plummeting real asset values, spiking inflation and high credit costs, the US would be in a very uncomfortable position, indeed.

Let’s hope that bad bond auction yesterday wasn’t the start of something big.

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