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 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 14-Jul-2008
Investor and public anxiety levels are sky-high following weekend twin bailouts

Web Log - July, 2008

Investor and public anxiety levels are sky-high following weekend twin bailouts

300 more banks are thought likely to be facing failure, said according to RBC Capital Markets analyst Gerard Cassidy, who had in February estimated no more than 150.

Washington Mutual Inc. appears to be at the top of the list, along with a number of smaller banks. "You have to look at companies with the greatest exposure to the highest-risk assets, which include construction loans and exotic mortgages," Cassidy said. "The final nail in the coffin for any depository institution would be a funding crisis where it is unable to gather deposits at reasonable cost, or wholesale funding markets are cut off."

There were two bailouts over the weekend, following the economic turmoil that occurred on Friday. IndyMac Bancorp Inc. was nationalized by the FDIC, after panicky depositors withdrew $1.3 billion in deposits.

In a separate action, unrelated the IndyMac action except that they happened to occur on the same weekend, GSEs (government sponsored entities) Fannie Mae and Freddie Mac, which guarantee $6 trillion in mortgages, was promised unlimited funding by the Fed and the Dept. of Treasury, to prevent it from defaulting.

Market summary, 14-July-2008
Market summary, 14-July-2008

Wall Street markets opened much higher on Monday morning, with the Dow Industrials immediately gaining 170 points. By noon, however, investors had lost confidence, and the market had turned negative, and by 1 pm the market was well over 200 points below it's morning high. It end the day net down 45 points, 22% below the October high.

Crisis of confidence

As I've said many times, the ups and downs of the stock market are not important except insofar as they reflect the attitudes and behaviors of the large masses of investors.

It used to be that I would write about the euphoria and insanity of investors, as they pushed up the stock market indexes to ever newer highs, making the stock market bubble larger and larger.

For the last few months, it's been the opposite. Now it's the repeated lows that reflect changes in behaviors and attitudes -- for both investors and ordinary people. The totally irrational euphoria has been replaced by enormous anxiety. The "bad news is good news" syndrome is gone altogether.

For ordinary people, CNN had hours of programming on Monday on the economy. They referred to the stock market problems as a "crisis of confidence," and they sought to reassure bank depositors that their savings would be OK, even if their bank failed and the FDIC took over. Still, the news video showing hundreds of people standing in line to withdraw their deposits from IndyMac Bank in California really set the tone.

CNBC gave me the impression of chaos. There were lots of incredibly glum faces, but no one was saying much of anything except the usual sound bytes about strong fundamentals.

One thing that really set the tone for me is the increase in blame and finger-pointing, as evidenced by the fallout from Senator Charles Schumer's June 26 remarks that IndyMac's lax lending standards left it on the brink of failure. For the last three days there's been a spitball fight, with regulators blaming Schumer for sinking IndyMac, and Schumer blaming the regulators for not having done their jobs.

On Monday afternoon, analyst Chris Thornberg at Beacon Economics appeared on CNBC. He had said that the next batch of banks to fail will be banks with exposures to builders' loans, since commercial real estate is now failing in just the way residential real estate has been failing. But Thornberg refused to name names, for fear that he'd be blamed for anything that happened: "A lot of people are blaming Chuck Schumer for this. The only thing that Chuck did was point out what should have been obvious to investors in the first place, and that was that IndyMac was in big, big trouble."

Politicians and analysts have not been known for their honesty and openness for a long time now, but the Schumer drama is apparently casting an enormous pall that will keep anybody from saying anything negative. Do not, under any circumstances, believe any soothing words that you hear or read from anyone in the mainstream media.

Another indicator of anxiety is the MarketPsych investor fear index, which is computed by a computerized analysis of news stories in business publications. The index is computed essentially by counting the number of words in these stories that reflect anxiety, versus the number that reflect calm.

Here's Monday's version of the index:

MarketPsych Fear Index -- 14-July-2007 to 14-July-2008 <font face=Arial size=-2>(Source: Marketpsych)</font>
MarketPsych Fear Index -- 14-July-2007 to 14-July-2008 (Source: Marketpsych)

As you can see from the above graph, the index spiked high last August, when the global credit crisis began, and again in March, when the Bear Stearns crisis occurred. As you can see on the far right of the graph, in the last week, it's been spiking up again, higher than ever, indicating extremely high investor anxiety. This matches the chaos I saw on CNBC on Monday.

If I were to judge when the CNBC anchors appeared most anxious and panicky of all, it was when they were discussing the announcements of second quarter earnings for financial services firms. There was a brief discussion of the fear that Citibank, Merrill Lynch, and others will be announcing disastrous new asset writedowns. Other pundits said, essentially, "Well, maybe the earnings announcements will be better than expected."

On a related note, there's something strange to report. As regular readers know, each week I depend on the CNBC Earnings Central web site to tell me the latest estimate of S&P 500 corporate earnings growth, and I post a table showing how those earnings estimates keep falling, week after week. The CNBC web page is usually updated every Friday afternoon, but this week it hasn't been updated at all, so far. Now, it's a good thing that I'm not a paranoid person, or I would suspect that earnings estimates have fallen so far that CNBC doesn't want to risk shocking people by posting them. but since I'm not a paranoid person, I'm sure it's just an oversight, caused by someone being on vacation or something. (Update: The new stats appeared on Tuesday afternoon, 15-July.)

Actual second quarter earnings for financial services firms are going to start pouring in within a couple more days. These will probably determine the short-range direction of the market. If they're better than expected, the market will go up, at least for a while; if they're as bad as expected, or worse, the market should continue going down.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (14-Jul-2008) Permanent Link
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