by John M. Curtis
(310) 204-8700

Copyright August 5, 2007
All Rights Reserved.

all Street's latest chapter of “boom-and-bust” now centers on the housing market, where six years of unchecked inflation comes back to earth. Cheap credit supplied to otherwise unqualified borrowers provided the housing boom where even illegal aliens could own real estate. Thanks to lax enforcement and years of loose lending practices, the “subprime” or “B-paper” credit has begun to default, hurting the bottom line of the nation's biggest mortgage lenders, including Countrywide Funding. Qualifying otherwise un-creditworthy borrowers with “teaser” rates, sometimes one-tenth the price of a normal mortgage, encouraged almost anyone to get into homeownership. Now that these risky loans have reset, defaults and foreclosures are taking place in record numbers, hurting the bottom line of publicly traded companies, shocking Wall Street and destabilizing the economy.

      With the Dow in a freefall, dropping 281 points Friday, August 3, Wall Street looks to the Fed to ease credit. Yet Fed Chairman Ben Bernanke won't be swayed by Wall Street's whining, where the nation's biggest funds rotate out of stocks, temporarily park cash in bonds and drive the market down in what's known euphemistically as a “correction.” Since the Dow hit its record high above 14,000 July 19, the market has shed about 6% or 800 points. If fund managers get their way and Bernanke drops the Federal Funds Rate 25 basis points, it's going to hurt U.S. treasuries, where current yields already don't keep pace with currency devaluations for foreign investors. Making matter worse, Eurpope's Central Bank hiked rates, making U.S. Treasuries and other fixed income securities look unattractive. If Bernanke keeps rates steady, markets could shed another 5%, maybe more.

      Wall Street's biggest funds, known euphemistically as “investors,” have pushed up the Dow to unsustainable highs, forcing today's sell-off. With Bear Stearns' CEO James E. Cayne saying credit conditions are the worst he's seen in 22 years, Wall Street fund mangers have turned bearish—at least for now. More selling will eventually provide irresistible buying opportunities, prompting the big funds to shift capital out of bond and back into the market. When this happens, Wall Street will start clapping again, watching the Dow and other major indexes rocket upward. Unlike the tech bubble that popped in 2001, the housing bubble threatens the economy by directly taking cash away from homeowners, whose home equity lines kept the economy sizzling for the last four years. There's only so much the Fed can do to patch holes in today's inflated housing and lending markets.

      If past meltdowns are any gauge, it took two years before the big funds were willing to take back buying positions in the market. No major investors wants to buy in when large investment funds, especially hedge funds, are shorting the market, betting that the market will go down. While that hasn't happened yet, more runaway selling could trigger short-sellers to bet against the market, causing the same bear market seen in 2001. Unlike the last meltdown, there's been no Sept. 11 to accelerate an already bearish trend. In 2001, markets couldn't recover from the tech bubble, after terrorists hit the World Trade Center and Pentagon. While the subprime meltdown hurts some homeowners, the vast majority still have intact credit, largely having little effect on the overall economy. If the Fed holds interest rates steady, markets should recover once the correction is complete.

      Lurking in the background are former Fed Chairman Alan Greenspan's prophetic warnings Feb. 26, 2007 about the economy slowing down toward the middle or end of 2007. While markets sold off initially, they recovered quickly, taking the Dow from 12,500 March 1 to above 14,000 July 19. Once today's correction is complete, Wall Street's big funds are likely to buy back in, pushing markets ahead. If there's still doubt on the streets, it involves the subprime meltdown, failure of Bear Stearns' hedge funds and implications to the overall economy. Since two-thirds of the GDP is based on consumer spending, it only makes sense that a major credit crunch in the housing sector could slow the economy. Major U.S. homebuilders have already seen their stocks hammered, anticipating that a new borrowing standards will continue slowdown new and existing home sales.

      Wall Streets' endless cycle of “boom-and-bust” continues to put downward pressure on the stock market to complete the latest “correction.” In reality, coordinated programmed selling by the nation's biggest funds, namely, Wall Street's investors, will drive down the market until they perceive a new bottom. Once that occurs, the big funds will take new positions, driving the market upward. Whether it's today's subprime debacle or yesterday's junk-bond calamity, savings-and-loan crisis, Asian market meltdown or any other excuse, programmed buying will kick-in once computer programs perceive a new market bottom. While corporate earnings or other economic news play a part, Wall Street's big funds know when it's time to dump shares and when it's time to buy them back. As always, little investors can only watch portfolios go through the latest cycle of “boom-and-bust.”

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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