The Unsustainable US Financial Sector

According to Bloomberg, the vast majority of the Big Five banks’ profits consisted of a taxpayer subsidy — the Too Big To Fail guarantee. If the Too Big To Fail banks had to lend at the rates offered to their non-Too Big to Fail competitors, their profits would be severely shrunk (in some cases, to a net loss):

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What does that mean?

That means that the American financial sector is a zombie, existing on the teat of the taxpayer.

It means the huge swathes of liquidity spent on saving the financial sector are ultimately good money chasing after bad.

As Bloomberg notes:

The U.S. financial industry — with almost $9 trillion in assets, more than half the size of the U.S. economy — would just about break even in the absence of corporate welfare. In large part, the profits they report are essentially transfers from taxpayers to their shareholders.

Neither bank executives nor shareholders have much incentive to change the situation. On the contrary, the financial industry spends hundreds of millions of dollars every election cycle on campaign donations and lobbying, much of which is aimed at maintaining the subsidy. The result is a bloated financial sector and recurring credit gluts.

This is extremely prescient stuff. The Fed since 2008 has reinflated the old bubbles, while allowing the same loot-and-pillage disaster-corporatist financial model to continue.

It is insane to repeat the same methods and expect different results. This credit glut, this new boom that has seen stocks rise closer and closer to their pre-crisis high (which may soon be exceeded) will just lead to another big 2008-style slump, just as the Fed’s reinflation of the burst tech bubble led to 2008 itself. This time the spark won’t be housing, it will be something else like an energy shock, or a war. Something that the Federal Reserve cannot directly control or fix by throwing money at it.

America (and the Western world in general) post-2008 needed real organic domestic growth built on real economic activity, not a reinflated bubble that let the TBTF financial sector continue to gorge itself into oblivion. 

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The Contrarian Indicator of the Decade?

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

Sir John Templeton

Buy the fear, sell the greed. Since bottoming-out in 2009 markets have seen an uptrend in equity prices:

Now it seems like the euphoria is setting in. And in perfectly, deliciously ironic time, as shares of AIG — the behemoth at the heart of the 2008 crash — are returning to the market. Because reintroducing bailed-out companies to the market worked well last time didn’t it?

Joe Weisenthal:

Markets are down a hair today, but the theme of the morning is clear: Uber-bullishness. Everywhere.

This is the most unanimously bullish moment we can recall since the crisis began.

Note that this comes as US indices are all within a hair of multi-year highs, and the NASDAQ returns to levels not seen since late 2000.

Big macro hedge funds, who have been famously flat-footed this year, are now positioned for a continued rally.

Bank of America’s Mary Ann Bartels:

Macros bought the NASDAQ 100 to a net long for the first time since June, continued to buy the S&P 500 and commodities, increased EM & EAFE exposures, sold USD and 10-year Treasuries. In addition, macros reduced large cap preference.

J.P. Morgan’s Jan Loeys:

We think the positive environment for risk assets can and will last over the next 3-6 months. And this is not because of a strong economy, as we foresee below potential global growth over the next year and are below consensus expectations. Overall, we continue to see data that signal that world growth is in a bottoming process.

SocGen’s Sebastian Galy:

The market decided rose tinted glasses were not enough, put on its dark shades and hit the nightlife.

And the uber-bullishness is based on what? Hopium. Hope that the Fed will unleash QE3, or nominal GDP level targeting and buy, buy, buy — because what the market really needs right now is more bond flippers, right? Hope that Europeans have finally gotten their act together in respect to buying up periphery debt to create a ceiling on borrowing costs. Hope that this time is different in China, and that throwing a huge splash of stimulus cash at infrastructure will soften the landing.

But in the midst of all that hopium, let’s consider at least that quantitative easing hasn’t really reduced unemployment — and that Japan is still mired in a liquidity trap even after twenty years of printing. Let’s not forget that there is still a huge crushing weight of old debt weighing down on the world. Let’s not forget that the prospect of war in the middle east still hangs over the world (and oil). Let’s not forget that the iron ore bubble is bursting. Let’s not forget that a severe drought (as well as stupid ethanol subsidies) have raised food prices, and that food price spikes often produce downturns. Let’s not forget the increasing tension in the pacific between the United States and China (because the last time the world was in a global depression, it ended in a global conflict).

It would be unwise for me to predict an imminent severe downturn — after all markets are irrational and can stay irrational far longer than people can often stay solvent. But this could very well be the final blow-out top before the hopium wears off, and reality kicks in. Buying the fear and selling the greed usually works.