Thursday, October 15, 2009

Another Wall Street bubble, thanks to the bailout

Guest post by redbedhead:

I suppose it shouldn¹t come as a surprise that the biggest of the big banks in America that sucked up tens of billions in government aid are now rolling in profits. That¹s how this game works. Thus, JPMorgan has just reported a 580% profit increase over last year to a whopping $3.6 billion third-quarter profit. The reason is, purely and simply, ­ that the money that the US government pumped into the banking and financial sector has created a new Wall St. bubble ­ with stock prices rising by nearly 50% to top the psychological benchmark of 10,000.

The actual meaning of that number is a mystery to most of us not initiated into the occult world of the stock market. But the basic gist is that there's a lot of cash floating around and people are doing to the stock market what they did to the housing market ­ bidding it up, out of relation to the value of the assets that they represent. The trouble is, in the real world, the shithouse is still burning. Community banks in the US, which make their profit by loaning money to people to buy houses, finance small businesses, other consumer loans, etc. are tanking badly. These 7,000 banks have collectively lost about $2.7 billion. And many are outright failing:

"Ninety-eight banks, mostly small, have failed so far this year, and regulators predict the harvest from the current recession is less than halfway complete."

The reasons why are straightforward, with loan delinquencies sitting at a record 4.35 percent and climbing ­ and real estate development loans have rocketed to 16 percent. Amongst homeowners, 7.35 percent were delinquent ­ - another record. In previously frothy markets like south Florida the freefall is continuing. According to one real estate agent foreclosures have risen by 25 percent compared to last year and the trend is higher. It is certainly possible that the present round of profit reporting ­ including a positive report from Intel Corp. boosting share earnings and projecting an extra $1 billion in revenue for the fourth quarter could in fact herald a recovery. But it¹s also the case that, like previous recessions ­ going back to the Reagan arms boom ­ this one will have been ended by laying the basis for the next one.

In particular, what we have seen in recent decades is a game of debt ping pong, with debts being shunted back and forth between governments, private individuals and the corporate sector (including banks). Until that debt can be dealt with it will act as a drag upon the economy and create other problems that will increasingly limit the ability of governments (in particular the US government) to act. My own view is that in the short to medium term, once the present round of "irrational exuberance" wears off ­ and I don¹t think it will last long once stockbrokers remember that there¹s a real world ­ will see us return to an extended period of stagnation. Some of the weaker centres of the system - droopy old Britain, for instance ­ may experience Icelandic types of crashes. As Nouriel Roubini might say, this ride ain't half over yet.