Clear explanation of how tight credit is crashing stock market

[Thump553]

I haven't seen any explanation for the link between tight credit and the stock market crash before, except the oft-repeated "investor uncertainty." Here is a very interesting article from Investors Business Daily (like the Wall Street Journal, only politically closer to Genghis Khan) that explains an obvious point I have overlooked. Big hedge funds, etc. that must raise cash can't sell off their mortgage backed assets, so they must dump stocks no matter how irrational that is. If true, then when the G7/USA finally gets the credit markets unstuck, then the stock slide should stop immediately.


A quick and (hopefully inexpensive) fix to me is the proposed joint guarantee of all inter-bank debt for US and G7 banks. That should make the TED spread plunge overnight and get cash flowing.

Link to article: Levered Investors Sell Anything Easy

 

[LegendKiller]

It's not just that, but also the fact that companies that need credit are getting fucked. They either can't get it, which is slowing growth, or if they can get it, it is very expensive and decreasing profitability.

 

[Thump553]

It has a lot to do with it. Companies raise capital in a couple of ways-institutional borrowing, selling bonds, selling more stock. Selling stock is probably the cheapest for the company-just time for SEC paperwork and expenses of the placement. In today's market a $40 stock company is selling for about $15-20, so they get screwed on the stock offering. The decline in their stock value also affects their borrowing ability. The credit illiquidity leads to stock selloff leads to stock price decline leads to more credit crisis. It's a vicious cycle.

And that doesn't even bring up the leverage part mentioned in the article. Us retail stock customers can lever our stock 1 to 1 on the margin (ie, you have $50,000 in stock, you can borrow up to another $50,000). Apparently these hedge funds, etc. can lever their stock holdings 30 to 1.

Query: Will reducing the leverage limits drive the markets down (at least temporarily) by requiring more selloffs and reducing demand? My head spins-every apparent good solution has thorns to it.

 

[heyheybooboo]

Originally posted by: Thump553
I haven't seen any explanation for the link between tight credit and the stock market crash before, except the oft-repeated "investor uncertainty." Here is a very interesting article from Investors Business Daily (like the Wall Street Journal, only politically closer to Genghis Khan) that explains an obvious point I have overlooked. Big hedge funds, etc. that must raise cash can't sell off their mortgage backed assets, so they must dump stocks no matter how irrational that is. If true, then when the G7/USA finally gets the credit markets unstuck, then the stock slide should stop immediately.


A quick and (hopefully inexpensive) fix to me is the proposed joint guarantee of all inter-bank debt for US and G7 banks. That should make the TED spread plunge overnight and get cash flowing.

Link to article: Levered Investors Sell Anything Easy

They've been trying since August, 2007.

There is no easily defined way out. The problem is one of valuation. I tend to turn into a free-marketeer (it's the Libertarian in me) and think the financial institutions should work it out. Central Banks (primarily the Fed) need to slowly increase their discount rates while institutions level accounts at their own self-determined rates.

The spread will be gi-normous. Commercial lending rates will soar. The world-wide recession will be deep. Inflation will leap.

The smartest guys in the rooms need to develop an insurance plan (or guarantee as you noted) with weighted ratios that back a percentage of the interbank lending. Some 'thing' like a long-term FDIC insurance that is capitalized initially by the public sector and reimbursed by fees overtime from the institutions themselves. Not-for-profit - but any institution who underperforms should be held accountable and the institutions who overperform should be rewarded.

Manipulators and speculators who profit at the margins must be chastised and punished.

As LK noted folks who need credit are going to get reamed. Someone needs to come up with a way to incentivise (did I just make up a word?) the extension of credit in the private sector. If this cash comes in the way of gov't 'freedom loans' to banks in exchange for an equity position, I just don't know ....

And anyone who complains of public assistance to individuals or market regulations should be tried for sedition.

Leverage has to be reduced slowly over time and 'equitable' reserve requirements need to be set. Nobody wants to over-regulate but maybe some type of a ""sliding scale"" based upon risk would be appropriate.

If it's set up in a way that everybodys' pissed (but not too bad ) it's probably about right ...

 

[Muse]

I don't think you need to be an economist to realize that it's vital to restore the credit market. If companies and individuals can't get credit there is going to be complete economic collapse that will rival if not be worse than the Great Depression.

 

[Muse]

Originally posted by: Thump553
I haven't seen any explanation for the link between tight credit and the stock market crash before, except the oft-repeated "investor uncertainty." Here is a very interesting article from Investors Business Daily (like the Wall Street Journal, only politically closer to Genghis Khan)

Link to article: Levered Investors Sell Anything Easy

I'm a subscriber to IBD online, but my 3 year subscription is about to expire and I won't be resubscribing. For one thing, I don't have any cash on hand to invest, but a major reason is their political positions. They should really refrain from taking political stances, but they can't help themselves. The publisher is extremely canny when it comes to the stock market, one of the most brilliant ever, but I can't stomach their politics. It's easy enough to ignore, but it grates on me.

 

[StageLeft]

It seems somewhat similar to what Cramer (come on, he's not that bad!) was saying yesterday. I only caught a bit of it, but hedge funds can be encouraged to sell when they otherwise may not want to.

 

[Thump553]

Originally posted by: Muse

Originally posted by: Thump553
I haven't seen any explanation for the link between tight credit and the stock market crash before, except the oft-repeated "investor uncertainty." Here is a very interesting article from Investors Business Daily (like the Wall Street Journal, only politically closer to Genghis Khan)

Link to article: Levered Investors Sell Anything Easy

I'm a subscriber to IBD online, but my 3 year subscription is about to expire and I won't be resubscribing. For one thing, I don't have any cash on hand to invest, but a major reason is their political positions. They should really refrain from taking political stances, but they can't help themselves. The publisher is extremely canny when it comes to the stock market, one of the most brilliant ever, but I can't stomach their politics. It's easy enough to ignore, but it grates on me.

I'm partway through my one year subscription but I totally agree with you. I wouldn't mind it if they limited the politics to the editorial pages, but it's been half the front page recently-including the headline article.

 

[Muse]

I just read the article. What seems apparent to me is that they have to change the rules so brokerages, hedge funds, etc. don't imperil the economy with their leveraging. 30-1 leveraging! That has to be part of a recipe for disaster.

Retail investors are limited in how much debt they can take on to buy stocks. Not so the investment banks, which since 2004 have been able to leverage at debt-to-equity rates of 30-to-1.

and

In a rising market, high leverage produced massive profits. With 30-1 leverage, a 10% gain on $1 million in capital grows from $100,000 to $3 million.

and

With each decline, leveraged investors must raise more capital. To do so, they sell what they can. This puts more downward pressure on asset prices and triggers new margin calls.

 

[Muse]

Originally posted by: Thump553

Originally posted by: Muse

Originally posted by: Thump553
I haven't seen any explanation for the link between tight credit and the stock market crash before, except the oft-repeated "investor uncertainty." Here is a very interesting article from Investors Business Daily (like the Wall Street Journal, only politically closer to Genghis Khan)

Link to article: Levered Investors Sell Anything Easy

I'm a subscriber to IBD online, but my 3 year subscription is about to expire and I won't be resubscribing. For one thing, I don't have any cash on hand to invest, but a major reason is their political positions. They should really refrain from taking political stances, but they can't help themselves. The publisher is extremely canny when it comes to the stock market, one of the most brilliant ever, but I can't stomach their politics. It's easy enough to ignore, but it grates on me.

I'm partway through my one year subscription but I totally agree with you. I wouldn't mind it if they limited the politics to the editorial pages, but it's been half the front page recently-including the headline article.

Honestly, I haven't been reading them. They used to mostly put their political views on the editorial page, but the front page often betrayed their political biases and I winced to read some of that stuff. Really, the main reason I would subscribe was just to find out where the markets are going, whether they gauged them in rally or correction mode. It's possible to figure that out for yourself if you can get the volume numbers for the indexes. IBD uses Wm J. O'Neill's (IBD's publisher) methods, which he states plainly in his books, which I mostly have. You can calculate very easily yourself using those methods. I'm sure all the info needed is available easily online.