Greenspan's Put Is Shot

Gentle reader, the whole world now turns its weary eyes to Mr. Greenspan. The financial press portrays him as the savior of the modern world. TIME magazine, in fact, once put him on the cover, along with Robert Rubin and Larry Summers with this headline: Committee To Save the World – with no trace of humor. In Bob Woodward’s book he is the “Maestro.” Fortune ran a cover story: “In Greenspan We Trust.”

And on Tuesday, Mr. Greenspan…the former jazz saxophonist and Ayn Rand devotee…seemed to live up to his billing. “Greenspan Arrests Wall Street Collapse,” said the headline in La Tribune. Greenspan had apparently done it. He had pulled out his put option and saved the day.

And yet…the dollar continues to fall. And the price of credit continues to rise. Either of these are probably sufficient to render Mr. Greenspan’s put option worthless. “Euro continues to rise,” reports the financial section of France’s Figaro newspaper. The hapless European currency has defied almost every financial pundit in the known world by doing what none of them expected – it has gone up.

So delicately balanced – at the margin – is this international flow of funds that merely a small shift in sentiment away from the dollar could be devastating. In effect, if the dollar falls – it means that foreigners will demand a higher rate of return for buying U.S. assets…and the cost of credit will increase, not go down as the Greenspan Put requires..

Alas, Mr. Greenspan’s put is shot.

Mr. Greenspan’s only real weapon is central bank interest rate policy. But, as mentioned here in the last few days, that weapon only works when the enemy is in retreat. Lowering the price of credit does no more to alleviate credit problems than lowering the price of Jim Beam whiskey helps cure dipsomania.

In both cases, the problem is not the price of the elixir…but the use to which it has been put.

Over the last few years, every silly idea that came along could belly-up to the credit bar and imbibe almost as much as it wanted. Trillions of dollars worth of capital were raised…spent…and have now disappeared. What’s left are I.O.U.s, stocks, bank loans, and bonds. The quality of these debt instruments is falling rapidly.

“The junk bond market is suffering through its worst funk since at least 1990,” reports Boston Globe. “The market is cheap,” according to Fred Cavanaugh, director of high-yield assets at John Hancock Mutual Funds. “The question is whether it represents value.”

“The average junk bond mutual fund had lost 10.85 percent for the year through Tuesday..” continues the Globe article. “In 1990, by any measure a disastrous year for junk bond investors, the average high-yield fund lost about 9.6 percent.”

“So-called ‘TMT’ companies, working in telecommunications, media, and technology, are the most worrisome creditors in the junk bond market. They borrowed huge sums to build out new communications networks and some are running into financial walls. ICG Communications Inc. had borrowed $2 billion by the time it filed for bankruptcy protection last month.”

Falling prices for junk bonds means rising costs of credit for the borrowers – and not just TMT borrowers. J.C. Penny’s bonds now yield 18%….Tenneco Automotive’s bonds yield 21.3%. And the gold producer Ashanti’s bonds can be bought to yield 27%.

These are all troubled companies. But that is what you get after a credit binge – companies with problems…companies that have taken up too much capital and spent it too freely. You also get consumers with problems, for much the same reasons.

One company with trouble to spare is the Bank of America. “They let credit quality get away from them and it’s coming back to haunt them,” said an analyst quoted by Bloomberg. “Loan problems are mounting at U.S. banks,” the Bloomberg piece observes, “…as customers find it more difficult to pay debt. Bank of America expects to write off $1.1 to $1.2 billion in bad loans in the 4th quarter, compared to $435 million in the 3rd quarter.

BOA was the a main creditor of Armstrong, the vinyl floor maker that went bankrupt a few days ago and Owens Cornings, which filed for bankruptcy on Oct. 5. Both companies were plagued by asbestos suits.

BOA wrote off a $500 million loan to Sunbeam…and also lent to Pillowtex and ICG – both of whom went bankrupt on Nov. 14.

A bank with this keen a nose for deadbeat borrowers could have hardly missed the movie business. In fact, it lent $1.2 billion to Regal Cinemas – the nation’s largest theatre chain – 2 years ago. Naturally, Regal defaulted and may also go Chapter 11.

When credit is too cheap, people treat it cheaply. The result is trouble. But it is not the sort of trouble that can be cured by even cheaper credit.

The U.S. economy is now at the end, I believe, of one of the biggest credit binges in history. The headaches and regrets cannot be dodged or ignored. And easier credit is not likely to make much difference – just as it has had no effect in Japan over the last decade.

The entire psycho-profile and attitude of the market is changing. Instead of dreams…there will be nightmares. Venture funds are being replaced vulture funds. And hard- nosed, bitter-end investors and workout specialists are taking the places of naive amateurs… The focus of serious investors will no longer be on cleaning up in the market…but on merely cleaning up.

Investors, who used to believe everything was possible and who accepted every fairy tale business plan, chapter and verse, are coming to believe nothing and accepting only chapters 11 and 7.

Things can’t be put back in order without cleaning up the trash and butt ends. This won’t be done by quarter-point decreases in the Fed Funds rate.

More on this next week…including more insight into why people would borrow and lend at such a furious pace…and why Mr. Greenspan’s Put will not work…

Bill Bonner Paris, France December 8, 2000

Your constantly amazed, always amused, and often surprised correspondent…

*** Et tu, Intel? Less than a month ago, the `must own’ Big Tech company assured investors that its business and financial progress was “on track.” But, yesterday, after the close of business on Wall Street, Intel confessed: it would not be able to hit its sales targets for the 4th quarter.

*** Intel’s disclosure followed other earnings disappointments. Motorola and National Semiconductor, for example, both allowed as how growth and profits may not measure up to expectations.

*** Even beyond the Big Techs, earnings were a source of embarrassment. Coca Cola and Bank of America said they were having trouble. Bank of America’s problems are worth further comment…more below…

*** Almost all the companies blamed their problems on situations beyond their control. God, not man, was at fault. Sales were down across the board at Intel, the CFO explained, because of “a worldwide economic slowdown.”

*** And so, stuck in the mud of a worldwide economic slowdown (WWES) Wall Street sank gently yesterday; the Dow dopped 47 points. The Nasdaq slipped 43.

*** Microsoft fell 6% as analysts realized that maybe a WWES might not be good for software sales.

*** Yahoo! found no cause for cheer either. WWES or not, ad sales revenue on the Worldwide Web (WWW), are definitely going down, as people realize that web advertising doesn’t work well. An analyst from W.R. Hambrecht downgraded the stock…and then Yahoo! fell to less than $35, after having been as high as $250 earlier in the year.

*** True believers in the New Economy must be delighted with the WWES; it is making it far cheaper for them to buy their favorite WWW stocks. Amazon, for example! The River of No Returns slid more than $2 yesterday – it is barely holding above the $20 mark.

*** Amazon also has plenty, indeed perhaps a surfeit, of debt instruments available for investors with a sense of adventure. I have not checked them lately, but investors can expect at least 3 times the return of a passbook savings account – at least, while it lasts. Amazon has $2.2 billion of debt outstanding, a heavy burden for a company with no profits.

*** Wall Street bonuses will hit another record this year – even while the customers’ yachts fall with the tide of stock prices. The 178,000 employees of the securities industry are expected to get average bonuses of $74,000 this Christmas.

*** But beyond Wall Street, there is a world of trouble. Glancing down the list of headlines suggests that the Autumn of Anxiety is quickly giving way to the Winter of Woe.

*** “The Dow will experience its own Bataan Death March,” says a cheery note from Bill King. “OTC’s are down more than 50%. Small caps and OTCs typically peak a year or more in advance of the DJIA.”

*** When markets are going up, King explains, “companies feel like the village idiot” when they report losses. But when a WWES occurs, they see an opportunity to bring losses out of the closet and get rid of them. “They’ll report the biggest losses possible,” he predicts, “looking back 5 years to get refunds from the IRS.”

*** “Protesters Battle Police in Nice,” declared the International Herald Tribune, describing European leaders’ most important get-together in years. Protesters include the usual anti-globalization crowd – the rebels without a clue – and Basque separatists, who know exactly what they are doing.

*** “California Limps Along with Threat of Blackouts,” says an item on the Prudent Bear website. Power bills in California are 50% higher than last year.

*** Oil is below $30. The dollar slipped further against the euro… and bonds were up again.

*** Gold dropped $1.20. But the gold mining companies were up. Gold stocks rose in the `30s deflation. Gold is real money, after all…and real money rises in deflation.

*** And now, a moment of lachrymose reflection on the state of the New Tech industry….a note from Andy Carpenter: “Last year USInternetworking rented a museum for a lavish holiday gala. This year, no kidding, they’ll be partying at a YMCA camp. Last year they danced to the mellifluous strains of big band music. This year we can only assume they’ll boogie to the Village People.

Last year, USi’s 1,000 employees donned fabulous formal wear. They sipped champagne and martinis in the museum’s glass-enclosed atrium – which features a spectacular view of our downtown Baltimore skyline. This year’s party, no kidding again, will feature a rustic log cabin, a bon fire and a $20-a-plate buffet.”