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Echo Bubble


The federal debt now stands at $12 trillion. Historic. New York State Comptroller Tom DiNapoli issued a statement warning New Yorkers that the state is “on track to spend $4.1 billion more this year than it will take in,” characterizing this deficit as “irresponsible and unacceptable.” On Long Island we are being squeezed by every taxing authority under the sun. But the government isn’t alone. Homeowners across America are underwater with mortgages they cannot afford and drowning in the highest household debt ratio in history.

Incredibly, the Dow Jones Industrial Average has crept above 10,000 in recent weeks despite every indicator contradicting Wall Street’s enthusiasm.


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I’m amazed at the level of blind faith the public places in the voodoo wisdom of Wall Street. In daily conversations, economists, investors and the general public blithely repeat figures that track the upward progress of the Dow Jones Industrial Average or the S&P 500 without putting any thought into how Wall Street arrived at these numbers. Unemployment rises and so does the Dow. Consumer confidence plummets and the market rolls on. Foreclosure rates climb, loan modifications fail and the market forges ahead. Our collective optimism is unparalleled in the world; an admirable trait until it runs into the brick wall of reality—and the wall is closer than you think.

We trust somehow that the savvy Wall Streeter in pinstripes, Polo frames and wingtips actually knows what he is doing. Less than two years ago this same swindler was hawking swaps and derivatives built on bad mortgages, and there was a sucker for every share. Today the only sucker is the blogger or talking head on television pontificating about how the economy seems to be recovering. The fact is the blogger and talking head aren’t investing in the market right now because they don’t have any money. Worse yet, they’re drawing economic conclusions from the surge in the stock market and passing it along as gospel. In reality, virtually all of the growth in the market today is from dollars being poured into the market by unregulated hedge funds.

Here we go again.

The hedge funds are investing in equities because it’s the fastest way to turn a buck. Move the market, make your nut, and dump out. But the hedge funds aren’t receiving any money from individual investors either. They’re getting it from the banks through low interest loans and funneling the money back into the equities market for short term gain. See where this is going? The only banks with enough money to loan to hedge funds are the ones that were bailed out by the federal government which had to borrow the money on the international market to support the banking industry. When these notes are due the federal government will dip into the only available revenue source it has to pay down the debt: You and me—the taxpayer.

One of the missed opportunities during the initial months of the young Obama administration was its failure to address the regulatory environment on Wall Street to provide greater transparency in the financial markets. The central problem remains in the Senate Banking Committee whose members are in the pockets of the investment banks and the hedge funds. Make no mistake, Senators Schumer and Dodd run America’s balance sheet, not the Fed. The contributions they receive from the financial sector are mind blowing, which is why the Senate refuses to lift the veil of secrecy from the financial system. If Americans got the chance to peek under the hood of the fiasco that is our economy it would all come crashing down. Either way, it’s coming. The only difference is that we will not be forewarned.

So despite what anyone tells you, we are not in a recovery. People casually refer to last year’s banking collapse as a tsunami. A fast and furious storm that indiscriminately ravages everything in its path. Remember though, it’s not the first wave of the tsunami that kills. It’s the second. My friend Peter Klein, senior VP of UBS Financial Services, describes the period we’re in right now as an “Echo Bubble.” According to Peter, the term was coined by Nobel Laureate Vernon Smith to describe typical post-bubble activity whereby the initial burst is followed by a secondary bubble “during which market psychology matches the extremes of sentiment displayed in the first bubble. Typically, markets do not find a genuine bear market bottom until after the echo bubble bursts.” Put another way, we are returning to the beach to assess the damage of the first wave unaware of the far more dangerous swell that is fast approaching.

So what happens next? This bubble bursts when the first big hedge fund pulls out of the market. Don’t let the man in pinstripes fool you. It’s around the corner.

If you wish to comment on “Off the Reservation,” send your message to jmorey@longislandpress.com.

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