Patient Renter: Up front I’ll admit that I am an accountant by discipline and my knowledge of both the stock and bond market was driven by handling investment income for the insurance brokerage where I worked. I learned the hard truth about Merrill Lynch and Pru-Bache brokers (they’re salesman first and investment bankers second) and so sat down and educated myself. Being a fan of both Ben Graham and Warren Buffett, as well as an accountant, I will admit to always erring on the (very) conservative side.
That being said, I think the Fed is keenly aware of their culpability in this present housing mess, and they know full well that it stems from their desire to avoid a recession following the dot.bomb/NASDAQ bust. I think they are trying to hew to a course that is solidly in the middle and hoping that inflation simmers down of its own accord.
You mention gut instincts. Mine is telling me that the reason that the volatility indexes are so out of whack is that risk (true risk) is not being properly accounted for and the usual market mechanisms are therefore not behaving accordingly. Only recently has the bond market started to react and if you pull back and look at the complete picture, it appears as though the market(s) are finally starting to key on the dangerous combination of excess liquidity, improperly accounted for risk and the dangerous levels of risk inherent to certain sectors (i.e. CDO/CDS products).
The accountant in me says that a single serious market event, such as a blowout in the lower rated MBS sub-prime tranches will spread. Why? Because at that point scrutiny will increase, followed by a review of diligence procedures, followed by a revaluation of the portfolios (book values of CDO/CDS products are notoriously overvalued and very arbitrary). At this point, the pain will spread as a whiplash effect occurs and the various players involved scramble to protect their positions.
As I said earlier in another post, there is a Wall Street expression that goes, “Don’t panic. But if you do panic, panic first”. Merrill’s dumping of their position within the Bear Stearns MBS sub-prime unit was not a measured response from seasoned professionals; it was a fire sale. There is a recognition within the industry that there is an undue level of risk accompanying not just these (MBS sub-prime securities and instruments), but with other MBS products as well.
At some point Rational Market Theory goes out the window and the herd mentality takes over. I don’t think its any coincidence that UBS just unseated their CEO (following disclosure of the losses sustained in the sub-prime market), or that “warehouse” lending from the big investment houses has been severely curtailed, or that Bank of America is now reviewing their risk posture in the mortgage market.
Gut instinct is one thing, but you get a definite sense of the breeze starting to shift.
