-->Credit Bubble Bulletin, by Doug Noland

Climbing the Wall of Water
March 14, 2003

We have reached the point where there is no turning off the Credit excess, no turning off the GSEs, no turning off the Mortgage Finance Bubble, no turning off the destabilizing world of derivative trading, and no turning off the rampant financial speculation and its increasingly destabilizing effects. It is truly one massive Bubble running out of control. And let’s not ignore the reality that these frightening financial convulsions are symptomatic of an extremely sick system. One of these days there will be a life-threatening seizure. What we have here is an historic circumstance of a dysfunctional monetary regime and a central bank that will defend it at all costs.

I have in the past used a flood insurance analogy in an attempt to explain how derivatives - an inexpensive market in flood insurance - increase risk by fostering a building boom along a river. I also “updated” A Derivative Story awhile back, ending the tale abruptly with torrential rains falling, near chaos in the flood “re-insurance” market, and increasing homeowner panic along the river. Well, devastating floods and resulting financial collapse were fortunately averted. Specifically, the community made it through the panic after a bold government official guaranteed that the authorities would “take extraordinary measures” to stop the flood waters before damage initiated a vicious spiral of financial and economic collapse. The authorities began working frantically up the river, using whatever materials and means available to construct dykes, dams and levees. These efforts saw the river level recede and, quite favorably, the rain let up for a few months.

However, the torrential rains soon return, although, curiously, this time there is little panic in the insurance marketplace. The players sleep well at night with the knowledge that the authorities are on the case - up the river working diligently to hold the water at bay. Down river in the community the water level rises only minimally. And, much to the delight of everyone, the insurance market remains open for business and prices remain uncharacteristically stable. The trepidation and angst that had become the rainy day norm, has been replaced by calm and optimism. (Those incessant naysayers are shocked by the complacency) What’s more, in the midst of the rainy season the community is emboldened to increase construction. With the river level rising only moderately and the insurance market functioning splendidly, the litany of homeowners, builders, bankers and insurers come to a consensus that it has become practical to build well inside the 100-year flood plane. The insurers are emboldened by now tested assurances from the authorities - they promised and delivered. Homeowners, witnessing newfound stability and inexpensive prices in the insurance market, have been relieved of one of their greatest worries.



And while the energized community gets back to business as usual, up the river the make-shift dams and levies grow only taller and less stable. There’s one hell of a Wall of Water rising steadily, inches by the day. With no viable alternative, the authorities just keep stacking sand bags, one after one, day after day, week after week. A few now regret that they did not settle for a less than catastrophic flood some time ago. But most expect it to stop raining soon and then everything will be ok. But what about the ever-Climbing Wall of water? Order more sandbags and keep it a secret.



Well returning to reality, what a strange week in a most extraordinary period. On Tuesday, Harry Dent and James Glassman appear on CNBC to commemorate the 3-year anniversary of the NASDAQ Bubble peak. Instead of appropriate contrition, both made it sound like, while admittedly a little bumpy, things are progressing about as they expected toward Dow 36,000 and The Great Boom Ahead. And then on Wednesday viewers witnessed Milton Friedman calling for the legalization of insider trading, which really makes about as much sense in today’s environment as his monetary theories. But the lunacy was not confined to CNBC. The schizophrenic stock market had the wheels coming off Wednesday morning, only to miraculously engage in four-wheel drive for Thursday’s melt-up. And, all the while, we countdown the days to a war opposed by much of the world community. This is a much different world nowadays than it was not all that long ago.