After the Market plummeted to begin the year, it staged a magical 4.9% week to finish January. Don’t believe the magic. In the following analysis I take a look at why last week should be described as the market’s emotional attempt at a bear market rally. To get a closer look at the financial sector, I took a lead from Mish at the Global Economic Blog but took it further. Here’s the scoop:
At the heart of all this and most evident at the time is sub prime. However, no one can really understand how bad it is until they see the crisis in charts. To quickly recap the damage it has wrought just take a look at the following year long stock charts: Moody’s, Countrywide, Citigroup and almost every other commercial bank… and the list goes on. This has been happening for some time now so people are predicting a bottoming out around now, hence the rally last week.
Mish pointed out this interesting chart a few weeks ago:
As can be seen on the chart something is not right. Moving back in time lets look at history:
The sharp decline of borrowed money from Depository Institutions, aka “the US banks”, is the result of massive sub prime write downs. A quick look can show you that this todays levels are unprecedented. No crisis has tested the reserve requirements of banks to such a massive extent.
The next closest circle, for comparison purposes, is the recession of 1991, aka the Savings and Loans crisis. The only time in history that financials have been sold off this much was during the Savings and Loans crisis of 1991, aka financial stocks are currently valued at the cheapest level in a long time. Notice how the reserves never went negative but in fact went up during this period. On simply a reserve basis, we can see that the financial stocks are overvalued, if they are selling at 1991 levels, assuming the magnitude of the subprime crisis is much bigger.
Then we have the recessions of the 1970s. In those times we saw an even bigger run up in housing prices and a bigger decline than what we have today. Here we see that although banks became net borrowers, it never and as rapidly amassed to such huge levels of borrowing from the Fed.
Finding this interesting, I decided to take a further look at the total non-borrowed reserves of depositary institutions.
http://research.stlouisfed.org/fred2/series/BOGNONBR?rid=19
Surprisingly, the huge drop off of reserves happened back in December, not January. Meaning the huge drop in reserves seen here does not take into account the massive borrowing from the Fed in January. Notice how no crisis has ever depleted reserves like this since before the 1960s.
From their latest, non graphed records we can go to:
http://www.federalreserve.gov/releases/h3/Current/
Here we find that the preliminary results for Jan 30th is -$8,751 billion. To make it more clear: The American financial system as a whole has non of the reserve requirements necessary, aka they have all been lost due to subprime losses and banks are now borrowing to meet demand withdrawals. To make it clearer: The money you withdraw from your bank next time is actually borrowed from the Federal Reserve. Also, the Fed is charging banks interest on that money. If this was graphed on the above chart the value would be negative for the first time since before the 1960s. Again, the blue line would actually cross the x-axis.
This shows that banks need to sell more than $40 billion in assets to meet the reserve requirement without borrowing. Taking into account that they managed to raise $84 billion in cash from sovereign funds and that $72 billion of losses will be triggered in the downgrading of a bond insurer alone and the picture does not look good for the financial industry.
However, it is important to note that generally the market prices in recessions well before they actually happen and stock markets generally go up during recessions. For the reason explained above and many others that will soon be discussed here, I have a feeling we are far from over this sub prime mess.
Monterroza Research 
