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Kass: This Rebound Can't Mask the Real Damage

The credit-market blowup should reinforce the need for skepticism always.

This story originally appeared on RealMoney Silver on Aug. 1, and is being reprinted as a bonus for readers.

At about 5 a.m. EDT Wednesday, a well-regarded


commentator suggested that, as in times past, the market has often recovered from abrupt and large down moves like we saw yesterday. (She seemed to be implicitly stating that buying the dip is a good idea.)

And, Tuesday, many commentators on

and elsewhere suggested that investors were ignoring the positive news -- citing past earnings growth, past share appreciation, etc. (basically a lot of pasts were used in this analysis) -- and were saying that the market's selloff was unjustified. The short squeeze (which quickly disappeared) in

IndyMac Bancorp


was even used as an example of overdone negative sentiment that could have broad and positive market implications.

I disagree on all counts.

What is the favorable news? Why should stocks have a Pavlovian move higher and reverse this morning's weakness? And what bearing does one stock (i.e., IMB) have on the whole?

The reality is that credit markets have (predictably) seized up and the credit cycle is in the process of normalizing. I have been concerned with this since December 2006, when I penned an

editorial that described the bubble in credit availability in



For a time, there was a

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disconnect between widening credit spreads and stocks. No more.

Risk is being repriced, the carry trade is being dissolved, illiquid assets are being forced to mark to market, hedge funds have started to be disintermediated and we are witnessing a worldwide margin call. And the folly of partial and conformational analysis of sentiment is being uncovered.

This is all occurring in what I have described as a tightly (and levered) financial system -- and why I thought on July 23 "

It's Time to Panic."

The past levering up and current panic was importantly abetted by the fund of funds industry, the dominant investor in the dominant investment class (hedge funds), which failed to analyze how and why many hedge funds reported such consistent investment returns -- especially of a collateralized debt obligation and collateralized loan obligation kind.

The greatest risk is in our financial intermediaries that drank the credit Kool-Aid served up by the mortgage brokers, the investment brokers/bankers and the


, which kept interest rates too low for too long.

In looking at the dominant financial companies I have often written about and in quoting the lesson taught to me by my friend, bubby and pal, former

Institutional Magazine's

No. 1-rated bank analyst,

Mark Biderman, during adjustments in risk premiums, it is not the "apparent" level of earnings (or net interest spreads) that are important; it is credit quality that is the culprit and, at times, the system's fundamental undoing.

Does this all mean that our investment world is coming to an end?

No, it does not. We could get a rally at any time. But the experience of the last two weeks should be a lesson learned. And that lesson is that a healthy amount of skepticism should provide the backdrop to all of our investment decisions -- in good times and in bad times.

"We have met the enemies, and he is us."


At time of publication, Kass and/or his funds had no positions in any stocks mentioned, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $6 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."