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Aversion Therapy


The disconnect between the consumer world and the financial world has rarely been as great as during the past two months. I can't recall a time when the consumer was less worried and the policymakers more worried about the markets.

For almost everybody, this clash seems too difficult to fathom. How can the


be worried when the auto companies are reporting blowout numbers? What's the deal with these rate cuts when the consumer is liquid and refi'ed? Doesn't everybody have a good job with a good wage?

Consequently, we keep thinking that not only does the Fed not have to ease, but it didn't have to do the last ease. Painfully, I can recall last Friday's discussion among

Jimmy Rogers


Mark Haines


Kathleen Hayes



where Rip Van Rogers (I call him that because he appears to be living in the days of the


deficits) was railing about how the Fed panicked needlessly. Haines and Hayes knew better and Hayes did her best to try to explain the exceedingly complex "institutional credit" problems in the system. But Rogers, intellectual bully that he tries to be, wouldn't even attempt to understand what the far-more-rigorous-thinking Hayes and Haines were getting at.

So, even though I have dipped into this topic before, I think it is worth exploring again. The Fed did not ease because of the consumer. The Fed did not ease because of the stock market. If the Fed eases next time it will not be because of the consumer, and it will not be because of the stock market. It has and might ease BECAUSE OF THE JAM IN THE INSTITUTIONAL CREDIT MARKETS and its intermediate-term effects on the economy here and abroad.

The overuse of leverage, as represented by the fiasco of

Long Term Capital

, changed the Street's thinking about leverage. The firms that create credit and issue debt no longer want to issue or finance large quantities of the stuff. If you are long

National Gift Wrap and Box

, a BB-rated borrower and mythically publicly traded company, and you want to finance an expansion so you can handle next year's Christmas selling season, you could, if you wanted to, tap the debt market for the $200 million that you might have needed for plant and equipment, pre-Long Term Capital.

So, if you went to

Remarc Capital Markets

, it would gleefully take you on and issue a bond, probably about 200 basis points over Treasuries. It would then place, or sell, this bond with its high-yield buying accounts. Or it would issue a piece of paper yielding 5% that converts into equity 20% higher than where the stock is traded. Either one would be fine. Maybe you would do both. People would gobble this stuff up like candy. The latter piece of paper would be bought and the buyer would short the common stock of National Gift Wrap and lock in a decent rate of return. (This is called convertible arbitrage.)

Then Long Term Capital dropped the bomb and nuclear winter settled in. Now, nobody wants BB paper, and the accounts doing that convertible arbitrage have lost a lot of money because of the wacky way that all of the National Gift Wrap-type convertible bond stuff already in the market plunged in value because of the loan calls issued by these brokerage houses that got religion. (Remember when all of those big banks revealed that they had no real exposure to hedge funds that wasn't collateralized? That was because they called in the loans!!!) Even though National Gift Wrap will almost surely not default on the bonds, that "type" of paper plummeted in value, because it had to be sold to meet the margin calls issued by the brokers.

Normally, Remarc Capital would be willing to take the risk that it can sell the bonds and if it doesn't, it would take some of the merchandise down itself and keep it in its own inventory. But Remarc also was playing the Long Term Capital game and was borrowing a ton of money, leveraging its own capital, to issue and take down a lot of paper just like National Gift's as well as National Gift's Russian analogue.

Now Remarc wants to shrink its balance sheet, it has the Long Term Capital heebie-jeebies. It is too risky to take on National Gift Wrap paper now. And no bank wants to show it has a lot of junk on its balance sheet right now when everyone is doing his very best not to look like Long Term Capital to either shareholders or regulators. National Gift Wrap can't go to the European banks or the Japanese banks. They are pretty tapped out, too. Yeah, they were doing Long Term Capital games, also. Maybe someone will offer to do a deal for National at a tremendous "spread" above Treasuries -- there's that word you keep seeing -- but National either doesn't want to or can't pay the 9% to 10% interest that might make the deal work.

Normally, National Gift Wrap would then tap the equity markets. However, the equity markets, as robust as they look, haven't been a receptive place to sell new merchandise. Perhaps, after several weeks of small-cap rallies, caused by the Fed's easing, that's too pessimistic. But I go by the stack of prospecti on my desk and right now there is no stack. Which means no National Gift Wrap secondary. For now. And chances are National's stock is so low it doesn't want to sell any equity anyway.

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So, you say, why does it matter? Short term, the consumer is liquid and the job market is plentiful. People are feeling reasonably good about the economy. But now the National Gift Wraps of the world are beginning to cancel their building plans for next year. They are cutting back on expansion. And it is by no means just the industrial credit market that has dried up.

I don't know if you heard the excellent interview with

Sam Zell

, a very smart real estate guy out of Chicago, on


in the afternoon, but Zell made it clear that very few developers right now can get money for reasonable projects like retail, apartment or office buildings.

Mort Zuckerman

, another giant real estate socialite, also said the same thing last week on

Squawk Box

. It's getting tough to get any sizable loan, including a jumbo mortgage, without paying a very high price that has very little relevance to where long-term Treasuries are trading.

The reason you do not notice this stuff right now is that the building going on around you, the robust plans you see being executed, were formulated before Long Term Capital, when funding was easy. Companies in this country don't fund on a second-to-second basis. Money being spent now was borrowed before the rules changed. It's the money that needs to be borrowed after this money is spent that will cause problems.

Of course, there is a way to grease the system and make borrowers more willing to lend and institutions more willing to take down National Gift Wrap's paper. Cut the short-term borrowing rates to much lower levels so Remarc won't get hurt that badly financing National Gift Wrap's paper if the market doesn't firm. Make it so accounts like

General Electric

(GE) - Get General Electric Company (GE) Report

, with great balance sheets -- and no, bears, I am not willing to debate that -- can finance all the interesting "junk" paper they want with cheap overnight money.

Then you enable National Gift Wrap to borrow and build. And you guarantee that come six months from now, the expansion continues, unabated, without layoffs and shutdowns. That's what the second ease was all about. Maybe a third is necessary if more credit isn't forthcoming.

Did the Fed panic? Oh, please. Worldwide meltdown beckoned. Still might. I don't think so, but it still might. We could use some insurance on this issue, as the policymakers were pretty scared themselves.

As I have said from the beginning of this Long Term Capital debacle, we still have no idea how close we came to meltdown. Had the Fed not acted, I believe we would have had colossal failures stemming just from Long Term. Long Term was three, count 'em, three failing Brazils all wrapped up into one elegant Greenwich office complex. They could have brought down the whole shooting match.

Why some magazine or newspaper hasn't done the giant 10,000-word takeout about this is beyond me. I know that on Terrible Tuesday, the day after the '87 Crash, the


did some crackerjack Pulitzer work on what happened that day to save the system.

Now's the time to do another so people understand what the brink was like. And I am not talking about some lovefest piece about a knight-in-shining-armor New York Fed guy who discovered in September what should have been known in July when

Salomon Smith Barney

blew out its copycat global arb unit causing the whole Long Term margin call spiral to begin with.

Until you accept that Long Term's missiles had already left her silos, you will continue to believe that the Fed hit the panic button. The Fed averted impact with its antiballistic second ease. If you don't believe that, you've got some Long Term history homework to do.

James J. Cramer is manager of a hedge fund and co-chairman of

Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to at