From this little piece, I must have gotten two dozen requests to do a rewrite. As I am from the "customer is always right" school (unless you send me a nasty email), here goes.
People, the bond market is bigger than the stock market.
(About 10 times bigger. And far more important to the way business is done in this country. It is the lifeblood of business, not the equity market, and it provides the day-to-day cash for many enterprises large and small.)
The problems are in the bond market, not the stock market. Right now, the
could give a %^$#&^^#%&^# about the stock market. If it saves it, that's a moral hazard that the Fed will have to pay the price for. It will.
(I could not believe how many people told me I was nuts for saying this. Except our fixed-income readers -- they all applauded this piece as the first piece that told of the real plight. They know the truth. You can't float a bond in this environment. In fact, the last piece of paper that got done of any size was that giant Worldcom (WCOM) offering. Boy that could never get done today. We hear hints of the problems. Ascend (ANSD) and Lucent (LU) advance capital -- people like it from Lucent, hate it from Ascend. But you never read about the real pain in this market. It has always been like that on Wall Street. The day I first interviewed at Goldman Sachs, I was amazed to find that equities, at the most important equity house on Wall Street, were virtually Lilliputian compared to bonds. All the real big money came from underwriting. As the bull market took off, it got even worse. The big money came from securitization of different pieces of credit, car mortgages, house mortgages, credit-card mortgages. You name it. These giant pieces of paper were sold and sold aggressively. That's where the real money was. The underwriting fees from the issuers were enormous. But you could trade these pieces of paper and take 1/8th, as they say, and make millions. I never made as much money selling stocks as I did with bonds. Ever. And bonds always sell like hotcakes because people have to own them. Pensions have to own them. Retirees have to own them. They can take every piece of paper ever made and sell it -- even that Milken junk. Until now. Now, there is no money. Now, there are no buyers. That's the point of this article. By the way, Treasuries used to be sold aggressively when the government used to print them like newsprint. You could make pretty good money taking 1/64th on those! And what the heck is Jimmy Rip Van Rogers talking about? Our government doesn't do this stuff any more. We are skinflints. Have been since Clinton got in. I am no fan, but he's gotten the bond market right, for certain.)
I keep reading that the worst is over. It may be in the stock market. But the bond market? Heck, it is just beginning.
(In other words, the marginal buyers of everything but treasuries were, for the most part, accounts that looked and acted exactly like Long Term Capital. When you buy stocks and you want to leverage, you can borrow up to half of the value of the stock. When you buy bonds, you can repo them, get more money, leverage that and leverage it some more. Heck, you can borrow 10 times what you have. And if the Fed and the lenders turn a blind eye, you can borrow 20 times. And if the ex-Fed guys are involved and the lenders are invested, we know now you can invest 100 times your money. Or their money. Or whatever money you may be playing with. This market was like that scene upriver in Apocalypse Now when Martin Sheen is asking those soldiers at night "Who is in charge here?" and they turn to him and say "You are." Sure, nominally the Fed in New York is in charge, but that's a whole other story, one that no one is willing to do because it is too hard. Bond traders have always acted as if they had the full faith and credit of the U.S. government behind their purchases. Turns out they don't have the faith or the credit of anybody. Since Long Term Capital, what has happened is that no firms want to lend you money to finance bond inventories. If you are sitting on a giant inventory of bonds and you are Fannie Mae undefined, that's cool. You have no financing problems. But if you are anybody else, believe me, you need some financing to keep all of that inventory. In normal times, you could sell off what you had to sell if the lenders want their capital back that they lent you to take down bonds. But these are not normal times. The lenders want their money back, as they are all capital-constrained right now and are trying to slim down their balance sheets -- they basically loaned way too much, every brokerage house loaned way too much -- and the borrowers can't sell the fixed-income junk they have because the brokerage desks won't bid for the stuff and every other buyer is full up. So, one by one, these big players either liquidate via auction at prices that are barely able to keep them in business, or they default and lose the whole ball of wax, or they file bankruptcy a la Criimi Mae (CMM) . The numbers are staggering. We are talking billions of dollars in loans from brokerage houses that can't get paid. To make matters worse, the brokerage houses already have billions upon billions of dollars in inventory. And they are sitting on pieces of Long Term Capital's inventory. And nobody has the capital or the inclination to buy this stuff except at vastly reduced prices. As the crisis is worldwide -- all of the major banks in Europe were in this, and the Japanese were in too -- and simultaneously everybody wants to shrink his balance sheet -- there has been no movement in the market whatsoever. If the sellers elect to sell at the prices that the brokers are bidding, they will be forced to mark their other positions down to where they will have even less collateral, which will beget more margin calls, which will beget more forced selling. It is a real Mexican standoff. So, one by one, these holders of paper wither or default.)
That's where the layoffs and the shutdowns are occurring.
(Not only are the brokerages all trying to shrink their balance sheets, they are all trying to shrink these departments. They may not need all of those fixed-income traders and salesmen because there are no new issues to sell, nobody to sell them to right now as everybody just wants plain old Treasuries, where very little money is being made trading and selling because it has become so competitive and there are so few 30-year auctions, where all of the juice -- mark-ups, commish, whatever -- was to begin with. So, inexorably, everyone of these firms wants to fire people, streamline fixed income and get these incredibly expensive people off their books. It will only get worse when the bonuses, if there are any, get dispensed next month. Then I imagine we will see real bloodshed.)
That's where the market that has ceased to function.
(No one wants to take down any inventory. No one wants to extend financing. So, imagine a housing market with no new houses being created and no mortgages available so you had to pay with cash. Would you want to be a realtor, a contractor, a developer in that market? That's what the bond market looks like right now: a giant, multitrillion-dollar housing market with no mortgages available.)
Let me write that again: ceased to function.
(This is why I branded Bankers Trust in denial. This is why I wish that there were many more people writing about Long Term Capital instead of the equity market. This is why, except for Tom Wolfe, nobody seems to even know where the real masters of the universe used to reside. They resided in the bond market, not the stock market. And they are no more. And the people, the vast number of people you see downtown, are not needed anymore either.)
As that market is only about 10 times as important to the U.S. economy as the stock market, we should not gauge the stock market's strength as a measure of whether the Fed should be worried.
(Remember, it is not just the corporate bond market that is frozen. It is the collateralized security market -- mortgages, car loans, credit cards. It is the emerging debt market -- that's just vanished, vaporized, without a trace. It is the municipal market, nothing cooking there. Heck, even commercial paper has dried up. There is nothing for these people to do except eat pizza all day.)
If this freeze continues, a month from now, you could go to the fixed-income floors of the major firms on Wall Street and turn them into bowling alleys.
(I am not being overly dramatic. These people are dead men walking if this thing doesn't turn around soon. And those who follow stocks won't know the difference.)
There is still no liquidity. No credit. Nothing.
So, if you think the Fed is done easing because the market rallied 1,000 points, you are looking at the wrong market. It's the fixed-income market, stupid.
(Yes, there is a solution to all of this. You cut the rate that everybody borrows at overnight to some minimal level, say 3%, such as we had in 1990-91. That makes it more likely that these firms can finance inventories without going belly-up. Easier money in the form of lower rates would make much of this paper more attractive to buyers. It would solve the inventory problem. It would solve the credit problem. If it is not solved, we will have a bad recession. That is written. I don't care what the economists/talking heads say, this logjam gets broken or we go into recession. But the logjam is broken by making the overnight rates dramatically cheaper, so inventories of illiquid bonds don't cost much. The Fed, in its initial ease, hoped that the problems weren't as systemic as they turned out to be. Worldwide bond market shutdown isn't good for anybody. And it can be changed. The rates are low in Japan, but no banks have enough capital to finance inventories of bonds, and they are already financing real estate that loses value by the day. So it has to be us. We are the only ones who can break the logjam. Heck, if it causes the stock market to shoot up, so be it. We have no choice. Greenspan knows this. Now. That's what the second ease said. Why is no one else writing about this crisis? Maybe because they don't have any friends in the fixed-income business. I have tons of them. I know what's going on, and I don't want them to lose their jobs because of this crunch. But they will if the Fed does not ease big and fast. Amazingly, everybody who trades at the multimillion-dollar level, where corporations are financed, knows this. But no one in the press has a clue, and the talking heads they present seem equally oblivious. This is like if the Dow were to have dropped to 4,000 points overnight, except more stark, because the Dow would not yield 12% at these prices like many of these bonds do.)
That's what you should be paying attention to.
(How do you follow this day to day? Read the credit columns. Look for new issues. If you see a pickup, that's good news. But I don't think you will.)
If it still exists.
(Yeah, remember, bonds are capitalism. Stocks are offshoots of bonds. Stocks can do well in the very environment described, provided the corporations don't need financing and have big cash flows. Right now, corporate America is very liquid, so we don't see the problems yet. But if we wait around, we will. The Fed knows this, though. I got very negative on stocks when I did not think the Fed understood what I am describing in this very column. How could they? The New York Fed, which is supposed to monitor this stuff, was too close to Long Term Capital to see the problems. But, believe me, they know it now. And they can solve the problem. Which is why I am no longer bearish. Can't be. Not on equities. Not given the easings that the Fed will have to do put the fixed-income markets back to work again.)
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com.
At time of publication his fund was long Bankers Trust, Fannie Mae and WorldCom, although positions can change at any time. 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 TheStreet.com at
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