Waking up early Tuesday morning, I had what can only be described as a "Jenga epiphany." I must admit, it was sort of uncomfortable at first. But when it had fully dawned on me what it meant, a light bulb went off: The über-bears were about to get pounded.
And being on the bearish side myself, I realized that in some regards I was suddenly on the wrong side of that bet.
The Bear Stearns collapse wasn’t the beginning of the end, but the end of the beginning. The next phase, in all likelihood, would be a market that would begin to regain its footing.
The Bernanke playbook, in other words, was hitting its final strides.
The Bear Stearns Collapse Puts the Fed on the Offensive
So what’s the heck is a "Jenga epiphany," you ask?
Well, not surprisingly, it relates to the popular children’s game called Jenga. And if you’re familiar with the game, then you’ll know what I’m talking about.
It’s a game that centers around an inherently unstable tower comprised of wooden blocks that are stacked up one upon the other. The goal of the game is to take turns removing the blocks until the tower becomes so rickety that it collapses.
The loser, of course, is the person that makes the tower fall. Holding the tower up is expressly against the rules.
That was my analogy on Friday when the Bear Stearns news hit the streets. The pegs were coming out faster now and the tower was about to collapse.
And when the news broke on Sunday that Bear Stearns was being sold off to JP Morgan for a measly $2 a share, I began to think that it really was coming down this time. Dow futures had plummeted and a 500-point down day looked certain.
I mean, here was Bear Stearns, a company with $84 of book value only days ago, being liquidated for $2 at the behest of the Fed. It couldn’t end well.
But a funny thing happened on the way to that market collapse. The markets closed green instead.
My Jenga moment, then, was when I realized that the Fed had no intention of playing the game by the rules. They would use both hands to hold the tower up instead.
So now pegs–lots of pegs–could be removed without bringing the entire tower down.
And in that moment I realized that the game had changed entirely. A systemic financial collapse–the holy grail of the über-bears—had been taken off the table. The Fed simply wouldn’t allow it.
So in one fell swoop, the "big crisis"–a total meltdown–had bottomed.
Bernanke Rewrites the Rules
The master stroke, of course, lay in breaking the old rules. Ending 70 years of Federal Reserve tradition, Bernanke now was extending the same Fed guarantees to Wall Street investment banks that it had always extended to commercial banks.
That was huge. It was a signal that the Fed was now backstopping everybody that mattered in the game.
In fact, the rule change was so big that by Tuesday, a three-quarter point rate cut had become something of a sideshow. Bernanke, it appeared, has acted decisively this time.
And while some may continue to insist that the Fed has only deepened the "moral hazard" by backstopping this apparent abyss, that’s a tough sell now, especially for the employees and investors of Bear Stearns. Moral hazard or not, Bear Stearns is no more, its market cap cut to ribbons and its employees out of work.
As for the rest of the financials, the message couldn’t have been any clearer. The truly insolvent, like Bear, will be liquidated, and the rest will go on. But these moments won’t be enough to take the tower down entirely.
Of course, that doesn’t mean that we are out of the woods now–not by a long shot. A recession is a given. Home prices will still decline. And inflation will continue be troublesome. The economy and the markets will remain under pressure.
But here’s the key: None of this will be enough to make the über-bears right, either. We will bend but not break.
The truth, in other words, will be found where it usually is–somewhere in between.
So forget Dow 10,000. It’s not going to happen.
But be warned. The financials are still something to be wary of. The Fed simply won’t save them all–only those that can be saved. And if you know for sure who they are, then you’re way ahead of me. More meltdowns are given, then, especially for all things housing related.
Nonetheless, I’ve suddenly become considerably less bearish and a little more bullish. And I owe it all to that light bulb on Tuesday morning.
The tower’s not coming down after all, and fighting the Fed at this point is nothing more than a loser’s game.
It’s time to nibble instead, by picking up some of the bargains left behind in the rubble.
Systemic financial collapse is off the table. That’s a big win for the markets.
The long slow climb back has begun.
By the Way: Here’s what former Fed Chairman and inflation hawk Paul Volcker had to say about the situation a few nights ago in an interview with Charlie Rose:
Rose: Has [the economy] bottomed out, or have we seen the worst?
Volcker: Look. The basic economy is not irretrievably damaged in any way, shape, or form. We had to go through an adjustment, which is tough. It’s happening much quicker. You’d rather have it happen gradually. But I’m optimistic that, OK, we’ve got to get the consumption down, we’ve got to get spending in line with our capacity to produce. I think that’s going on. And that process is going to take a while. If we can stabilize the financial market, we ought to come out of this. Then we’ve got a lot of work to do about what we do with the regulatory system, the supervisory system, what the role of the Federal Reserve is, what the role of the Treasury and the government is, because this is a different financial market.
Smart guy, Volcker. And he is right you know. When this is over, we do need to take a serious look at all of the players that caused this mess and fix it.
Your down-off-the-ledge, bargain-hunting analyst,
Steve Christ, Editor