We Should Live - Ben Bateman

We got our bounce.

All the indexes are showing higher daily highs and lows over yesterday. Today’s highs were in the same general range as the highs from day before yesterday. In a less scary market I would be tempted to anticipate a few days’ worth of bull market with some little credit spreads on uptrending stocks.

But the news is grim. During the day I heard a news report about financial companies looking to foreign governments to shore up their balance sheets before they announce earnings, many of which apparently come next week. The subprime losses continue, and there may well be more blood in the water just before next week’s expiration. So it’s no time to be Pollyanna and play bullish. The market’s future is grim, folks. Probably not grim forever, but definitely for the next few months.

The news report I heard was vague on which companies were scrambling to hide subprime losses.  Charles Schwab (SCHW) reports earnings on January 14th.  Then Citigroup (C), US Bancorp (USB), State Street (STT) and JP Morgan Chase (JPM) all release earnings on January 15 with Wells Fargo (WFC) on the 16th.   Merrill Lynch (MER) announces on the 17th.  Financial heavy-hitters SLM financial (SLM), Suntrust Banks (STI) and Capital One Financial (COF) all release on January 23rd, with Bank of America (BAC) and Wachovia (WB) coming on the 22nd.

This is a great chance to illustrate something that confuses many investors.  When you hear about different companies by name, it’s natural to assign them roughly equal subjective weight.  But that’s wrong.  The publicly traded companies include huge companies and little companies, and it isn’t always easy to distinguish them.

For example, Drudge is running a big banner story right now about rumors of big losses at Merrill Lynch (MER).  To the typical news consumer, this sounds like a big deal, because they know what Merrill Lynch is.  It’s the sort of company that they might do business with.  But when you put pencil to paper, it isn’t that big of a fish in the financial pond.

A reliable and easy way to measure the size of a publicly traded company is its market capitalization, abbreviated as market cap.  This is simply the number of outstanding shares multiplied by the price per share.  In theory, it’s the value that the market has placed on the company.  I’ve ferreted out the market caps of all the companies listed above.

Merrill Lynch (MER) market cap: 43 billion

That’s a lot of money for you and me, but it’s dwarfed by some other big financial companies:

Dow component Citigroup (C) market cap: 136 billion
Dow component US Bancorp (BAC) market cap: 172 billion

JP Morgan (JPM) market cap: 135 billion

Wells Fargo (WFC( market cap: 91 billion

SLM market cap: 7 billion

USB market cap: 50 billion

COF market cap: 18 billion

WB market cap: 66 billion

STT market cap: 32 billion

STI market cap: 21 billion

Running the numbers on market caps also gives some idea of the scope of the subprime crisis.  On this date a year ago, Countrywide Financial (CFC) had a market cap of 23 billion.  Today the market cap is 3 billion.  The losses in this subprime mess are huge, much bigger than ordinary investors understand, and possibly bigger than most politicians understand.

Tonight I watched part of the GOP debate, and Romney said that we needed to “stop the housing crisis.”  I groaned.  What ignorance!  (Or cynicism.)  There is no fix for this problem.  Financial institutions thought that these mortgages were valuable, and on that basis they loaned money out into the rest of the economy.  And not just the US economy.  The world economy.  Now those assets aren’t worth nearly what those banks thought, so they will need to lend less until they bring the total of their outstanding loans down to an acceptable multiple of their assets.

I can think of only one way to present a bright side: This is only a bubble—so far.  Basically, the economy has been growing on lending that was in turn based on assets that weren’t really there.  We saw economic growth that shouldn’t have taken place, because it was based on a misperception of the value of those mortgages.  So now, hopefully, theoretically, the market will fall to the low-growth point where it would have been had everyone understood what their assets were worth.

It’s normal for markets to experience periodic bubbles like this, but only government intervention can really screw things up.  As banks make fewer and fewer loans to fix their loan-to-asset ratios, political pressure will mount on the Federal Reserve, and other central banks, to throw more money into the economy.  But more money won’t fix anything on the long term, because the problem isn’t that banks don’t have enough money to lend.  The problem is that banks don’t have the assets to justify the loans, and there’s no way for the Fed to dream up valuable assets where none exist.  But the Fed can distribute too many dollars in trying to “do something” about the falling stock market, and in so doing the Fed will inflate away the dollar’s value.  Then we could see some economic problems much, much bigger than the bubble that’s popping around us right now.

DISCLAIMER: You should not invest real money in the stock market.  If you do, then big mean men (possibly including myself) will seize your life savings and spend it on luxury yachts.  You should keep your money in cash under your mattress where it will seem safe—unless you understand inflation.  You also shouldn’t listen to anything I write about economics, because I probably don’t have the slightest idea what I’m saying.