Despite equity market euphoria, the worst is ahead for stocks, the economy and credit

Equity prices will decline anew, not only testing old price lows but setting new ones. The US and global recession will worsen. Unemployment will continue rising. The consumer will sharply curtail spending. Commodity prices will trend lower, with gold a possible exception. Credit will remain constrained. That all adds up to persistant and intense problems for financial institutions, business, governments and consumers. The worse is yet to come. I cannot make it any clearer than that.

Treasury yields will decline anew, though a return to the zero rate on Treasury bill yields on the panic flight to quality this past week is unlikely. A decline in inflation fears is likely to outweigh the increased volume of Treasury borrowing, at least for a year or possibly two beyond the recession. The Fed is virtually certain to be forced by circumstances to ease further.

Quality yield spreads will widen. There will be additional financial institution bankruptcies. Indeed, the Administration will be looking for financial bankruptcies to accept, those that do not threaten to destroy the global financial marketplace. The Admistration still wants to subscribe to the view that bankruptcies serve a useful purpose in capitalism, as well as avoiding the appearance of promoting the so called "moral hazard" risk that even incompetence will be bailed out. Losses are likely to force the FDIC to borrow from the Treasury to shore up its asset base. The Federal effort to quarantee money market funds will benefit brokerage firms at the expense of banks.

Corporate profits will erode, even with the slide off in commodity prices. The reason of course is that global demands for goods will slacken, intensifying competition. There has been a speculative over-expansion across the globe. Even China has its share of vacant speculative real estate. So far there is no proposal to significantly ameliorate soaring US home foreclosures and forced US bank sales of such foreclosed properties. The FDIC ended foreclosures at Indymac, the bank it siezed. Such a moritorium on foreclosures of occupied homes when homeowners were making good faith efforts to be current on their mortgages was the pattern when the FDIC was first organized late in the depression. It is time to resurrect that practice.

Do not be misled by the spectacular equity market rally toward weeks end and the lessening in the flight to quality amidst pronounced credit market fears. It will not last. The favorable Thursday and Friday market developments were largely due to a panic short-covering rally on a temporary ban on shorting 799 financial equities (until October 2) and market relief on the proposed $700 billion two-year Resolution Trust Company-type Federal bailout of Wall Street, as well as other forms of financial institution problem solving. The heart of the proposal is the Federal government purchase of up to $700 billion of the possible two to four trillion dollars in distressed mortgages and other related financial instruments currently worth 80 cents or far less on the dollar. The purchases will relieve the pressure on beleagured financial institutions. At the same time it is hoped that the distressed assets will eventually improve in value and price so that the net loss on the Federal purchases are minimal. The Federal entity will presumably not be subject to the disasterous mark-to-market rules that deprive non-Federal corporations of capital.

As far reaching as the new intiatives may seem, the favorable market responses thus far are likely to prove only temporary. Even if the Treasury-Fed proposals are enacted, by no means a certainty, they will not address the deepening global recession, the continuing real estate price contraction and the still intense credit crunch. And they will not solve all the financial industry problems. Far from it. The bailout or takeover of AIG will turn out to be more the exception than the rule. Rather, the acquisition of Merrill by Bank of America is more likely to set the pattern for the resolution of further distressed financial institutions. Thus, the equity market rally is best viewed as a welcome opportunity to raise cash. Even the perennially bullish Jim Cramer of CNBC Mad Money recommended selling twenty percent of your equity holdings on Monday, especially of newly reflated financial institution stocks.

The necessary deleveraging of the debt-bloated financial industry will continue. The requirement to write down the market value of depressed assets even when there is no effective market for those assets under the pernicious mark-to-market rules remains a destructive force in the viability of financial institutions. Thus, unless mark-to- market write downs are at least temporarily suspended, the need for substantial new capital infusions will persist, a prerquisite for recognizing losses. Despite the proposed Federal purchases of distressed assets, the sales of those financial assets will still be at considerable losses. Credit growth will thereby remain contrained. And with credit growth the key determinant of economic activity, that credit contraction will comensurately depress economic growth.

The signs of deepening recession abound. The index of leading indicators is still falling. Industrial production is dropping. The consumer is retrenching. The housing sector is still deteriorating. Home prices nationwide are only down about half as far as they will ultimately fall. Car sales will weaken further. Indeed, the recession will likely persist throughout 2009 and perhaps into 2010. That exceptionally prolonged recession will markedly slow the rate of inflation, both overall and core.

Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731

E-mail address:philipbraverman@Gmail.com