The banking system got high marks from the Federal Reserve on the recent stress tests. Markets responded in Pavlovian fashion. So, what else is new?
A better question is why the favorable Fed report was considered a surprise? Matters are bad in the financial system, but they are unable to say so without jeopardizing matters more than they are. Did anyone expect the Fed to issue a negative report saying that everything done over the last three plus years had no effect or made matters worse?
The stock market took off like a jack rabbit with the Dow rising over 200 points. Rick Ackerman, in How High Can The Fed Pile Manure?, commented on this reaction:
… many on the Street, and even a contributor or two in the Rick’s Picks forum, were seeing cloudless skies at least till the election. “Money is going to be pouring into the stock market at the expense of other investments,” noted one forum regular, Gary L. “I now see the possibility of a 20 percent rise in the stock market year over year,” he continued. “If external factors don’t derail this trend, we are in a perfect sunny day lasting perhaps another nine months. This will make Obama’s chances of winning re-election an odds on favorite.” We’re not so sure ourselves, especially since the real economy that most Americans encounter in their day-to-day lives is wholly different from the sunny illusion being spun with increasing brazenness by The Powers That Be.
Zombie banks — Citicorp, Bank of America, Wells Fargo, etc. — were the big gainers.
The stock market reaction was a remarkable demonstration of how much people want to believe that the economic crisis is being solved. Investors apparently have reached their saturation point, where they are willing to believe anything positive, even when the belief is contradictory to what they witness every day. Despite unprecedented government intervention, there has been no meaningful economic improvement. This conclusion is especially evident when comparing this economic cycle with others. This one lasted longer and has shown almost no response to enormous stimulus.
The US financial system is irrevocably insolvent. The government has taken on more debt and made more promises than can be kept. This economic crisis should have occurred in 2001 or even earlier. The government kept postponing the crisis with easier credit and more stimulus. These ”fixes” over the last three decades literally papered over the problems and prevented the economy from making the necessary corrections to distorted prices and mis-allocated capital. All government did was postpone the day of reckoning, while ensuring the pain would be greater.
The imbalances in the economy are now so large that growth and the standard of living will continue below normal, perhaps even reverse. The house of cards has been kept standing, but is no longer functional in a meaningful economic sense. Conditions are no better outside the US. Europe is disintegrating. Japan is drowning in debt. Western democracies are insolvent, having over-committed to welfare state models that are unsustainable. A domino-like collapse will topple all welfare states at some point.
The New “Economic Policy”
The government, via the Federal Reserve, produced a temporary rise in market optimism. Nothing other than that has changed, but that