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Subprime Housing Market Financial Sector Crash and Jim Cramer's Sage Rage

Stock-Markets / Financial Crash Aug 06, 2007 - 11:59 AM GMT

By: Brady_Willett


In what is quickly becoming one of his most popular television tirades to date (which is saying a lot), Jim Cramer completely lost it last Friday during a discussion on CNBC. Coined a "passionate plea to Federal Reserve Chairman Ben Bernanke to consider cutting interest rates" , the incensed Cramer said: "It is no time to be an academic... open the darn Fed window. He [Bernanke] has no idea how bad it is out there. He has no idea! He has no idea! I have talked to the heads of almost everyone single one of these firms in the last 72-hours and he has no idea what its like out there. None!!!...

My people have been in this game for 25-years, and they are losing their jobs, and these firms are going to go out business...and he's [Bernanke] nuts. They're [The Fed] nuts . They know nothing!!!...The Fed is asleep. Bill Poole is a shame. He's shameful!'

To summarize, some of Cramer's wealthy friends are losing their jobs because too many bad loans were made during the good times, and the Fed is now expected to bail everyone out. Sound about right?

The first problem with Cramer's rant is that his sentiments go against comments he penned in ' The Lie That Will Kill Hedge Funds '. In this commentary Cramer calmly discussed how mortgages are packaged into bonds, purchased by arbitrate managers using leverage and, in recent months, how these loans/hedge funds have started to blowup. The following quote will suffice:

"You will hear a lot of chatter about "the resetting of risk premium" right now. And it is true. But what's really going on is lying prices. These strategies didn't take into account the risk of default. The agencies didn't take it into account. The packagers didn't. The homebuilders that relied on it didn't...

This process is playing out everywhere, and the government isn't going to bail out these hedge funds. The good news is that it will happen fast. The money will come out, the losses will be big, but these hedge funds will all be closed by year-end. Trillions will vanish. But then we will start all over again.

Once this whole process is understood, the casualties, including some banks and some homebuilders and almost all mortgage companies except Countrywide (CFC) because it has a bank and lots of other businesses and is not a pure broker, will be taken. By November, this will be over."

How Cramer can go from offering thoughtful analysis on the subprime/credit problems plaguing the financial markets to attacking Bernanke and Poole as out to lunch academics isn't entirely clear. Back in 2000 - as the bear started to bite and Cramer called for bottoms and picked soon to be doomed stocks - he contradicted himself on a weekly or monthly basis. Apparently hours, and a mild sell off on Wall Street, is all it takes today.

The second problem with Cramer's antics is that his attack is misdirected. To be sure, it was former Fed Chairman Greenspan who did nothing as the housing bubble took shape, as regulators openly questioned suspect loans being made, and as hedge funds acquired a preposterous amount of clout in the financial markets. Here are Greenspan's three mistakes - discussed in 2005 - to help add some color to events transpiring today:

" Greenspan's greatest mistake was not doing anything on the regulatory front to help ensure the long-term stability of the US financial markets...

Greenspan's second mistake is that his policy of ignoring asset bubbles as they form and 'aggressively easing' when these bubbles meet resistance has helped create a situation wherein people always expect the Fed to save the day . That the expectation of omnipotent Fed management engenders irrational investment decisions is not so much a question after 18-years of Greenspan, but a fact of investment life.

Greenspan's third mistake - which can only be validated at some point in the future - was/is his failure to recognize that the speculative forces allowed to fester in the late 1990s were not expunged by declining stock prices, but merely dispersed into other stock and assets classes. As Greenspan took the Federal Funds rate down to 1% and effectively taxed savers into riskier investment vehicles he did so under the assumption that post-bubble insurance was required to avert a Japanese style bust. What Greenspan did not consider was that his actions might create a larger and even more menacing credit bubble that will need to be reckoned with on a later date. "

As the credit bubble Greenspan helped create meets resistance it is not surprising that many are expecting the Fed to save the day. Given that Greenspan waved his magic rate-cutting wand many times before, why can't Bernanke do the same? However, what is surprising is that Cramer - fully aware that the subprime/hedge fund blowups are not likely to peak until at least October - wants Bernanke to act now. Does he not realize that Fed action now could have the unintended consequence of prolonging the pain?

When Will Bernanke Ride To The Rescue?

Even if Bernanke is strictly adhering to the Greenspan bailout script, the type of financial calamity that warrants Fed intervention has not yet come to pass. Moreover, there are other things for Bernanke to consider, many of which Greenspan never had to be concerned about. For example, the U.S. dollar is critically weak, commodity prices are no longer influenced solely by U.S. economic activity, and asset prices around the world have, albeit perhaps temporarily, gained independence from the U.S. markets. It is not as simple as saying some firms on Wall Street are hurting so it is time to start easing.

With all of this said, it would naive to think that Fed will stand idly by if the financial markets continue to tank. As much as Bernanke wants to be regarded as an inflation fighter there does come a point when failing to provide a timely injection of liquidity could have a devastating impact on investor confidence and the U.S. economy. In other words, given that we are probably a major hedge fund bust or stock market meltdown away from the Fed entering the fray, the seemingly psychopathic ramblings of Jim Cramer could prove oddly prescient of future events, at least until he changes his mind.

By Brady Willett was launched in January of 2000 with the mandate of providing an alternative opinion on the U.S. equity markets.  In the context of an uncritical herd euphoria that characterizes the mainstream media, Fallstreet strives to provide investors with the information they need to make informed investment decisions. To that end, we provide a clearinghouse for bearish and value-oriented investment information, independent research, and an investment newsletter containing specific company selections.

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