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Diane Francis

Diane Francis

Posted March 17, 2009 | 07:35 PM (EST)

The market bottom? no way Ben


Bank stocks had their best week on record last week and early this week as investors bet the bottom had been reached.
I don't think so and hope I'm wrong. It was a sucker's rally.
Optimism seemed to be based on the G20's pledge to collaborate and on Federal Reserve Chairman Ben Bernanke's estimate that the U.S. economy will probably emerge from recession this year.
But one of the best barometers about banks is the never-ending bailout of AIG which is really a taxpayer-funded flow through payment to its clients or counterparties, mostly banks, governments and pension funds.
So far the cost to American taxpayers has escalated from a two-year loan of US$85 billion from the Federal Reserve Bank in September to US$150 billion in December, then another US$30 billion this week.
But the cost to taxpayers has only just begun. The tab will likely hit at least US$447 billion in months or years, if not more. This is the amount that AIG underwrote, in the form of credit default swaps, to banks, pension funds, insurers and Wall Street firms.

AIG made gigantic bets against bond prices falling, insurance products against falling prices called credit default swaps, that it couldn't afford to make. So it securitized, or shared, the risk of default with Wall Street and other insurers, some of whom have also gone bust and had to be bailed out.
These outstanding credit default swap liabilities are the 800-pound elephant in the room that nobody wants to talk about. Some reports are that their gross contract value outstanding, or notational value, approached US$50 Trillion (as big the world economy as a whole), with a loss potential of between US$5 to US$10 trillion.

Dr. Doom drubs optimism
The recent market jump is a sucker's rally, or dead cat bounce, says Nouriel "Dr. Doom" Roubini.
He also disagrees with Fed Reserve Chair Ben Bernanke's estimate that the recession will end in 2009. Roubini says theUS recession could drag on for years without drastic action - action that nobody in Washington is contemplating.
"We are in the 15th month of a recession," said Roubini, a professor at New York University's Stern School of Business in a recent CNBC interview. "Growth is going to be close to zero and unemployment rate well above 10 percent into next year."
There is "no hope for the recession ending in 2009 and will more than likely last into 2010. Most of the U.S. financial institutions are entirely insolvent."
He advocates a temporary nationalization of all banks to clean them up and kick start the financial market again.
That will not be enough to get the economy going though, he added. All mortgages on real estate should be written down at once, rather than piecemeal. This will provide a collective revaluation like a bankruptcy workout.

Once those messes are mopped up he believes that the current stimulus package is not enough, at US$800 billion, because much of it is soft dollars, in the form of tax cuts which may or may not occur or make any difference.
In conclusion, he said that anyone who thinks a recovery will start in the second half of 2009 is "delusional". He forecasts the S&P 500 at 500 and the Dow at 5000.
In fact, based on Roubini's calculations, we could conceivably see the S&P 500 at 500, the Dow at 5000. They are currently at 760 and 7255 respectively.
Another measurement that the bottom may not be nigh is that price/earnings ratios for the S&P 500 stock index hit 12 times' by March. This is dramatically down from 44 times' in the bubble peak of 1999 but not as low as were P/E ratios in 1929 or 1982.

Diane Francis