The best explanation for the continued unrelenting rise in stock prices and other risky financial assets, is simply that the Fed and Treasury have removed all risk and accountability from the financial system. In so doing, they have destroyed any ability to price financial assets, and in the process have actually layed capitalism to rest.

This is, of course, may or may not be a good thing. Only time will tell. One thing is clear, though:
With all notions of risk removed from major financial institutions, there is now, in theory, no upper limit on financial asset prices.

Recent Reports Provide Continued Evidence of the Removal of Risk and Accountability for Major Financial Institutions

The evidence for the abandonment of risk metrics and acccountability in financial markets is in the SIGTARP’s report, which is available here:

http://www.sigtarp.gov/reports/congress/2009/July2009_Quarterly_Report_to_Congress.pdf

(Note: As is detailed in the SIGTARP report linked to above, insider trading by major financial institutions is now encouraged by the Fed and Treasury).

Another recent article in the Financial Times, also highlights the fact that the Fed purposely allows Wall Street firms to profit by front-running the Fed, even as the Fed remains the primary buyer in critical financial marketplaces, such as mortgages.
See the Article here: http://www.ft.com/cms/s/0/e84383dc-7f8c-11de-85dc-00144feabdc0.html

What is clear from the SIGTARP report and from a variety other sources, is that the government has, and continues to fork over enormous sums of capital to major financial institutions with absolutely no oversight, and more importantly no risk! Pretty much any sort of garbage or fictitious asset can be passed to the Fed at any price.

Without Risk any Price is a Fair Price and Capitalism Ceases to Function

However, if there is no risk to buying a financial asset than any sort of valuation or pricing is meaningless.

If endless capital is available to major economic entities with zero risk, there can be no notion of risk/reward. Without risk/reward the pricing of financial assets makes no sense. If there is absolutely no risk in paying for a particular asset, and capital is available at any price to pay, than any price is a fair price. Why not pay 50X cash-flow for a company, if your investment entails no risk? And if 50X is not risky, than why not 200X? And ad infinitum…

In such a case, capitalism ceases to function, since there is no longer any logical meaning to the basic tenets of capitalism, such as risk/reward, and market pricing. Basically, any price is the right price and all profit is guaranteed. There can be no pursuit of profit, if profit is guaranteed!

The only logical outcome of such a scenario is a staggering rise in prices, such as is now being experienced across all financial markets.

Warning: Don’t Run Out and Pay Any Price

Be forewarned, though, that the death of capitalism, and the new paradigm of “Any Price is a Fair Price”, is not an invitation to go out and buy stocks at any price. The reason for this is simply that the government is only removing risk from financial institutions, not individuals. So individuals still face enormous risk when buying financial assets, especially since there is no longer any ability to price these financial assets. In other words, for all intents and purposes, capitalism, competition, and hard work, still exists for Main Street, though it has been dismantled for Wall Street.

Nevertheless, understanding the new economic paradigm is helpful in devising some failsafe investment strategies, that I’ll get to in another post.

Will Asset Inflation Translate into Hyperinflation for Real Goods? It’s Possible, but Unlikely at This Point

Another worry for individuals, is the possibility of asset inflation crossing over into the “real” world and leading to hyperinflation for basic human necessities. While, this sort of situation can’t be ruled out, I’m no longer certain it is a major imminent danger, precisely because the financial nirvana now gripping Wall Street will never “trickle down”, for reasons that I’ll also discuss in a future post.

However, it is 100% certain that if the Fed and Treasury do not reinstate capitalism into the financial markets, in due time, paper inflation will quickly cross over into the real world and prices for basic good will rise by a staggering amount. The trouble, of course, is that the Fed and Treasury can only reign in asset inflation by causing a financial crash. And who’s ready for another crash just yet?