Is This Another Bubble?

Richard Drew / AP Photo The markets are rallying as home purchases are up 10 percent—to a 6.1 million annual rate, the highest level since February 2007—and gold rose to a new high on the back of a weaker dollar. But Charlie Gasparino says it may be just another case of irrational exuberance.

It’s true—Wall Street loves unemployment.

How do I know this? When I speak to CEOs and others in the executive suites of our big banks, they tell me that if not for the unemployment rate heading toward 10.5 percent, the markets would never have recovered from their financial-meltdown lows. Business conditions are uniformly lousy, but the markets are surging because they are celebrating the government’s solution to high unemployment: easy money. The near-zero percent interest rate offered by the Federal Reserve is supposed to make credit cheap and allow businesses to expand. It hasn’t quite worked out that way, but easy money has made stocks more liquid because investing in anything else doesn’t pay. (Just check out 10-year bond prices.) So stocks will keep going up as long as interest rates remain where they are, and that’s why Wall Street loves high unemployment. Even as the number of jobless Americans continues to mount, the investment banks make money off free money.

“The advice I gave people when the Fed began to lower rates is buy into the market but get ready to sell when they reverse course,” said a board member of one large financial company.

But even Wall Street knows this scheme has got to end; the dollar is getting hammered and people are bidding up gold, all pointing to the growing realization that unless the Fed raises rates again, the dollar will soon be worth far less than a dollar. That’s why a growing number of senior Wall Street executives I speak to use the word “bubble” to describe the market’s recent rally, with the Dow Jones Industrial Average going from a low of around 6500 in March of this year, to comfortably above 10000.

It’s not that they’re pulling money out in any significant way—at least not yet. The banks are, however, poised to do so the minute they see the Fed begin raising its base “Fed Funds” rate, the interest rate that other interest rates take their cues from. That simple act will tighten credit and, so the theory goes, make it less advantageous to invest in U.S. stocks.

“The advice I gave people when the Fed began to lower rates is buy into the market but get ready to sell when they reverse course,” said a board member of one large financial company. “When will the Fed do that? I can’t tell you because the economic fundamentals are so bad they have to keep rates low, at least for now.”

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We may now finally be producing economic growth through an increasing GDP, but much of that growth is a function of the fact that things couldn’t get much worse. Beyond that, these big firms have put a hold on hiring, so in many cases they can make money just by sitting still.

Meanwhile, unemployment keeps rising because small businesses can’t get credit to expand from banks that are still holding toxic assets and may need more capital. Commercial real estate is heading into the gutter with the residential stuff. Other job killers include higher taxes on the “rich” and small businesses that are a given thanks to among other reasons, the latest new entitlement coming out of Washington, health-care reform.

Put all of that together and you have what Alan Greenspan once famously termed “irrational exuberance.” Stock touters might believe the Obama Administration that the economy has turned the corner and that the market gains are real, but some smart people I know who run firms and need to make payroll don't think so. In fact, they believe much of the market's gain can be attributed to the herd mentality of investors acting en masse, ignoring the danger signs and completely unaware of what's really propping up stock prices, which is the essence of a bubble. But the bullish herd has a way of changing course, and you don’t want to be standing in front of it when it does.

Charles Gasparino is CNBC's on-air editor and appears as a daily member of CNBC's ensemble. He is a columnist for The Daily Beast and a frequent contributor to the New York Post, Forbes, and other publications. His new book about the financial crisis is The Sellout.

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