Understanding The Gobal Financial Crisis Upon Us

Bank losses on Fannie, Freddie stock apparently underestimatedAccording to a survey conducted by the American Bankers Association, nearly one-third of U.S. banks hold preferred stock issued by Fannie Mae and Freddie Mac. Nearly all $36 billion of such stock was cleaned out when the Federal Reserve took the mortgage giants over. "The negative impact on banks -- particularly Main Street community banks -- is far greater than regulators first thought," Edward Yingling, CEO of the ABA, wrote in a letter to the Treasury, the Federal Reserve and other banking regulators. Financial Times (23 Sep.)

SEC's Cox says "voluntary regulation doesn't work"Securities and Exchange Commission Chairman Christopher Cox said during a Senate Banking Committee hearing Tuesday that "voluntary regulation doesn't work." He said he is seriously concerned that no government agency has regulatory authority over investment banks. He wants the SEC to be granted authority to require disclosure statements as well as power over products such as credit-default swaps. InvestmentNews (23 Sep.)

Analysis: Privacy in market for credit-default swaps led to problems: No one truly knew the volume of trading in the market for credit-default swaps, possibly leading to overinsurance in the sector. That, in turn, fueled the financial crisis. "The pressure to hedge has led the most liquid contracts to overshoot, in effect pricing in absurd default risks and recovery rates," according to a Financial Times analysis. Financial Times (23 Sep.)

To fund those deficits, we're going to have to borrow an ASTRONOMICAL amount of money. The Treasury just held a record $34 billion sale of 2-year Treasury Notes. That was followed by a $24 billion sale of 5-year Notes, the biggest such sale in more than five years. Those numbers will only go higher with time.

White House, Congress agree on rescue proposal President George W. Bush's administration and congressional leaders came to terms on a $700 billion rescue plan for the financial system. The House and Senate will likely vote on the legislation this week. Many of the plan's mechanics were left to the Treasury, including how much the government would pay for toxic assets and which assets would be bought. The Treasury has 45 days under the bill to issue guidelines regarding those procedures. Read the draft proposal. ClipSyndicate/Bloomberg (29 Sep.) , The New York Times (28 Sep.) , Financial Times (29 Sep.)

In fact, Congress is raising the federal debt ceiling to a whopping $11.3 TRILLION to account for this additional borrowing.

The likely impact: All the additional supply will drive bond prices LOWER and interest rates HIGHER. Heck, 10-year Treasury Note yields have already surged from around 3.4% to almost 3.9%. That will blunt the impact of the bailout by driving financing costs higher on all loans whose rates are benchmarked to Treasuries. I’ll bet they will be lower interest rates soon to counter act this unwanted effect. (Bernanke lowered them on Oct 21st.)

Rescue plan defeated on Capitol Hill; Dow falls 777 points Despite pleas from President George W. Bush and leading lawmakers from both parties, the U.S. House of Representatives voted 228-205 against the $700 billion rescue plan. The development sent markets plunging -- the Dow dropped 777 points -- and left leading lawmakers scrambling. Only 65 Republicans, or about a third of those voting, supported the plan, while 140 Democrats, about 60%, said yes, although many voiced concerns. Both presidential nominees, Sens. John McCain and Barack Obama, supported the bill. ClipSyndicate/Bloomberg (29 Sep.) , International Herald Tribune (29 Sep.) , The Economist (29 Sep.) , The Wall Street Journal (subscription required) (30 Sep.) , Bloomberg (30 Sep.)

U.S. financial ills spread to Europe and beyondAbout a week ago, European leaders rejected calls from U.S. counterparts to join their economic-rescue effort. Now Europe is facing a financial crisis nearly as dire as the American situation. The turnaround of events shows just how quickly problems are spreading. "In this day and age, a bank run spreads around the world, not around the block," said Thomas Mayer, Deutsche Bank's chief European economist. "Once a bank run is under way, it doesn't matter anymore if you have good loans or bad loans. People lose confidence in you." International Herald Tribune (01 Oct.) , Reuters (01 Oct.)


Lack of confidence sends Libor to record levelWhile stock markets around the world suffer steep declines, the overnight dollar Libor surged to 6.88%, an indication that lenders are concerned that money they lend to other financial institutions may never been seen again. "The reason Libor is so elevated is a lack of confidence between counterparties in the financial sector," said Charlie Diebel of Nomura. The situation forced central banks to inject billions into the system. Telegraph (London) (01 Oct.)


Manufacturing contracts faster than expectedThe measure of American manufacturing activity marked its first significant decline of the economic downturn. The index of the Institute for Supply Management has been hovering for most of the year on what economists call "the boom-bust" line." "The headline ISM has plunged into recession territory," said Ian Shepherdson, chief U.S. economist at High Frequency Economics. The New York Times/The Associated Press (01 Oct.)

Credit-card debt may be next to slap finance sectorInnovest StrategicValue Advisors predicted that credit-card debt is the next wave to crash against the financial sector, saying banks will charge off $96 billion in delinquent accounts in 2009, twice the forecast for 2008. Gregory Larkin, senior banking analyst for Innovest, said all of that bad credit is going to surface rapidly, and he predicted that credit-card charge-offs will mimic those of mortgages. MarketWatch (30 Sep.)

SEC extends ban on short salesTo give Congress more time to pass the $700 billion economic-rescue plan, the Securities and Exchange Commission extended the temporary, emergency ban on short selling in nearly 1,000 stocks. The ban will continue until three business days after the rescue package is enacted, if it gets approved. But the ban will not last past Oct. 17. Reuters (01 Oct.) , Financial Times (02 Oct.)

FDIC seeks unlimited-borrowing authorityThe Federal Deposit Insurance Corp. asked Congress for temporary authority for unlimited borrowing. The request was in the U.S. Senate's bailout legislation. The 451-page bill would raise the limit on federal bank-deposit insurance from $100,000 per depositor to $250,000. Reuters (01 Oct.)

Commercial paper sees biggest weekly drop since 2001Data from the Federal Reserve show a stunning $95 billion drop in commercial-paper investment, the biggest weekly reduction in six years. The shrinkage in commercial-paper financing raises fears of serious cash-flow problems for corporate borrowers and banks. Freezing of the market is hitting even highly rated companies, including General Electric and AT&T. Financial Times (02 Oct.)

"Ghost of deflation" haunts marketsAs banks tighten credit, commodity prices plummet and asset values decline, the world may be turning from the dangers of inflation to the risk of falling into a vicious deflationary cycle. "The ghost of deflation could be dragged out of the closet again in coming months," said Joerg Kraemer, chief economist at Commerzbank in London. David Owen, chief European economist at Dresdner Kleinwort in London, agreed, saying, "We are certainly more worried about deflation than inflation." Bloomberg (06 Oct.)
U.S. plans bold moves to shore up financial system

The U.S. Treasury Department plans to invest as much as $250 billion in banks and guarantee newly issued bank debt for three years to battle the financial crisis, officials said. The Federal Deposit Insurance Corp. will guarantee all deposit accounts that do not earn interest. Capital injections will come from the $700 billion rescue package approved earlier this month. President George W. Bush is expected to announce the plan Tuesday. ClipSyndicate/Bloomberg (14 Oct.) , International Herald Tribune (14 Oct.) , Bloomberg (14 Oct.)

Economic slowdown clamps lid on runaway commodity pricesWorld prices for wheat and corn have dropped 40% since spring, oil is down 44%, and metals such as aluminum, copper and nickel have fallen by a third or more, as financial panic brings the commodity bull market to an end -- at least for the moment. This sudden about-face is the brightest news on the horizon for consumers because it puts money into their pockets at a time when they really need it. The New York Times (13 Oct.)

The world is on notice.

Several of the world's Central Banks launched a determined and coordinated attack against the widening global financial crisis by lowering short-term interest rates in unison last week.
The Federal Reserve Bank, the European Central Bank, the Bank of England, Canada, Sweden, Australia, and Switzerland all cut short-term interest rates by a half percentage point.
Across the Pacific Ocean, the People's Bank of China, Australia, South Korea, Hong Kong, Singapore, and Taiwan cut interest rates, too.

This is the first time that central banks have moved in unison since the September 11 terrorist attacks, and I think it is just the start of global government efforts to keep the global economy from further deterioration. Then, over this past weekend, we saw additional coordination from the U.S. and European Central Banks: The Fed, the European Central Bank, the Swiss National Bank, and the Bank of England all saying they would provide unlimited U.S. dollar funds to financial firms.


2 kinds of investors

Academics and economists deal in a world populated by rational investors. Unfortunately, we live in a world populated by behavioral investors. Rational investors look at the turbulence in today’s markets and calmly evaluate the potential risks and rewards of remaining invested. Rational investors do not confuse certainty with safety. They recognize that, although the principal value of funds invested in Treasuries and CDs may be certain, after factoring in taxes and inflation, the return they receive on their “safe” portfolio they realize that it may fall woefully short of what they need to maintain their standard of living in retirement.

This is not so for behavioral investors. They see the frightening headlines and are bombarded minute by minute on the radio, television, and internet with financial crazy making. The result is all too often a growing panic that leads them to seek the mythical “safety” of dumping stock and running to cash. Which one are you?

A bit of perspective

If the Central Banks were our kids, we'd be taking their credit cards away. They are spending us into the poor house!

Sure, Wall Street is at the rotten root of this crisis. Their toxic debt is poisoning the global economy and financial system. But there's plenty of blame to go around.

It makes you wonder just how big that $700-billion bailout package will need to be, now that they've expanded it from buying toxic debt to buying preferred shares in banks. All this new spending is in addition to the $1.8 trillion in total government bailout money since the financial crisis started.

Maybe we won't get those higher prices in gold right away, because investors are scared of deflation.

On the other hand, throwing trillions and trillions of dollars at the system is inherently inflationary.
Do you think Beijing thinks that the dollar's status as a reserve currency is soon going to be history. Just like the pound sterling lost its status as the world's reserve currency in the early 20th century.
Beijing's bank is overflowing with money. In fact, at nearly $2 trillion, China has the largest foreign reserves of any country in the history of the planet.

That's why they're going to back the yuan with gold ... loads of it. China has already started purchasing small amounts of gold.

Economists say U.S. housing market nowhere near bottomHome prices across most of the country are likely to continue falling through the end of 2009, economists said, and in some markets may keep falling even longer, depending on how bad the slowdown gets. In the hardest-hit states such as Arizona, California and Florida, the story is the same: More houses are going up for sale while escalating interest rates on mortgages, falling wages and rising unemployment are putting pressure on an already-diminished pool of possible buyers. The New York Times (15 Oct.)

IMF raises estimate of losses from crisis to $1.4 trillionIn its quarterly report on global capital markets, the International Monetary Fund increased its estimate of losses from the financial crisis to $1.4 trillion, up from $945 billion in April and $1.3 trillion last month. The IMF also estimated that major global banks will need approximately $675 billion in capital in coming years. "The combination of mounting losses, falling asset prices and a deepening economic downturn has caused serious doubts about the viability of a widening swath of the financial system," the IMF said in its assessment. International Herald Tribune/Reuters (07 Oct.)

Consumer borrowing sees first fall in more than decadeConsumer borrowing fell at an annual rate of 3.7% in August as households scaled back their use of credit drastically, according to the Federal Reserve. This is the first time that consumer borrowing fell in more than 10 years. Although economists expected a $5.25 billion increase in August from July, borrowing was instead down $7.88 billion, totaling $2.58 trillion. The New York Times/The Associated Press (07 Oct.)

The government is throwing everything ... and I do mean EVERYTHING ... at the credit and mortgage markets. But rates on 30-year fixed loans aren't going down. They're going up.

How can rates be going up when the economy is tanking and the government is throwing everything it can at the banking sector and credit markets?

Because bond investors are dumping the heck out of bonds — and when bond PRICES fall, bond YIELDS (interest rates) rise.

Why are investors selling bonds? Well, they just learned that the budget deficit soared to $454.8 billion in fiscal 2008, which ended September 30. That was more than double the $161.5 billion deficit in 2007 and the highest in the history of the country.

Politicians and policymakers would like you to think they can make things better, drive mortgage rates down, save the banking sector, and return us to the happy-go-lucky, reckless lending days of 2003-2007. But they can't. Well, they can and just today they lowered rates by another ¼ point… but the bond market is pushing back and saying loud and clear: "We can see the writing on the wall, there will be too much supply of future government bonds and too little demand, they are out of there."

Federal deficit takes back seat to stabilityConfronted with a hugely expensive economic crisis, Democratic and Republican lawmakers alike elected to pay the bill for a bailout by borrowing money rather than cutting spending or raising taxes. The problem lurking in the shadows is that while borrowing is relatively inexpensive in a weak economy with plummeting interest rates, the cost will become a much heavier burden when growth returns and interest rates climb. The New York Times (19 Oct.)

Job losses hurt every corner of U.S. economyLayoffs are spreading beyond the financial and home-building sectors to every corner of the economy, with the situation likely to worsen as the holiday season approaches. A survey of more than 100 chief financial officers and other senior executives found that 58% expect to reduce payrolls next year, while a majority plan to cut operating costs by at least 5%. A four-week moving average of new U.S. government jobless claims hit its highest point last week in seven years. Reuters (17 Oct.)

Bernanke backs another stimulus packageCongress would be wise to start thinking about another fiscal-stimulus package to pull the U.S. out of a long downturn, Federal Reserve Chairman Ben Bernanke said. Predicting an economy "likely to be weak for several quarters," Bernanke explicitly endorsed for the first time another stimulus package. For months, Democrats have been pushing for a second round of stimulus measures, targeted to domestic construction projects, expanded food stamps and broader federal spending to help states pay for growing health care costs for the poor. Reuters (21 Oct.)

And so it goes…