The First Stock Market Crash of 2008

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog: http://www.youtube.com/watch?v=CCt8d6zsjQI

Monday witnessed the biggest point drop in U.S. stock market history. While the carnage was brutal, it was by no means final and the market bottom is still waiting for us somewhere in the future. Some of the worst hit stocks were the financials (down around 13% as a whole), despite the ban on shorting them - a ban that was imposed by the SEC because manipulative traders were supposedly driving their prices down artificially (so much for that theory). Gold, the ultimate safe haven in times of crisis, was up over $20, while economically sensitive oil dropped an even greater percentage than the Nasdaq.

While the point drops were the greatest ever yesterday, the largest percentage drop is still the 1987 crash when the Dow fell 22.6% in one day (the Dow dropped 23% in two days in 1929). The Nasdaq's drop of 9.1% (200 points) yesterday can't match that drop, nor can the S&P 500's drop of 8.8% (107 points) or the Dow's drop of 7.0% (778 points). Both the Dow and the S&P would have dropped more if the ban of shorting financials didn't exist and may have even exceeded the Nasdaq's losses. As has been the case for a few months now, small caps fared better than the big caps. The Russell 2000 fell only 6.7%, less than all the other major indices.

Examination of the intraday charts show that even though the market was mostly falling the entire day, there were two notable periods of sharp selling. The markets opened on a sour note because of three major bank failures here and in Europe and continued dropping gradually until it became apparent that the Wall Street bailout bill would fail. Then the floor fell out. Only five minutes later the Dow was down and additional 400 points (and the other indices a proportionate amount). Stocks quickly attempted a recovery in immensely volatile see-saw action and started drifting down again toward the end of the day. The Nasdaq hit an air pocket at the close, dropping 35 points in only a minute. The Dow, because of the market making system on the NYSE, couldn't print a final quote at 4:00 because of unresolved trades. There were huge sell-on-close orders (institutions were desperate to get rid of stocks) the last of which were processed at 4:15. The Dow fell around 200 extra points during this extended closing action.

It is not surprising that gold went up while the stock market was tanking (if you look back at what happened the day of the 1987 crash, you will see that a number of gold mining stocks actually were up on the day, there were no ETFs at that time). Not only were traders buying gold yesterday because of the crisis in the financial system, but there were also inflationary reasons as well. The U.S. Federal Reserve pumped $630 billion in liquidity into the system on Monday. This was planned before the Wall Street bailout bill failed and was being done because of the bank failures that had taken place overnight. This amount of liquidity is enormous (and possibly the most ever) and under ordinary circumstances would have resulted in a huge stock market rally. Apparently ordinary circumstances no longer apply to the U.S stock market however.

NEXT: The Next Banks and Brokers to Cash Out

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

A Bridge Loan to Nowhere - the Wall Street Bailout Plan

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Videos Related to this Blog:
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As I write this the U.S. House of Representatives has just defeated the Wall Street bailout plan.

On Sunday, the final details of the bill emerged from the fetid backrooms of the nations capital. After intense negotiations congress and the administration managed to put together the costliest and least effective piece of legislation ever to emerge from Washington D.C. The Emergency Economic Stabilization Act of 2008 was supposed to free up the credit markets and get banks lending again. Yet there were no provisions, no mechanism, and no requirements in the bill that would have made this happen. In exchange for their $700 billion dollars, American taxpayers were guaranteed nothing - and they were likely to have received it in abundance.

Even if the bill had had some means in it to revitalize the U.S. banking system, this still would not have happened. The simple reason for this is that the bailout was much too small to have had any significant impact. At no point in the verbose discussions and pontifications in the congressional hearings did anyone specify approximately how large the problem was that this bill was trying to address. I personally had no problem of finding an estimate of $13 trillion of bad loans (which I think is much too low). The Treasury, the Fed and the congressional research staff either couldn't determine this number or didn't want to discuss it publicly. If they had, the absurdity of this latest government endeavor to deal with the credit crisis and its real intent as just a give away to big Wall Street banks would have become immediately obvious.

To make the bailout more palatable, the cost tag was divided into three parts: $250 billion immediately, $100 billion additional at the discretion of the president, and another $350 billion unless congress decided to rescind it (fat chance of that ever happening). The Treasury secretary, not exactly someone known for his good judgment and lack of corruption, still would have had wide leeway in deciding who got the money. Inexplicably, loans up to March 14, 2008 were eligible for government purchase, even though the credit crisis was front page news starting in late July 2007. Why wasn't that the cut off date set for eligible funding?

According to government press releases, the plan was supposed to prevent the big money from profiting big time from the bailout. In reality, the bill insured that this would happen. The bill specifically made banks that acquired assets in a merger or takeover (this includes JP Morgan, Bank America, and Citibank so far) eligible to dump the bad assets they acquired on the taxpayer. This provision was also a de facto bailout for the FDIC, which would itself be bankrupt as of today because of the failure of Wachovia, if it didn't exist.

The taxpayers were supposedly protected in the bill because the government would get some ownership rights in companies that had their bad debts purchased. Rights in a company that fails - and most if not all of these companies will fail - are of course worthless. If after five years the government is facing a loss in the program, the president was required to 'submit a plan'. How submitting a plan would magically restore lost money from out of business companies was not detailed in the bill description.

What about caps on the $50 million dollar paydays for Wall Street executives? The bill created some 'tax restriction' on earnings above $500,000 and imposed some 'limits' on golden parachutes. What those 'tax restrictions' or 'limits' were, seemed somewhat vague. Executives that received huge bonuses in the past were not required to return any of the money before a company received bailout funds from the taxpayer, even if those bonuses had been obtained under false premises.

What direct benefits and new protections would the people paying for the bailout get? The average investor, pension holders, homeowners, people on Main Street in general, those who suffered because of the bad decisions of Wall Street companies weren't to benefit from the government's largess at all - they were only supposed to pay for it.

NEXT: The First Stock Market Crash of 2008

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Three Bank Monty - Monday's Global Bank Failures

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The nationalization of the world's banking systems took a big step forward on Monday, with major bank failures happening in the U.S., England, and the European continent. In all cases, the respective governments are getting a piece of the action. While it is generally acknowledged that socializing anything will lead to inefficient operations, general dysfunctionality, and substandard practices, apparently the governments of a number of developed economies have decided that socialized banking is an important component of the solution to the current economic crisis. These are of course the same geniuses that created the government policies that allowed the current economic crisis to take place and then remained completely oblivious to them as they unfolded.

In the U.S., Wachovia now no longer exists. Only last week it was the fourth largest American bank. Over the weekend the FDIC 'facilitated' troubled financial giant Citigroup's purchase of Wachovia's banking operations. Wachovia's own demise can be traced back to its takeover of mortgage lender Golden West Financial in 2006. Citigroup is supposed to be absorbing $42 billion in Wachovia's losses, but this will not happen if the banking bailout plan passes because the bill states that the taxpayers pick up the tab in such circumstances. The FDIC is supposed to cover any remaining losses and in exchange for doing so will get $12 billion in preferred stock. Nevertheless, in a statement that seems to lack both truth and consistency, the FDIC said that the Wachovia bailout won't cost its deposit insurance fund anything. Even though Wachovia's stock fell to 91 cents in Monday's before the bell trading (under one dollar is the market's statement that a company is insolvent), the FDIC claimed the Wachovia did not fail. If you believe that, you are also likely to believe that a pile of manure is a mountain or roses. Wachovia is indeed the largest bank failure in U.S. history (at least for now).

While Wachovia was collapsing in the U.S., the Benelux countries (Belgium, Luxenbourg and the Netherlands) had to bailout Fortis NV with a $16.4 billion cash infusion. In return, the three governments will get a 49% stake in the bank. The demise of Fortis should be seen as a derivative implosion similar to that which brought down U.S. insurance giant AIG. Fortis has had to write down its credit default swaps (CDOs) by 78% so far and this essentially made it insolvent. As was the case for Wachovia, the downward spiral for Fortis was also caused by it taking over a financial company with a dicey lending book. Fortis was part of a three bank consortium that purchased ABN Ambro in October 2007 (long after the credit crisis was front page news). The lead bank in that consortium, Royal Bank of Scotland, is on New York Investing's likely to fail bank list and its stock was down 11% in early Monday trading.

England doesn't have to wait for a future bank failure however. The British government on Monday was forced to nationalize Bradford and Bingley, taking over its $91 billion mortgage operation. The Brits also paid Spain's Banc Santander $33 billion to 'facilitate' its purchase of Bradford and Bingley's savings business. Bradford and Bingley specialized in mortgages for rental properties and it was reported that there had been no income verification for at least 17% of its loans. This was the second bank nationalization in England, Northern Rock was the first, and followed the government arranged purchase of HBOS Plc by Lloyds TSB Group only nine days ago. It is quite obvious that it will not be the last either. Total mortgage lending in Great Britain has fallen 95% (yes 95%) in the previous month. A credit collapse of this magnitude makes the dislocations of the 1930s Great Depression pale in comparison.

NEXT: A Bridge Loan to Nowhere - The Wall Street Bailout Plan

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Ron Paul on the Wall Street Bailout Plan - Part 2

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Today's Blog: Congressman Ron Paul's insights on the proposed Wall Street bailout

Washington's current approach to today's credit crisis is the same destructive strategy that government tried during the Great Depression: prop up prices at all costs. The Depression went on for over a decade. On the other hand, when liquidation was allowed to occur in the equally devastating downturn of 1921, the economy recovered within less than a year.

F.A. Hayek won the Nobel Prize for showing how central banks' manipulation of interest rates creates the boom-bust cycle with which we are sadly familiar. In 1932, in the depths of the Great Depression, he described the foolish policies being pursued in his day - and which are being proposed, just as destructively, in our own:

Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years [late 1920s], all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion.To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection - a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end... It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the [1930s] depression.

The only thing we learn from history, I am afraid, is that we do not learn from history.

The very people who have spent the past several years assuring us that the economy is fundamentally sound, and who themselves foolishly cheered the extension of all these novel kinds of mortgages, are the ones who now claim to be the experts who will restore prosperity! Just how spectacularly wrong, how utterly without a clue, does someone have to be before his expert status is called into question?

Oh, and did you notice that the bailout is now being called a "rescue plan"? I guess "bailout" wasn't sitting too well with the American people.

The very people who with somber faces tell us of their deep concern for the spread of democracy around the world are the ones most insistent on forcing a bill through Congress that the American people overwhelmingly oppose (calls to the capitol have been running up to 100 to 1 against the bailout). The very fact that some of you seem to think you're supposed to have a voice in all this actually seems to annoy them.

NEXT: Three Bank Monty - Monday's Global Bank Failures

Daryl Montgomery

Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Ron Paul on the Wall Street Bailout Plan - Part 1

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Today's Blog: Congressman Ron Paul's insights on the proposed Wall Street bailout

The financial meltdown the economists of the Austrian School predicted has arrived.

We are in this crisis because of an excess of artificially created credit at the hands of the Federal Reserve System. The solution being proposed? More artificial credit by the Federal Reserve. No liquidation of bad debt and malinvestment is to be allowed. By doing more of the same, we will only continue and intensify the distortions in our economy - all the capital misallocation, all the malinvestment - and prevent the market's attempt to re-establish rational pricing of houses and other assets.

Wednesday night the president addressed the nation about the financial crisis. There is no point in going through his remarks line by line, since I'd only be repeating what I've been saying over and over - not just for the past several days, but for years and even decades.Still, at least a few observations are necessary.The president assures us that his administration "is working with Congress to address the root cause behind much of the instability in our markets." Care to take a guess at whether the Federal Reserve and its money creation spree were even mentioned?

We are told that "low interest rates" led to excessive borrowing, but we are not told how these low interest rates came about. They were a deliberate policy of the Federal Reserve. As always, artificially low interest rates distort the market. Entrepreneurs engage in malinvestments - investments that do not make sense in light of current resource availability, that occur in more temporally remote stages of the capital structure than the pattern of consumer demand can support, and that would not have been made at all if the interest rate had been permitted to tell the truth instead of being toyed with by the Fed. Not a word about any of that, of course, because Americans might then discover how the great wise men in Washington caused this great debacle. Better to keep scapegoating the mortgage industry or "wildcat capitalism" (as if we actually have a pure free market!).

Speaking about Fannie Mae and Freddie Mac, the president said: "Because these companies were chartered by Congress, many believed they were guaranteed by the federal government. This allowed them to borrow enormous sums of money, fuel the market for questionable investments, and put our financial system at risk." And of course, by bailing out Fannie and Freddie, hasn't the federal government shown that the "many" who "believed they were guaranteed by the federal government" were in fact correct? Doesn't that prove the foolishness of chartering Fannie and Freddie in the first place? Doesn't that suggest that maybe, just maybe, government may have contributed to this mess?

Then come the scare tactics. If we don't give dictatorial powers to the Treasury Secretary "the stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet." As for home prices, they are obviously much too high, and supply and demand cannot equilibrate if government insists on propping them up. Left unsaid, naturally, is that with the bailout and all the money and credit that must be produced out of thin air to fund it, the value of your retirement account will drop anyway, because the value of the dollar will suffer a precipitous decline.

NEXT: Ron Paul on the Wall Street Bailout Plan - Part 2

Daryl MontgomeryOrganizer,

New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

This Week's Largest Bank Failure in U.S. History

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our videos related to this posting:
http://www.youtube.com/watch?v=qfpE0wAz-nA
http://www.youtube.com/watch?v=ZIxTlP5FU_Q

Last night, Washington Mutual became the biggest bank failure in American history when it was closed by the Office of Thrift Supervision (its $307 billion in assets dwarfs the previous record holder, Continental Illinois, which had only $40 billion in assets) . The FDIC was immediately named as receiver and it just as immediately sold Washington Mutual to JP Morgan Chase. The only surprise in Washington Mutual's failure was that it took place on a Thursday instead of the usual bank seizure day Friday (the situation must have really been desperate), although based on news reports, the CEO seemed to have been unaware that it was going to happen. There was a major surprise however in that the FDIC claimed that it will not have to pay any money out of its deposit insurance fund because of the failure (this doesn't mean that the money isn't going to be paid, see below for some insight into the latest scam that the U.S. government seems to have going).

The New York Investing meetup first predicted Washington Mutual would go under last April and again in our September meeting (it was amazing it was still operating at that time). Its impending failure was an open secret in the last few weeks. A slow run on the bank followed, with $16.7 billion (or approximately 12%) of deposits being withdrawn since September 15th. While filings indicate that Washington Mutual had $143 billion in deposits at the end of August and deposits were likely dropping in the first 15 days of September as well as after, the government stated in its takeover press release that Washington Mutual had $188 billion in deposits (interesting arithmetic, but typical of the U.S. government).

Washington Mutual had all the major markers of a bank likely to go under - a huge drop in the stock price (down 95% from the high yesterday); option ARM and subprime lending (as much as half of its $227 billion in loans; massive losses ($3 billion in the last quarter alone) and write downs; a fired CEO; way above average interest rates to get deposits (5% for one-year CDs), and incidents of capital raising. Unlike other failure prone banks, Washington Mutual had only one major capital raising event because the terms granted private equity firm TPG made it impossible to raise additional funds. TPG agreed to rescind those terms a couple of weeks ago, but too late to save the $7 billion it funnelled into the doomed Savings and Loan last April (once again the 'smart' money doesn't seem so smart after all). There was even an additional augur of Washington Mutual's impending end that can not be reliably counted on - S&P downgraded it to junk status on September 15th and then again to even lower junk status on the 24th (with ratings as low as C, only one step above the minimum possible D, which means default). Kudos to S&P for finally downgrading a company before it went out of business.

As for the terms of JP Morgan's takeover, they are quite interesting to say the least. JP Morgan agreed to pay $1.9 billion for the acquisition (similar to the price it paid for Bear Stearns). It has no obligations to Washington Mutual's equity, senior, or subordinated debt holders, all of whom will be wiped out. It is going to have to take a $31 billion write down for Washington Mutual's bad loans however. This figure is approximately what the FDIC would have had to pay out of its deposit insurance fund because of Washington Mutual's failure. It is doubtful though that JP Morgan will really suffer the full cost of this write down. It not only has a major account with the Federal Reserve, but its CEO, Jamie Dimon, has a seat on the New York Fed's board and gets to vote on decisions that could be very helpful to his bank. Somehow, I think the Fed will make sure that JP Morgan is taken care of.

NEXT:

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Pinnochio's Reflection in Washington's Crystal Ball

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

Dire warnings of a bleak economic future for the American economy have been prognosticated by Fed Chair Ben Bernanke, Treasury Secretary Hank Paulson and President Bush in the last few days - unless of course their proposed emergency Wall Street bailout plan is passed immediately by the U.S. congress. These statements represent a complete turnaround of what the three of them have been saying during the last year and as recently as a couple of weeks ago. This immediately raises the question of whether they were lying then or are they lying now? To be fair, it is possible that Bernanke, Paulson and Bush have not purposefully been lying, but they just don't have the slightest idea of what's going on. Regardless of whether their behavior can be explained by dishonesty or incompetence, they have assured us that if we just follow their lead now, everything will be OK.

The consistent message from the economic triumvirate this week has been that a recession will be taking place in the future along with increased unemployment, home foreclosures, and bank failures unless congress gives $700 billion to the big Wall Street banks. In his testimony on Tuesday, Ben Bernanke bluntly warned of this scenario. He followed up with, "the financial markets are in quite fragile condition and I think absent a plan they will get worse". In his testimony, Paulson suggested that the fallout from the credit crisis would hit almost everyone in the pocketbook unless forceful action was taken.

President Bush in his speech on Wednesday night echoed Bernanke and Paulson's concerns and while requesting the biggest corporate bailout in U.S history made the following obviously insincere statements:

1. "I'm a strong believer in free enterprise ..."
2. "I believe companies that make bad decisions should be allowed to go out of business."
3. "This rescue effort is not aimed at preserving any individual, company or industry."

Like Bernanke, Bush was also worried about the stock market going down and specifically stated that without the bailout, "the stock market could drop even more". But he assured the nation there was no need to worry if his recommended actions were taken because "the plan is big enough to solve a serious problem" and "we expect much, if not all, of the tax dollars we invest will be repaid". If you believe that, I have a bridge in Brooklyn that I would like to sell you.

The reality is that $700 billion is not going to be able to deal with an estimated $13 trillion in toxic debt and that only the most worthless of this debt will be transferred to the government in this bailout. There is no chance whatsoever for the taxpayers getting their money back. Furthermore, the U.S. is already in a recession and the government has been jiggling the figures to hide it and that recession is going to get worse along with unemployment, home foreclosures and bank failures regardless of what bailout package is passed by congress. And you may assume that Bernanke, Paulson, and Bush know perfectly well that this is what's going to happen.

NEXT: This Weeks Largest Bank Failure in U.S. History

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Buffett Sacks Goldman

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

While Ben Bernanke and Hank Paulson were making the case before Congress on Tuesday as to why the free markets can't work in the current credit crisis and how only a nationalized banking system can save the day (the early communists would have been proud), the man who knows more than anyone about how to make money was showing them up for the buffoons that they are. Warren Buffett provided Goldman Sachs with some desperately needed cash, and in return he got one of the good deals that he is famous for. Buffett's move is only the beginning of the big money cashing in big time if the bank bailout goes through.

Goldman Sachs became a more desirable holding for Buffett over the weekend when it, along with Morgan Stanley, became a commercial bank. With this action the era of free standing investment banks was over. The era began in 1933 when the Glass-Steagall Act forbade U.S. banks to engage in both commercial and investment banking activities. The intention of this legislation was to prevent a return of the credit crisis that caused the Great Depression in the 1930s. After most other Depression era banking reforms had already been removed over the years, the Gramm-Leach-Bliley Act repealed Glass-Steagall in 1999. The credit crisis we are now experiencing, which rivals the one that took place in the 1930s, began only seven years later. Only five major independent investment banks still existed at its inception. Then Bears Stearns was forcibly acquired by JP Morgan when it folded in March and this month, Lehman declared bankruptcy and Bank America took over Merrill Lynch. Goldman and Morgan Stanley have now added commercial banking. They will be subject to additional regulation, but can participate fully in the Fed's entire range of funding largess for commercial banks.

The deal for Buffett is not only lucrative, but is almost as can't lose as you can get. In exchange for his $5 billion cash infusion, Buffet is getting preferred stock with a 10% dividend and calls for up to 9% of Goldman stock with a strike price of $115 and an expiration date five years from now (Goldman closed at $125.04 the day of the deal). Goldman can buy back the preferred at any time at a 10% premium to Buffet's purchase price. So if things turn around soon, Buffet would make a quick 10% and even more on his options on Goldman's stock (which he gets to keep until he converts them). Buffett is also reasonably assuming that whatever form the bailout bill takes, Goldman will be at the top of the list of its beneficiaries if Paulson has anything to do with it.

The Buffett deal is not something the average investor could ever get. It is a great example of how the more capital you have, the greater returns you can make. It also highlights how the U.S government is instrumental in both creating and maintaining wealth for favored corporations and individuals. Buffett is merely taking advantage of the banking bailout in the works. While it may be the most blatant example ever of cronyism and corporate socialism in our history, it's not the first time that 'too rich to fail' has been U.S. policy.

NEXT: Pinnochio's Reflection in Washington's Crytal Ball

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Pump up the Market, Pump up Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

If you examine the press coverage about the government bailouts of banks, brokers, insurance companies, Fannie Mae, Freddie Mac and now the first major system wide bailout ($700 billion to handle $13 trillion in toxic bonds somehow just doesn't seem enough), you will see little coverage of any possible consequences. Just as always, there will be no free lunch even though you aren't hearing it from the media. Lunch in fact will not only not be free, but its price will be skyrocketing.

While it is possible for governments to manipulate markets in the short-term, it is not possible in the long term. Markets will always return to their equilibrium points eventually. Blatant government interference in the U.S. stock market began last August when the Fed announced a reduction in the discount rate one hour before the futures expired, causing a dramatic reversal in their prices and wiping out the profits of the shorts. Last Friday, just before options expiration, the SEC just out and out banned shorting (of financial stocks) and then the Treasury announced a massive bailout for financial companies. If you look back you will see major Fed and/or Treasury actions around options expirations during the market meltdown in January, the Bear Stearns bailout in March and the Fannie and Freddie bailout in July (and there is other activity during other expiration dates as well).

While manipulation results in the biggest bang for the U.S. buck during an options expiration, the impact has lasted at most two months and usually not even that long. Over time, even though the government's market interference has become more desperate and more extreme, the effects are nevertheless becoming more transitory. The short-selling ban and announcement of the biggest government gift in history to financial companies rallied the Dow 369 points and the Nasdaq 75 points on Friday. The Dow then fell 373 points and the Nasdaq 95 points on Monday completely wiping out Friday's gains. The market was still off the bottom though because the big rally began Thursday, the afternoon before this major news came out. Of course, only the most cynical would think that this news was leaked to the big Wall Street players so they could take advantage of it at the expense of the small investor.

While the U.S. government on one hand is busy trying to support the collapsing floor of the stock market, it is blowing off the roof in the commodity markets related to inflation. The biggest one-day rallies ever had already taken place in gold and silver last Wednesday with gold up over 11% and silver up over 14%. Oil though put them to shame Monday when it was up $25 a barrel (or 24%) at one point . . It closed up 16.37 or 16% on the day (even more amazing than it seems since the easily manipulated U.S. dollar was also rallying). The price then fell on Tuesday after the September contract had settled and the October contract became the front month. Commodities simply do not go up these amounts in one day, but it's happening right before our eyes. While the government has done everything possible to juice up the stock market, there are reasons to believe that it has done the opposite with gold, silver, and oil, or at the very least turned a blind eye to manipulations by the big players to drive down prices in these markets. Gold, silver and oil though will have to return to their equilibrium points just like stocks. They are gushing upwards because the inflation pressure cooker, filled with government bailouts and seemingly limitless money pumping, looks like it's about to explode.

NEXT: Buffet Sacks Goldman

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Bailing Out Henry Paulson - and Wall Street Too

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

When Henry Paulson became Treasury Secretary, his net worth was estimated at $700 million. As the former CEO of Goldman Sachs, much of his fortune is in Goldman Sachs securities and depends on the continued health of the company. If Goldman Sachs went under, Paulson would go from being one of the richest men in the United States, to someone with little wealth. By Wednesday, September 17th, Goldman stock had fallen into the 80s (the high was well over 200) and the stock looked like it might be starting the same death spiral that Lehman and Bear Strearns followed. Paulson's net worth was plummeting. Coincidentally, that was the day the Paulson realised that there was a need for an urgent and massive Wall Street bailout that had to be financed by U.S. taxpayers.

The details of the rescue plan dreamed up by him read like the powers granted to a Banana Republic dictator. Like the dictator, all powers are essentially granted to him and they are not subject to judicial review. He will have the right to loot the treasury at his discretion. The rule of law that has been known in the United States since its inception, is to be jettisoned. The reason - it's an emergency, the same excuse used throughout history to justify totalitarian government actions.

Under the proposal, Paulson will be able to purchase at his discretion: home loans, mortgage backed securities, commercial real estate loans and any security linked to them. In consultation with the Fed chair, the Treasury Secretary also would be able to purchase any other asset deemed necessary to stabilize the financial markets. Foreign banks and brokers who do business in the United States are eligible to to get in on the bailout bonanza as well. The cost for this Wall Street slush fund is currently $700 billion. The National Debt Ceiling will be raised by that amount, less than two months after it was raised by $800 billion for the Fannie Mae and Freddie Mac bailouts. The budget deficit next year will be well over one trillion dollars. President Bush nicely summed up official Washington's reaction to this taxpayer gouging by stating that he was "unconcerned that the price tag of the package may seem high".

So far in the credit crisis the Fed and Treasury have already directly pumped $800 billion into financial company bailouts and the situation has only gotten worse. They have continually failed to realize the extent of the problem and their efforts to solve it have been ineffectual . Now they are telling us that we should give them an additional $700 billion to work with and then they will once and for all be able to take care of an estimated $13 trillion in troubled financial instruments. If this situation seems to be a bunch of government failures bailing out a bunch of Wall Street failures, that's because it is. There is no future for an economy that engages in this behavior.

NEXT: Pump Up the Market, Pump Up Inflation

Daryl Montgomery
Organizer, New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Panic in the Money Markets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

On Wednesday Sept 17th, the Primary Money Market Fund froze redemptions. A run on the fund had reduced its assets from $63 billion the previous Friday to $23 billion by the close on Tuesday. Word had gotten out that the fund held $785 million in short-term Lehman debt that was going to be written down to zero. The Primary Fund was managed by The Reserve, the first company to create money market funds in the early 1970s and was one of the oldest of all funds. It was also the first in money market fund history to break the buck for retail investors. While one other money market fund, the Community Bankers U.S. Gov't Money Market Fund, broke the buck in 1994 by paying out only 96 cents on the dollar, this only affected institutional clients. Once it opened again, the Primary Fund planned on returning 97 cents on the dollar.

The previous week had witnessed $80 billion in withdrawals from the $3.5 trillion total in the U.S. money fund market. While this may not seem to be a lot, it was the biggest week for withdrawals since money market funds began. On Monday, troubled bank Wachovia announced that it would pump money into three Evergreen funds to prevent them from breaking the buck, following 20 fund companies that had had to take similar measures in the previous thirteen months. Then on Wednesday, system wide money market withdrawals ballooned to $89 billion in a single day or 2.5% of total deposits (20 times the usual rate). The next day Putnam announced it was closing its $12 billion Prime Money Market Fund because of "significant redemption pressure".

This blow up in money markets, like every other facet of the current credit crisis, was apparently not anticipated by the Federal Reserve or the U.S. Treasury. However, once the problem became obvious to even an intellectually challenged five year old, they both did act swiftly, albeit perhaps not legally, to counteract it. On Friday, the Fed announced plans to inject liquidity into money market funds by extending nonrecourse loans (this means taxpayers get stuck paying off the debt if it goes bad) to banks to finance their purchases of asset-backed commercial paper from money-market managers who face redemption pressures. For its part, the U.S. Treasury announced it had established a money market guaranty program lasting one year for up to $50 billion. The assets would come from the Exchange Stabilization Fund and represented its entire holdings. This U.S. government entity was created in 1934 to conduct interventions in foreign exchange markets. The use of this fund for its intended purpose requires the consent of the president, but not congressional approval. Of course, bailing out domestic money market funds had nothing to do with its intended purpose.

This was not the first time that extra legal or questionably legal measures have been used by the U.S. government to deal with the credit crisis, and it is highly unlikely that it will be the last.Once this threshold has been crossed, it can't be determined how far a government will go with its "emergency measures". When all the power centers of a country agree that it is OK to break the law, there are no longer any of the checks and balances in the system that ordinarily limit government action. But why get bogged down with legal niceties? As long as the U.S. doesn't need to maintain a functional economy or keep the country a desirable destination for desperately needed foreign capital, this cornerstone of all successful economies can be ignored.

NEXT: Bailing Out Henry Paulson - and Wall Street Too

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Free Market Goes Under

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

On Friday morning before the U.S. markets opened, the SEC announced a ban on short-selling 799 financial stocks. Britain's Financial Service Authority had already instituted a similar ban on Thursday. As the reason for the ban, Chairman Cox stated that "the commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investor confidence". Apparently only the shorting of financial stocks threatened investor confidence and other forms of market manipulation and the shorting of other types of stocks did not.

The SEC's ban will last until at least October 2nd, with the possibility of being extended for up to 30 days (Britain's ban will last until January 16th). The ban includes every type of financial stock including all banks, brokers, thrifts, mortgage companies, bond insurers, mortgage insurers and all other types of insurers. Market makers are exempt from the ban because they claimed markets can't function properly unless they are allowed to take short positions (the usual there's one set of rules for us and another set of rules for you). Short-sellers with positions of over one million dollars are required to report this information to SEC and it will be made public (no trader ever wants their stock positions to be public). The SEC justified this action as being in the public interest because it will provide "protection for investors and will insure transparency." Transparency is apparently just a good thing for short sales however, since no similar rule exists for long positions.

Meanwhile over at the Comex, margin requirements for gold and silver contracts were raised as much as 47% on Thursday to dampen the explosive price rises (apparently investors lose confidence too if precious metals go up too much). The rise had taken place after a long and protracted sell off in the metals that affected the miners even more. While there were charges of illegal naked short selling on precious metal mining stocks, the SEC didn't seem nearly as concerned as it was when this same action took place with financial stocks. The U.S. government of course would like to see the price of gold and silver depressed in order to help support the dollar.

While the SEC's actions produced the government's desired result of bulling the stock market up in the short term, it will cost the U.S. a lot in the long term. While banning short sales is something that can happen in a third world backwater, it is unprecedented in the United States because it reeks of market manipulation and favoritism for privileged groups (generally those that have paid the most bribes to influential politicians, more likely to be called campaign contributions in the United States). The level of corruption an action like this indicates generally goes hand in hand with economic stagnation and capital flight. No one will play a rigged game for too long - and the SEC's ban follows a series of market rigging maneuvers on the part of the Fed that began last August. The United States market and economy will likely suffer for many years (if not decades) to come.

NEXT: Panic in the Money Markets

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Central Bank Liquidity Tsunami Returns

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

After Lehman declared bankruptcy on the Monday the 15th, Merrill Lynch had to be taken over by Bank America and AIG was nearing its end, the market was looking for a rate cut from the Fed during its Tuesday meeting. The Fed and Treasury had conditioned the market to expect bailouts for financial firms and then failed to deliver when they didn't rescue Lehman and grant AIG its initial loan request of $40 billion. The Fed failed to deliver again when it didn't cut the funds rate. This seeming policy reversal, refusing to support failing financial firms with loan guarantees and the stock market with rate cuts, not surprisingly started a huge market sell off.

The Fed started pumping money into the financial system at the rate of $70 billion a day on Monday and Tuesday. While this was well above normal, it was by no means adequate for the financial crisis that was unfolding. Not only did the Dow go down 45o points and gold go up $90 on Wednesday, but the bond market indicated a panic flight to quality. For a brief time, interest rates on 1-month T-bills became negative. The rates on 3-month T-bills remained barely positive at 0.2%, the lowest level since 1954. The TED spread a measure of financial system stability, or lack thereof, hit the level it reached during the crash of 1987.

The Fed's apparent obliviousness to the magnitude of the situation was truly mind boggling, but not inconsistent with Bernanke's previous missteps - after all he didn't expect the subprime crisis would have any serious impact on the market as of June 2007, if not later. After the market route on Wednesday, along with Morgan Stanley acting as if it was about to go under, the Fed decided to flood the world financial system with liquidity. It supplied a line of credit of as much as $247 billion to the ECB, Bank of England, Bank of Japan, the Swiss National Bank and the Bank of Canada. These banks in turn added their own funds and a gusher of money poured forth from every central bank spigot available. As one observer noted, the central banks were essentially providing unlimited liquidity to world financial markets. Not surprisingly, stock markets reacted positively everywhere with big rallies, with the Dow being up 410 points and the Nasdaq up 100 points on Thursday.

Euphoria from liquidity injections usually lasts only a short time, unless the underlying problems get fixed. In this case, the problems may be even worse than the market realized. The Fed's delayed reaction to the market turmoil and its initial cold shoulder to AIG may not have been voluntary, it may have had no choice. On Wednesday, the Fed asked the U.S. Treasury to raise money on its behalf by selling bonds and by Thursday it had received $160 billion from this operation. The Fed has never made this request from the Treasury before. While the official explanation for doing so was to help with its cash management, this is highly unlikely. More plausible is that the Fed itself has run out of money and is being secretly bailed out. Events that took place Thursday evening lent further credence to this belief.

NEXT: The Free Market Goes Under

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Mega Move Up in Gold and Silver

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video related to this posting:

It looks likes gold and silver had their biggest one day move up in history, both in absolute and percentage terms, on Wednesday . The price run up looks even bigger than the one that took place the day the previous commodities bubble peaked in 1980. The underlying picture between then and now is quite different however. While the move in 1980 indicated the end of a major rally, the move yesterday indicates the beginning of a new one.

In 1979 and into the beginning of 1980, gold and silver prices were going straight up in what is termed a blow off top. A huge move up, similar to what took place yesterday, ended the rally and the secular bull market that had been in place for the previous decade. What had preceded yesterday's rally was six months of selling for gold and silver, not buying. From high to low, gold was down 29% and silver 52%. Both had hit major areas of support - 738 for gold and 10 to 11 for silver. Gold then moved up 11.3% (or $90) and silver moved up 14.4% (or about $1.50) from the previous day. The gold miners index, the GDX was up 11.7%. These moves took place on high volume, more than triple the average for the GLD ETF and more than double for the SLV ETF, confirming the bullish picture.

The bullishness was furthermore limited to gold, silver and to a lesser extent oil (up 6.6%) and food commodities (up about 3%) . It was not part of an overall commodities rally, copper was actually down on the day, nor even a precious metals rally. Platinum was up 1.7% and palladium up only 0.5%. This rally was massive short-covering linked to increased inflation expectations and pessimism about the future of the U.S. dollar. The trade-weighted dollar fell 1.4% - a huge one-day move for a major currency. The hyper response of gold and silver to this drop indicates that much of the previous selling had been short selling and not traders dumping their positions as has been repeatedly reported in the media.

While panic buying was hitting the gold and silver market, panic selling was taking place in stocks. All of the major U.S. indices almost hit the mini-crash level of down 5%. Nasdaq came closest with a 4.9% drop on volume 50% greater than average. The Dow had a lesser drop at 4.1%, but it took place on double average volume. The S&P was down 4.7%. Since August 2007, whenever the U.S. stock market has started falling apart, the Fed has come in with some sort of major liquidity injection to prop it up. By last night one of the biggest liquidity injections ever, involving most of the world's major central banks, had been arranged. What a surprise!

NEXT: Central Bank Liquidity Tsunami Returns

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Peoples Republic of the U.S. - the AIG Bailout

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

In a socialist state, the government decides what a company is worth, not the market. The Federal Reserve clearly demonstrated this concept by purchasing almost 80% of the insurance giant AIG on Tuesday night, September 16th. The Fed paid over 10 times what the market said its stake in AIG was worth. It is not clear what U.S. laws allow for the nationalization of part of the insurance industry, nor what companies will be bought next now that this precedent has been set.

The final phase of AIG's death spiral began on Monday evening when the major credit agencies downgraded it. This credit downgrade required AIG to post billions of dollars of additional collateral for its mortgage derivative contracts - capital that AIG simple didn't have. The implications were far more serous than the public realized, since AIG is a central player in the CDS (credit default swaps) market and does business with almost every financial institution in the world. If AIG went under it would have been unable to pay off its CDS obligations and its counter parties would have unable to collect on its trades. It was estimated that a large number of hedge funds, and possibly some banks, would have gone under along with AIG.

Over the weekend AIG attempted to borrow $40 billion form the Federal Reserve. The Fed, originally set up to lend just to commercial banks, had no legal authority to lend to insurance companies. And even though it had extended its lending to broker-dealers in March and to mortgage giants Fannie Mae and Freddie Mac in July, it was reluctant to add insurance companies to the list. Then on Tuesday evening, the Fed (with support from the Treasury and President Bush) decided to extend its legal authority way beyond anything ever intended by agreeing to pump $85 billion into AIG. The media described this $85 billion as a 'loan' even though a 79.9% equity stake in AIG was being given in exchange (note to media: this is a stock purchase, not a loan). This is not for already existing AIG stock, but for newly issued AIG stock, so AIG will have to increase its outstanding amount of stock to five times its current level. This is a better deal for stockholders than usual, since they will be left with something, instead of being completely wiped out.

Based on Tuesday's closing price, AIG had a market cap of just over $10 billion dollars. In order to buy 80% of the company (which was worth $8 billion according to the market), the U.S. paid $85 billion or over 10 times the market price. Socialism leads to just such economic absurdities. Unless this is stopped, expect more of this in the future - and the permanently ruined economy that always follows.

NEXT: The Mega Move Up in Gold and Silver

Daryl Montgomery
Organizer, New York Investing
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Lehman, Merrill Lynch and AIG - the Morning After

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Monday, September 15th was a bloody day on Wall Street. The Dow dropped 504 points, in its biggest point loss since 911. The financial stocks led the way down. Lehman went to 21 cents. Merrill Lynch, the success story of the day gained an entire penny. Its acquirer, Bank of America, fell over 20%. The market made it abundantly clear what it thought of the Merrill acquisition. AIG, the latest and the most serious of the financial blow ups, lost almost 60% of its value.

The day's trading tone was set when Lehman declared bankruptcy in the morning claiming in its filing that it had $639 billion in assets and $613 billion in liabilities. A three day marathon session at the Fed's New York offices failed to piece together a rescue package. All the possible acquirers wanted federal government guarantees for Lehman's bad loans and the government refused to grant them. The real reason for this refusal has yet to come to light. It is highly unlikely that Paulson or Bernanke suddenly realized fiscal responsibility was a good thing. More plausible explanations are that the money is simply no longer available; Lehman has already borrowed some astronomical sum through the Feds PDCF and the Fed was unwilling to throw more good money after bad; or the authorities realize there is going to be a need for funds for a much more serious bailout in the near future.

The deal that was pieced together at the weekend session was Bank of America (BAC) acquiring Merrill Lynch in an all stock deal. The acquisition price was based on the price of 0.8595 shares of BAC and rises and falls with BAC's price. Initially estimated to be worth $29 a share to Merrill, the takeover price had fallen to just under $23 by the market close on Monday. According to news reports, the takeover was 'encouraged' by the Fed and the Treasury department.

Also resulting from the meeting was the creation of a pool of $70 to $100 billion put together by a consortium of big banks to lend to financial institutions in trouble. This purpose was to prevent the dumping of close to worthless bond holdings on the market, driving their prices down even lower - and forcing banks to record the actual prices on their books, instead of the inflated ones currently being used. The Fed said that for its part it would be more generous with how it handled its credit facilities to help support this effort.

AIG, the biggest insurance company in the world has literally imploded since the end of last week. Its problem is somewhat different from the those being experienced by Lehman, Merrill and Bear Stearns before them. Exposure to CDOs (credit default swaps) is AIG's undoing and this seems to be the first derivative meltdown of the credit crisis. AIG was saved, at least temporarily, from oblivion when New York State agreed to let it tap $20 billion as a 'loan' from its subsidiaries. JP Morgan and Goldman Sachs were exploring putting together a credit facility of between $70 and $75 billion for AIG with the 'full support' of the Fed. AIG had first tried to get a $40 billion precedence setting loan directly from the Fed itself. Considering that the market cap of AIG was just under $13 billion at the market close on Monday, any loan even close to to that amount, let alone way above it couldn't be justified as being financially sound.

Next on the list of possible insolvencies, Washington Mutual and Wachovia did not fare well either in Monday's action. Washington Mutual was downgraded to junk status by S&P (Moody's had cut it to junk last week) and fell 27% to 2.00. It is already perilously close to the less than one dollar price that indicates an imminent bankruptcy. Wachovia fell 25% on the day closing at a much safer, at least for now, 10.71.

NEXT: The People's Republic of the U.S. - the AIG bailout

Daryl Montgomery

Organizer, New York Investing

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Banks and Brokers Most Likely to Fail - The Big Players

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=sBhEO14lwMg

Other videos on this topic: http://www.youtube.com/watch?v=ZIxTlP5FU_Q

At our September 8th meeting, the New York Investing meetup presented a talk on the 'Banks and Brokers Most Likely to Fail'. This was a follow up to material that was already presented in our April meeting 9th meeting talk, 'The Dirtiest Dozen Financial Companies' (the notes for both of these talks were posted on our web site at: http://investing.meetup.com/21/files). Putting together all the criteria that should be considered in determining whether or not a bank of broker could be insolvent or heading in that direction the following list of large banks or brokers resulted (how much their stock was down from the high is the figure next to their name):

Washington Mutual -down 93%
Lehman - down 91%
Wachovia - down 87%
Merrill Lynch - down 78%
Citibank - down 75%
UBS - down 73%
Royal Bank of Scotland - down 73%
Keycorp - down 82%

With the exception of Wachovia, the Royal Bank of Scotland and Keycorp, these companies had already appeared on our April list.

Washington Mutual and Lehman were obviously both in desperate shape and jocking for the number one position of who would be gone first. Washington Mutual had the highest one-year CD rates in the U.S and the willingness to pay a lot more for funds than its rivals indicated how urgently it needed funds. It could also not raise capital because it had sold stock at $8.75 a share with an agreement to reimburse the buyer for the price difference if it sold stock again at a lower price. It's price had fallen so low (it's price dipped to $1.75 a share the day of our meeting) that if it sold new stock, it would have to pay more to this purchaser per share than it would from the sale. Lehman on the other hand, had been in serious trouble since March and would have gone under right after Bear Stearns failure except for Federal Reserve cash infusions into the company from the newly established PDCF (Primary Dealer Credit Facility). It had just released its earnings and had lost $5.62 a share in the third quarter versus $5.19 a share in the second quarter. Its stock was falling rapidly and would close at $3.65 on Friday.

Lehman had been trying to sell some of its operation or part of the company for the previous several weeks. The Korean Development bank finally withdrew from negotiations claiming they were asking too much. Lehman had deteriorated so much that an emergency meeting was held at the New York Fed's office starting Friday evening and going into Sunday. The Treasury secretary and all of Wall Street's movers and shakers were there. Even then, nothing could be worked out for Lehman. For the first time, the Treasury refused to offer government guarantees. This should not be interpreted as the Fed and Treasury finally realizing the danger of Moral Hazard, or that no one voted for the U.S. becoming a socialist state, but rather that they themselves are out of funding sources.

Without a government rescue, Lehman was forced to declare bankruptcy Monday morning. Ironically, Bank of America agreed to buy Merrill Lynch as a result of the emergency meeting (both were there), apparently with some prodding from government officials. Elsewhere, insurance giant AIG requested access to the Fed's lending facilities, in order to stave off its own impending bankruptcy.

NEXT: Lehman, Merrill Lynch, and AIG - the Morning After

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.


























































































































NEXT: The Banks and Brokers Most Likely to Fail








Daryl Montgomery
Organizer, New York Investing meetup







http://investing.meetup.com/21








This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Probable Future Outlook for the United States

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Guest Blogger: Trevor Gauntlett from 'Running the Gauntlett'

What concerns me most is looking at the highly probable future outlook for the U.S. …

The government is taking over Freddie and Fannie, which will help out new, but not existing home buyers. By assuming responsibility for their debt, the gov’t is using inflation adjusted tax dollars to keep these companies operating . However, a $500 billion dollar short fall is projected this year in the budget and the U.S. national debt is already at about 9.7 trillion and growing ever so rapidly. If we tack on unfunded liabilities, we are talking anywhere from 50-70 trillion in obligations. Effectively the government is insolvent. Now what happens when government revenues begin to decline due to the slowing economy, baby boomers start to take money out of social security and access Medicare when they retire, and the continuation of the Iraq war / Afghan war / maybe Iran war?

I’m failing to see the light at the end of the tunnel.

During the housing boom, U.S. consumers purchased houses because money was cheap. Everyone felt rich so they purchased more consumables for immediate gratification. These weren't investments with productive value that would add to the economy in the future and they experienced immediate depreciation. Once U.S. consumers could no longer get money out of their homes through refinancings and HELOCs (home equity lines of credit), we started using our credit cards. Look at who is producing and who is consuming… we in the USA are primarily guilty of the latter and it is all funded through the rest of the world’s savings. At some point other countries are going to refuse to continue supporting the U.S. spending binge - this might already be taking place.

As for housing it will have to come back down to reasonable values. If we encounter a period of hyperinflation then housing could be a good asset to hold onto (although this was not the case during the hyperinflation in Wiemar Germany in the early 1920s). On the other hand, if we have a depression I could argue the opposite.

People are already losing their HELOCs because banks are worried that consumers won’t be able to afford them. Legal or not this is happening. I also heard from a Real Estate agent in Seattle that banks are asking for 25% down on new mortgages. In an earnings call in late January 2008, Bank of America executives said credit card delinquencies in California, Florida, Arizona, and Nevada—states with high foreclosure rates—increased five times as fast as in other states, suggesting that consumers struggling with their mortgage debt are also finding their credit card bills hard to pay. “We’re focused on getting paid for the risk we take,” said Joe Price, chief financial officer. - US News and World report 2/28/2008.

What happens if the United States dollar loses its status as the reserve currency? Then everyone with dollars will flood the market to get rid of them. The dollar is a commodity just like gold and silver, but unlike gold and silver any amount of it can easily be created. It has no intrinsic value and is a exchangeable commodity and legal tender because of government fiat (hence paper money is fiat money or fiat currency). If people want dollars, the price rises and as people desire them less, the price falls. Loss of reserve currency status would mean the demand for U.S. dollars would fall significantly. Why would anyone want dollars when you look at the future for the US economy except because of necessity or political reasons?

The GSE bailout will help to prolong the issues that the financial industry is facing. The United States government will do everything in its power to support the system through money creation and taxation, giving individuals and institutions more time to pull their money out of the dollar. An immediate collapse would make that very difficult and costly.

I’m getting the sense that things could get a whole lot worse than any of us imagine.

NEXT: The Banks and Brokers Most Likely to Fail - The Big Players

Daryl Montgomery

Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - The Government Takeover

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: TBA

It took only about six weeks after congress passed a bailout package before the U.S. government had to take direct control of Fannie Mae and Freddie Mac. The terms of the bailout package were open ended and extremely generous at Treasury Secretary Paulson's insistence. He claimed that if it was made obvious that the full financial power of the United States government was behind Fannie and Freddie, the need to take any action would be minimized (despite the fact that is was universally agreed that Freddie was insolvent and would therefore need continual cash infusions to keep operating). The Congressional Budget Office backed up Paulson by estimating that there was a greater than a 50% chance that the bailout would cost nothing.

On September 7th, the U.S. government seized Fannie Mae and Freddie Mac, firing their top management and taking direct control of their operations. The Treasury department announced almost immediately that it would initially be pumping $200 billion into the two companies (so much for the bailout costing taxpayers nothing). Auditors who had been examining Freddie and Fannie's books found that Freddie had made accounting decisions that pushed losses into the future and postponed a capital shortfall until the fourth quarter of 2008, which it wouldn't have had to disclose until early 2009. Fannie Mae had used similar methods, but to a lesser degree. Both companies needed capital and a lot of it to keep operating. One wondered how many U.S. banks and brokers were doing similar things with their books, but the public didn't know about it because there were no outside auditors to tell them.

With the government takeover, Fannie and Freddie's over $5 trillion in debt would now reasonably have to be added to the official U.S. national debt figures. Adding Fannie and Freddie's total debt to the national debt would increase it to between $14 or $15 trillion or roughly the size of the official GDP figures (the actual GDP figures were much lower than those claimed by the government and the actual national debt, including social security, medicare and medicaid entitlements was somewhere around 50 to 60 trillion dollars). Ironically, the idea of privatizing Fannie Mae was conceived of in the 1960s during the Johnson administration to get its debt off the government's books.

The government bailout was intended to support Fannie and Freddie's bonds, many of which were held by foreign governments including China and Russia. U.S. banks and thrifts also held an estimated $1 trillion of this debt. If Fannie and Freddie defaulted on their bonds, the U.S. would have had great difficulty ever borrowing again from foreign sources and both our government and economy would wind up seizing up almost immediately. A number of U.S. banks would likely have gone under soon thereafter as well in the event of a bond default. While bonds holders got bailed out, the stockholders were wiped out. This included U.S. pension funds, most of whom were major holders of Fannie Mae and Freddie Mac stock.

Fannie and Freddie were by far the largest bailout in U.S. financial history. Where would the already debt ridden U.S. government get the money to pay for it? If it couldn't borrow the money, which was indeed likely, it would have to print it. Only time would tell how much inflation this would cause and how much value the U.S dollar would lose as a result .

NEXT: Probable Future Outlook for the United States

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Exposing Fannie Mae and Freddie Mac - The Risks

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video for this posting can be found at: http://www.youtube.com/watch?v=w0am1FJVD88.

While not bailing out Fannie Mae and Freddie Mac posed major risks to the world financial system, the bailout itself had the potential to be extremely risky to the United States itself and extremely costly to the U.S. taxpayer. The blank check guaranteed by congress for Fannie and Freddie was likely to be utilized in any number of ways.

By the time the bailout bill was passed, an audit had already revealed that Fannie and Freddie had $20 billion of known losses that they had yet to declare (unrecognized losses were probably much larger). New accounting rules meant that both companies would have to raise an additional $75 billion in capital and it was unlikely this could be done on the open market. These costs were minor though compared to those that would be generated if mortgage insurers went under (a high probability event) and couldn't pay off defaulted mortgages. Fannie and Freddie had over a $1 trillion of exposure to insured mortgages, mortgages that were for over 80% of the purchase price and therefore the riskiest in a market with falling home prices. These were also the mortgages that cost Fannie and Freddie the most when they defaulted.

Recession and falling house prices weren't the only major risks to Fannie and Freddie's finances, so was inflation. Obviously, the worse the economy, the more foreclosures there are and the less money recovered in the sale of a repossessed house. Fannie had $4.7 billion in foreclosed properties on its books by the first quarter of 2008, double the amount from a year earlier and increasingly rapidly. The prices being obtained for these houses were no where near their previous purchase prices and the gap was widening further. An inflationary environment however wouldn't do away with Fannie and Freddie's financial risks. Since both receive income based on long term mortgages (those in the 2000s had very low interest rates), but have to borrow short term to fund there operations, high inflation is potentially disastrous for both of them. If short term rates went into the higher single digits or more, Fannie and Freddie would continually lose money and the losses would become greater and greater as interest rates rose.

In the longer term, perhaps the greatest risk of the the Fannie and Freddie bailout was that the U.S. government could lose its triple A credit rating and then all government borrowing would cost more. S&P made a statement in spring 2008 that a government takeover of Fannie and Freddie was likely to result in such an action. Moody's made a similar comment in June.
The bailout bill passed by congress in late July was of course not the same as a takeover of the two companies, although it set up the possibility. Only six weeks later that possibility became reality.

NEXT: Exposing Fannie Mae and Freddie Mac - the Takeover

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.