10 Reasons We Are in a Credit Crisis

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Yesterday's news was about a potential Greek default and it caused a global market selloff. Today,  hopes of preventing a Greek default are causing markets to rally. This alternating news flow is repeating over and over again. Investors should pay attention to the big picture however and not the noise of the day. The important thing to realize is that we are in a second global credit crisis.

Credit crises follow certain patterns, which include: recognition of overpriced financial assets, money flowing into safe havens, increased market volatility, rising costs for financial insurance, and various forms of government action to stop the problem. The specifics of the current credit crisis are below.

1. Government debt is being downgraded. This happened in Italy yesterday, the U.S. in early August and many times in Greece. This is the upfront recognition of the problem, which is almost always widespread public knowledge by the time it happens. In 2008, securitized debt containing subprime real estate loans was downgraded in mass, frequently from the triple A ratings that had previously been given.

2. Global money is flowing into safe haven U.S. treasuries. When yields hit lower levels than a previous credit crisis or all-time lows, this indicates this is happening on a mass scale. U.S. government two-year notes had a yield below 0.15% at one point this September 19th. During 2008, the two-year held above 0.60%. The ten-year yield has fallen below the 2.04% low in 2008 and below the all-time low of 1.95% in 1941.

3. Global money is flowing into safe haven currencies. In 2008, this was the U.S. dollar and the Japanese yen. In 2010, this is the Japanese yen, the Swiss franc, and gold (which needs to be thought of as a currency if it is to be analyzed correctly). The Swiss franc rallied so much that the Swiss stopped it from trading freely. The Japanese have also taken action to try to lower the value of the yen.

4. Stock market volatility has increased enormously. In 2008, there were a significant number of mini-crashes (a drop of 5% or more in one day). These were more common in the U.S. back then. Now they are more common in Germany, but they have been happening here as well. The flip side of mini-crashes is sudden sharp moves up in the market. These are also occurring.

5. Bank stocks are the focus of the big moves up and down in the stock market. U.S. banks and other financial stocks really got hit in 2008 -- a number of the companies themselves went under. This time it's European banks falling the hardest. One-day drops for some major EU and UK banks have been as high as 10%. Bank stocks aren't dropping that much in the U.S., but they are underperforming other sectors like technology.

6. Credit default swaps have hit record levels. Credit default swaps (CDSs) are bond insurance and they became a big news item in 2008 when they rose to unprecedented levels. While CDS rates for Greek sovereign debt have hit records and are rising for the other highly indebted EU countries, they have also hit records for some UK and EU banks in 2011 indicating a worse crisis than in 2008.

7. Major and ongoing bailouts are taking place. The EU had to bail out Greece in the spring of 2010 and then Ireland and Portugal. A second bailout for Greece had to be arranged this July, even though the first bailout was supposed to have taken care of Greece's debt problem. In 2008, the U.S. had TARP and arranged for failing banks to be taken over by stronger banks  (Bank America is now in trouble again because of the legacy loans from the banks it absorbed during this period). Fannie Mae and Freddie Mac had to be nationalized. 

8. Central banks are buying bonds in the open market. The EU has been buying up Italian, Spanish, Irish and Portuguese bonds in order to hold down interest rates in those countries. As long as it has an infinite access to funds, this strategy will work. The Fed began buying U.S. debt instruments in the fall of 2008 during the Credit Crisis. 

9. Global coordinated central bank intervention took place last week. The need for global action is a consequence of the interconnectedness of the world financial system. A major problem in one region (in 2011 this is Europe, in 2008 it was the U.S.) will invariably spread everywhere. Central banks coordinate their activity to try to control the contagion. 

10. The global economy is turning down.  Problems in the financial system impact the real economy and they can turn a shallow downturn into a major one as has happened in 2008. Economic figures throughout the world have flattened and there are some warnings of a bigger drop to come (extremely low consumer confidence numbers for instance). GDP contraction in a number of regions will be the final confirmation that another global credit crisis has occurred. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Why a Greek Default is Imminent

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

It may only be weeks, if not days, before Greece defaults on its debts. Interest rates and credit default swaps (bond insurance) have hit record levels and are still climbing. Stocks are getting slammed throughout the word, especially EU bank stocks. The Germans appear ready to abandon further attempts at bailing out the debt-ridden country. 

Yields on two-year notes in Greece were above 60% Monday morning -- the highest ever. The yield on the 10-year governments was over 20%. Both rates continue to climb making it more and more difficult for Greece to pay down its enormous pile of debt and requiring larger and larger bailout packages if Greece is to avoid bankruptcy. The market is becoming increasingly skeptical that Greece will survive financially however. The five-year credit default swaps on its government debt were at records highs last Friday and their cost keeps rising as well.

Markets presaged this week's trouble last Friday, with the Dow Industrials down 304 points. Juergen Stark announced he was resigning the ECB's executive board because of its program of buying bonds of the financially troubled EU members. Markets got slammed in Europe and in North America. The damage continued in Asia Sunday night with Hong Kong's Hang Seng down 836 points (4.2%) and the Japanese Nikkei down 202 points (2.3%).  Germany and France were down almost at mini-crash levels (a 5% drop in one day) after their Monday opening, but recovered somewhat by the end of the morning. As of last Friday, the German DAX had fallen approximately one-third (33%) from its highs earlier in 2011.

Bank stocks are bearing the brunt of the selloff in EU markets.  Major banks such as Deutsche Bank, BNP Paribas and Société Générale were down in the 10% range. Outside of Greece, German and French banks are the most exposed to Greek debt. German banks have more exposure to Greek government debt (the debt that wouldn't be paid off in the event of a default), while French banks have more exposure to commercial loans to Greek businesses. Reports indicate that BNP Paribas, Société Générale and Credit Agricole may have their credit ratings lowered by Moody's this week. Credit default swaps on some major European banks are also rising to record high levels.

The Germans appear ready to throw in the towel on the second Greek rescue package. Officials have increasingly been making statements that indicate that Greece must meet its targets for deficit reduction if further bailout payments are to be made. It is highly unlikely this will happen. Nevertheless, the Greek Finance Minister stated over the weekend that Greece was committed to the "full implementation" of the terms of the second bailout. He dismissed rumors of a possible default. Of course, so did the CEOs of Enron and Bear Stearns days before their companies imploded.

Disclosure:  None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing
meetup http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

EU-Centered Credit Crisis Continues

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The 2011 Credit Crisis continued Tuesday with the Stoxx Europe 6000 index hitting a two-year low, the Swiss taking desperate measures to control the franc, more record high prices for credit default swaps (bond insurance) on British Banks and yields on 10-year U.S. treasuries hitting an all-time low. Despite the dramatic turn of events, stock losses were somewhat muted.

U.S. markets opened sharply lower, but the Nasdaq and S&P 500 recovered toward the close in a technical move that involved filling the gap down that took place on the open. The Dow however still had a 101 point loss at the close. In Europe, the German DAX was down 1.0% and the CAC-40 in Paris 1.13%. While these losses would have been considered significant only a few months ago, they are minor compared to what has taken place on a number of trading days since late July. The British FTSE up even up 1.06%, despite trouble in the UK banking sector.

The British banks most in trouble are the ones that were nationalized during the 2008 Credit Crisis -- Royal Bank of Scotland and Lloyd's Banking Group. Credit default swap (CDS) rates for these banks are higher than they have ever been. CDS rates for HSBC and Standard Chartered are at one-year highs. The problem with these banks seems to be toxic loans left over from earlier in the 2000s. It is not clear if they were included in a sweeping statement made Monday by Josef Ackermann, CEO of Deutsche Bank, that "numerous" European banks would collapse if they were forced to recognize all losses against their holdings of government debt.   

The most significant market event yesterday was the Swiss capping the value of the franc. The Swiss National Bank (SNB) said it would "no longer tolerate" a euro franc exchange rate below 1.20. The franc then had a significant drop against all major currencies. A similar approach was tried in 1978 and it did succeed in stabilizing the franc back then. Such currency intervention measures generally only work for a short time however. It remains to be seen how long it will take before the franc begins rising again.

The new Credit Crisis is also showing up in U.S. treasury rates just as the one in 2008 did.  The 10-year yield made another all-time low at 1.97%, taking out the 2008 low. Global money flows into U.S. government bonds during periods of financial system instability because they are still seen as safe havens. While the 10-year is only a little below its low in 2008, the two-year at 0.20% on Tuesday is well below its low point back then.

Credit Crises are not very short events. The previous one lasted six months. This one could last that long or even longer. The cause of the problem has to be gotten under control. In this case, it is the ongoing debt crisis in Greece and the emerging ones in Italy and Spain. While a default in Greece could happen this fall and create some finality there, the problems in Italy and Spain are only in their early stages. So, this could go on for some time.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

German Flash Crash Shows Vulnerability of the Market

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Between 3:30 and 4:00PM Central European time the DAX, the major German market index, lost around 250 points. This is roughly equivalent to a 500 point drop in the Dow Industrials in half an hour. Prior to that, the DAX had been slowly drifting lower. Then suddenly it dropped like a rock.

The pundits were quick to come up with possible explanations. A fat finger error was cited as a possibility (this is when a clerk accidentally puts an extra zero or two or three after the number of shares when entering a sell order). This was pure speculation on the part of the media however. While it is certainly possible that this was the cause of the drop, there is as of yet no evidence supporting this claim.

New problems with the evolving and unending Greek debt crisis were also thought to have led to the floor falling out of the market. Greece's central bank activated the Emergency Liquidity Assistance (ELA) program to help its struggling banks stay afloat. ELA is only for emergencies, so its use indicates that Greece is teetering toward default. So what else is new?  At this point, anyone who isn't in a coma should realize a Greek default is inevitable.  

The Bank of England also announced that it was extending a swap line to the ECB. The swap line allows the ECB to borrow British pounds at low interest rates in order to maintain liquidity in the Eurozone's banking system. Investors should ask themselves what exactly is going on that the ECB needs help maintaining liquidity. This is of course is always a problem during a credit crisis.

There were apparently also rumors about Germany banning short selling. Not so farfetched considering that France, Italy, Spain and Belgium extended their short-selling ban on financial stocks, which would have ended this week. Traders dislike restrictions and their initial reaction is to get out of the market when they appear. Authorities also don't make these bans unless there is good reason that traders want to engage in heavy short selling. They are an admission that something is rotten in Denmark or in this case, Greece, Portugal, Ireland, Spain and Italy. This news was out around the time the DAX had its precipitous fall.

If today's drop was an isolated incidence it wouldn't necessarily be anything to worry about. However, there has been at least one serious market problem each week for several weeks now. The Nasdaq and Russell 2000 in the U.S. have had three mini-crashes. The DAX has had a few itself. The U.S. Dow is moving up and down in multi-hundred point increments. The situation is not stable yet and the market is making that abundantly clear. 

 Disclosure: None

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

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security. Investing is risky. If you don't feel that you are capable of doing it yourself, seek professional advice.

Stocks Rally in Short Term Reversal

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


After hitting a lower low on the open, U.S. stocks reversed their sharp downturn in late afternoon trade yesterday. The rally so far is an expected oversold bounce.  There is no reason yet to think that it will turn into something more significant.

Technicals, not fundamentals are driving stocks at the moment. Tuesday's action was an attempt to resolve an oversold condition from Friday the 14th. Seven trading days later, the major indices - the Dow Jones Industrial Average, the S&P 500, the Nasdaq and the Russell 2000 were all substantially lower. They were also well above their respective 200-day moving averages on the 14th, but all were below their 200-days yesterday.

The 200-day is the key dividing line between bullish and bearish behavior. With the exception of the small cap Russell 2000 (which is holding up best in the sell off), the major indices have violated their support at the 200-day twice in the recent sell off. The first time was during the odd crash on May 6th. Many considered the intra-day drop below the 200-day then to be a mere fluke. In the last five trading days though, the Dow, S&P, and Nasdaq have again traded below the key 200-day line at least part of the day. 

Stocks are also trading to try to fill gaps (a price range where no trading took place) in the charts. This usually occurs within a few days, although weeks and even months are possible time frames. There was a large down gap in trading on May 20th and another one before that on May 14th. The market will want to rise in the near term to at least fill the gap on the 20th. Yesterday's gap down was a short-term exhaustion gap (a gap after many down days or up days) and the markets moved up to trade into the empty space that had been left on the charts.

Technical factors are moving the market up at the moment, but once they get resolved, stocks are likely to head down again. The fundamental problems that emanate from the eurozone have not been fixed. For a major bottom to be put in, some dramatic event like a Greek default or Greece being removed from the euro currency union would be a good signal for a bigger rally. A much larger bailout, such as $5 trillion instead of a mere $1 trillion would pump up stocks as well. This is what reversed the markets during the Credit Crisis and the central bankers and treasury departments of the world will almost certainly attempt their tried and true money printing solution again. The only question is when they will do it.

Disclosure: No positions

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.

Liquidity from Euro Rescue Pumps Up Stock Market

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


As I have said many times, liquidity is ultimately the driver of stock prices. A perfect illustration of that took place on Monday when a trillion dollar rescue package was announced for the euro before the market opened. After finding out about the latest big liquidity injection into the global financial system, traders went wild and the Nasdaq gapped up 100 points. Huge volatility though is rarely a good sign for the stock prices going forward.

The extreme move up could be seen as a positive event, if the problems in the eurozone will actually be solved by the recently announced euro rescue package. This is unlikely. First the need for a large-scale regional bailout indicates that we are still suffering from conditions that arose during the Credit Crisis. These have been papered over by previous massive bailouts that have paused the problems the world faces, but have not created long-term solutions for them.  Spending more money on bailouts means printing more money and this will ultimately have unpleasant consequences down the road.

Investors need to realize that the euro rescue effort is a bailout for the big banks, the ultimate beneficiaries of the many trillions spent previously by government  and central bank Credit Crisis programs. The debt crisis in Greece could have been solved instantly and without spending one penny on a bailout, if dollarization had been used to deal with the problem. Under this approach, Greece would have been allowed to continue to use the euro, but been kicked out of the currency union. This would have prevented contagion to the entire eurozone and markets worldwide. It would have cost nothing. Instead, we now have another trillion-dollar bailout to rescue the global financial system.

The euro rescue package consists of three parts. The biggest part is $560 billion in new loans from the 16 countries that are part of the eurozone. Of those 16 however, five - Greece, Portugal, Ireland, Spain and Italy (the so called PIIGS) are troubled. So it might be more accurate to say that these loans are really from the 11 more solvent countries in the currency union. The second part of the package is $318 billion from the IMF. The IMF is controlled by the United States from which it gets around 40% of its funding (if not more). So American taxpayers are participating in bailing out Europe for its misdeeds and incompetence. The third and smallest part of the rescue program is a $76 billion lending facility from the European Commission.

The huge gaps up in stock prices on Monday morning came after a short-lived market meltdown in U.S. stocks the previous Thursday. In a span of 16 minutes, the Dow Jones Industrial Average dropped 700 points and then rose 700 points. The Dow essentially opened up 400 points higher on Monday morning. Healthy markets don't have multiple big moves up and down, especially within a short period of time. Sudden big drops in the spring can frequently lead to much bigger drops in the fall. Recovery in the middle, usually lulls investors into a false sense of security. You may want to think about that while you're relaxing at the beach this summer.

Disclosure: None relevant.

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.