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.

U.S. Interest Rates Go Negative Again

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.

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At one point on November 19th, the yield on a new 3-month T-bill fell to 0.005%. A rational person would think you couldn't go lower than that, but a rational person would be wrong. The yield on 3-month bills maturing in January 2010 briefly turned negative. This was not the first time in recent history. It happened last year on December 9th, 2008 at the bottom of the Credit Crisis - or at least what has perceived to be the bottom so far. A 3-month T-bill auction on that date had a high bid equivalent of 0.000%. Apparently not everyone got in at that great rate.

Interest rates below zero are theoretically impossible. After all why not just keep the cash instead of settling for less money after a period of time? They do happen in the real world however and are an indication of extreme risk aversion on the part of banks. They are a marker of severe financial crisis. Before the current Credit Crisis, T-bill yields were only negative in the U.S. in 1940, after years of financial stress from the Great Depression. The auction low for T-bills was 0.01% in January of that year. Rates apparently went negative because of punitive property taxes imposed by a number of U.S. states. T-bills were not taxable and investors kept more of their money by taking a slight loss on T-bills than if they had paid the tax. No such special circumstances exist today to justify negative interest rates. The explanation for current negative rates is that banks are loading up on short term government instruments to improve the appearance of their year-end balance sheets.

Negative interest rates also took place in Japan during their current 19-year (and counting) financial debacle. Short-term interbank lending had a negative return one weekend in January 2003. As was the case in the U.S. during 1940, years of severe financial stress preceded this event. In Japan's case there were a series of rolling recessions - the modern version of depression thanks to government's now common practice of continual economic stimulus programs. There have been other cases of negative interest rates, however these seem to have been utilized (usually officially by the government) as a type of currency control. Switzerland imposed negative interest rates during 1970s after years of appreciation of the franc for instance, but only for foreign depositors.

The appearance of negative interest rates after a long period of financial stress raises the question of when economic problems actually began in the United States. It is reasonable to assume that they started long before the awareness of the Credit Crisis in 2007. Interest rate anomalies may have in fact already existed in 2003. While it is not generally known, between August to November some U.S. government repurchase agreements had negative rates. There is more than enough evidence to indicate that recessionary period actually began in the U.S. in 2000. Manipulated inflation rates and GDP calculations hid the details from the public. The U.S. government, businesses, and consumers lived off ever-increasing borrowing which made up for declining income. The Credit Crisis was merely the unraveling of this scheme, not when the financial problems started. The return of negative rate indicates a deeply entrenched problem within the U.S. financial system - and it doesn't look like it has been fixed yet.

Disclosure: No position in T-bills.

NEXT: For Gold, Overbought Means Overgood

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 Latest From Davos Switzerland

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 invitation only annual World Economic Forum - a meeting of world leaders, central bank heads, economists from big financial firms, and billionaire investors - is currently taking place at Davos, Switzerland. In an opening forum, the people who pull the strings of the global economy and stock markets came to the following conclusions (long after they have been obvious to everyone else):

1. The world is facing unprecedented economic challenges.
2. Fiscal packages may not be enough to restore economic growth.
3. The multilateral financial system needs strengthening.

Fortunately, George Soros gave an early talk that had somewhat more substance than the above long-on-platitudes and short-on-specifics comments. At the same time, Nouriel Roubini who is in Switzerland, but possibly not at the conference, released a purposely well-timed statement about just how costly it would be to fix the banking system.

Soros stated that the current crisis has the potential to be worse than the one during the Great Depression in the 1930s. According to his calculations, the global banking system in developed countries still needs an additional $1.5 trillion to be rescued. Furthermore, the only way to pay for this is with money creation, or in other words - inflation. Nouriel Roubini now says that he estimates the total global bank losses from the Credit Crisis will be $3.6 trillion, far higher than his original estimates (and mine as well, last July at a talk at St. Johns University, I estimated $2 trillion, which was double the consensus at the time). Roubini further stated the biggest U.S. banks are insolvent (New York Investing first said Citibank was insolvent at the end of 2007).

Expect some talk about the two approaches to fixing failed banking systems. These are the Japanese model and the Swedish model. The Japanese reacted to their failed banking system in the 1990s by propping up as many failed institutions for as long as possible and the consequence was economic and stock market stagnation that has now lasted almost two decades. The Swedes had a banking collapse in the mid-90s and took that opposite approach. They took swift and drastic action, which was painful in the short term, but proved highly successful and their economy revived quickly. So far, the United States has come closest to the failed Japanese model in dealing with the banking crisis. The political will to step on some very rich and powerful vested interests has been lacking as has the willingness to admit that top U.S. banks such as Citibank and Bank of America are insolvent.

One person that is not yet at Davos is Federal Reserve chair Ben Bernanke. He is busy keeping fed funds rates at zero at the Fed meeting in Washington. The meeting ends today and presumably he will be jetting off to Switzerland shortly thereafter. Expect the quality of debate at Davos to suffer accordingly.

NEXT: Government Wants to Play Good Bank, Bad Bank

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.

When the Lender of Last Resort Becomes the Only Resort

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:

In the current credit crisis, central banks and governments in the U.S. and Europe are making the transition from supporting the financial system to becoming the financial system. There seems to be no ruined financial company that governments won't bail out (at least if its large enough or if the impact of its failure would have some significance), nor any limit to the amount of money that central banks will lend. The complete dependency relationship on governments that now exists among financial institutions is the ultimate outcome of Moral Hazard - banks have repeatedly been bailed out in the past, so they take on greater and greater risks until a total systemic failure takes place requiring a government takeover.

The latest bank bailouts include UBS last week and ING this weekend. After UBS declared a surprise profit, the Swiss government announced it would be injecting up to $60 billion into the bank and would get a 9% stake in return (apparently the Swiss government doesn't even believe their accounting figures). The UBS bailout was predicted long ago by the New York Investing meetup. The Dutch government today announced it would be giving ING Groep NV $13.4 billion in exchange for non-voting preferred stock, but would nevertheless be getting two seats on the board. Yesterday, the Korean government announced a blanket $100 billion backing for its bank's foreign currency debts.

As for cash injections into the financial system, these hit a record last week in the U.S. with banks and dealers direct borrowing from the Fed reaching $438 billion per day. This was up from the $420 billion per day the week before. The only Fed program that had less lending last week was the one that allows banks to purchase asset backed securities ($123 billion versus $139 billion the previous week). The U.S. Treasury sold $499 billion in T-bills for the Fed's Supplementary Finance Account to support all of this lending. Meanwhile, the Bank of England started implementing a new framework to provide emergency funds to banks. The new facility cuts the penalty for banks borrowing funds directly from it overnight. Why go elsewhere under those conditions? Ditto in the U.S. where funds from the Fed are plentiful and cheaper than can be gotten elsewhere.

If only one government was engaging in increased lending, a case could be made that it could borrow the money from other more financially sound countries. However, in the current crisis, all the developed countries are increasing available funds substantially. They do so by selling bonds. But if everyone is selling more bonds, who's left to buy them? Only an increase in the supply of the world's major currencies can make this possible, which means they are all being devalued in this crisis. By how much, only time will tell.

NEXT: The Fed Should Be Careful What It Wishes For

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 Third Crash is the Charm - Fed to the Rescue

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:

As predicted in earlier entries to this blog, there was a coordinated global interest rate this morning. The only mystery is why it didn't happen yesterday morning instead. Apparently two crash days in a row in the U.S. markets were needed to expedite this action. A G7 meeting is scheduled for this Friday in Washington and it was likely that the world central banks were waiting for the meeting to be over to show that it had resulted in them taking bold, decisive rate cutting action. The U.S. Fed also probably thought that its Monday/ Tuesday announcements of $900 billion increased lending from it various credit facilities and that it would buy up to a trilion plus dollars of commercail paper would be enough to bull the market up. Instead, U.S. stocks crashed again on Tuesday. So now the ever reliable 'cut interest rates to juice up the stock market' is being tried, not just in the U.S., but globally. Instead of bold, decisive action, it smacks of bold, decisive desperation.

Tuesday's market behavior in the U.S. indicated that the monetary authorities were losing their ability to impact stock prices with their usual bag of tricks. While the announcement of the Fed's massive liquidity injections did cause a major intraday rally on Monday and a strong opening on Tuesday morning, it didn't last. At the Monday low, the Dow, S&P500, and Nasdaq were down over 8.0% and because of the Fed's announcements they closed down only in the 3% to 4% range (still a pretty bad day). If you measure a crash by intraday action, there was most certainly a market crash on Monday. If you measure it only by a closing price drop of over 5.0% on the indices there was only a crash on Tuesday (as well as Monday a week ago). While stocks were up a good bit on Tuesday morning and everything looked like it was going according to plan, the market nevertheless quickly faded and selling accelerated toward the end of the day. By the close, the Dow had dropped 508 points or 5.1%, the S&P 500 61 points or 5.7%, the Nasdaq 108 points or 5.8%, and the Russell 2000 37 points or 6.2%.

So this morning the Fed has turned to more interest rate cuts to save the market. The funds rate was lowered by half a point to 1.5% and the discount rate by the same amount to 1.75%. The ECB also dropped rates by half a point, to 3.75%, as did the Bank of England, to 4.5% (the UK recently passed an $87 billion rescue package for its banks similar to the U.S. Wall Street bailout plan). Canada, Sweden and Switzerland also joined the rate cutting party (noticeably absent, at least so far, is Japan). China lowered a key interest rate for the second time in a month. Australia had cut rates a full percentage point on Monday. This was the U.S. Fed's second intermeeting rate cut this year (the next Fed meeting is October 28, 29th), following the large cuts that took place to prevent a market meltdown in January.

The reason that central banks have avoided rate cutting recently is because of the inflationary implications. The Fed itself has stated in the minutes from it recent meetings that it sees entrenched inflation as a danger in the current economic environment. It avoided lowering rates at its September 16th meeting because of this. The stock market which had been conditioned to expect automatic rate cuts during its bouts of weakness, starting selling off and entered a crash period. Like all addictive processes, if you don't keep feeding the addict the drug, painful withdrawal follows. Supplies of the rate cut drug are almost gone however.

NEXT: Meltdown Microcosm - U.S. Future Can be Seen in Iceland Today

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.