Europe Continues Its Slide Toward the Precipice

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 Finnish finance minister has said all eurozone countries are making contingency plans in case the currency union breaks up. With debt downgrades, bond market anomalies, troubled bailouts, and austerity packages with their associated riots becoming the new EU norm, their worries are obviously justified.

Last night, Moody's downgraded Italy's government bond rating two notches from A3 to Baa2. This is just above junk status. Moreover, the outlook is negative with further downgrades possible in the near future.  So what happened in the Italian government bond auction this morning?  Did buyers  demand higher interest rates to buy Italy's increasingly risky debt as basic economic principles would predict? No they didn't. Italy sold €3.5 billion of three-year bonds at an average yield of 4.65%, much less than the 5.3% it had to pay last month.  How is this possible? Apparently Italian banks couldn't resist an urge to grossly overpay for their governments newly issued debt. The ECB was most certainly backing them up behind the scenes. If this is how Italian banks do business, can we assume that they're solvent?

There is little need to pose that question for Spanish banks. Recent data indicate that they borrowed €365 billion in June from the ECB — a record amount. This compares to €325billion in May. These numbers indicate that Spanish banks have been closed out of the interbank lending market (a good indication of insolvency). The highly troubled Spanish banking sector, which has €3 trillion in debt on its books, will be receiving an immediate infusion of €30 billion in bailout funds from the EU and another €45 billion in November. This represents 2.5% of its total debt and that amount is supposed to fix the problem. The actual funds needed will be many times that. It is impossible to say exactly how much because the financial numbers for Spanish banks are not reliable.

Spain seems to be following Greece's descent into a self-reinforcing economic collapse. This week Prime Minister Rajoy announced further budget cuts of €65 billion over the next two years.  VAT was raised from 18% to 21%. Almost a quarter of the Spanish work force is unemployed, even worse than Greece's 22.5%. Spain though seems to be making a more serious effort at fiscal austerity than Greece. According to reports in the German daily Rheinische Post, the troika on its latest visit found that the Greek government failed to implement 210 of the 300 budget savings requirements it had agreed to in exchange for its bailout money.

While interest rates are pushing against unsustainable levels in Spain and Italy, they have gone to theoretically impossibly low levels in northern Europe. Negative interest rates first appeared in government debt in Denmark and the Netherlands last December. Then Germany paid negative rates on some of its short-term bonds starting in January. This week, France sold six-month Treasuries at a yield of -0.03% and two-year bonds at -0.001%. Below zero yields are a sign of severe market stress.

The euro this week has traded below 1.22 to the U.S. dollar, but is slightly higher today. Investors should watch the 1.20 level. If the euro breaks and stays below this area of support, it could drop to parity with the dollar. The major central banks would intervene to prevent this though, so the ride down wouldn't be smooth.

Stock markets reacted bullishly in late June and early July to the news of further bailouts in the EU. Most traders didn't ask where the money would come from, nor if the plans were even legally possible. They may not be. The German constitutional court will be ruling whether or not Angela Merkel's promises to participate in the ESM (European Stability Mechanism) can go forward.  Even if they rule favorably, there is little actual money committed to the ESM. More money printing (and the ECB has already done quite a bit) is the only option left to fund the various bailout schemes to save the euro. Of course, it's logically absurd that a fiat currency could be saved by producing excess amounts of it. The same is true for trying to solve a debt crisis by taking on more debt.  But hope reigns eternal in the land of euro make believe.

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.

Interest Rates Spike on News From Banks

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.

While the big Tuesday rally in stocks got all the media attention, the big selloff in U.S. Treasuries that accompanied it went largely unnoticed. Good news for banks apparently means much higher interest rates and bad news for consumers.

Yields on U.S. treasuries were not that far above historical lows before the boondoggle accompanying the Federal Reserve's stress test announcements. When JP Morgan jumped the gun and other banks followed on March 13th, stocks mounted a spectacular rally in the last hour of trade. No one asked however where the money to fund all of that stock buying was coming from. Even a casual analysis shows that it came from the selling of U.S. Treasuries (which continued into the next day). 

The two-day rise in yields from the bond selloff was sizeable to say the least, with the longer-end of the curve having the biggest gains in absolute terms. Yields were up 26 basis points on the 30-year, 25 basis points on the 10-year, and 26 basis points on the 7-year (a basis point is one hundredth of a percent). Even the 5-year yield rose 21 basis points. Essentially, interest rates rose a quarter of a percent on treasuries with maturities of 5 years or more — and it all happened literally overnight. 

Since interest rates were at such low levels, the spike in yields represented a big increase on a percentage basis. This was most pronounced at the middle part of the curve. Yields on the 7-year went from 1.43% to 1.69%, for a gain of 18%. Yields of the 5-year went from 0.92% to 1.13%, and this represented a 23% increase. An even bigger jump took place in the 3-year, with yields up 28%when rates rose from 0.47% to 0.60%. The two-year though was up only 18% after going from  0.33% to 0.40%. The percentage increase in the 10-year, where yields went from 2.04% to  2.29%, and the 30-year, where yields went from 3.17% to 3.43%, were modest in comparison.

Treasury bills were less affected with yields on the 3-month and 6-month unchanged. The one-year rate rose from 0.18% to 0.21%. The one-month yield (which went negative in late 2008 and late 2009) went from 0.05% to 0.08%.  Yield information for treasuries can be found at: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.

The Fed's Operation Twist, a plan to sell $400 billion of shorter-dated Teasuries and buy an equivalent amount of longer-dated paper is still ongoing. By the end of March, a switch of $268 billion will have taken place. The purpose of this operation is to keep rates for the 10-year yield low in order to stimulate the economy. Apparently, it wasn't working so well this week. The Fed publishes the schedule for its Operation Twist sales and purchases and these can be found at: http://www.newyorkfed.org/markets/tot_operation_schedule.html.

The rise in interest rates is not just important to investors, but to consumers. as well. Consumer loans are frequently based on some formula using the 10-year Treasury yield. If this goes up a quarter of a percent, so will the rates on consumer debt. This will be a drag on the economy. While rates have been kept artificially low by the central bank for the last three years (they have gone down during the "recovery", when they should have been going up), the sudden rise in yields this week indicates the Fed may be losing its ability to hold them down.

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.

S&P 500 Joins Global Bear 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.

Markets opened October with almost all assets declining everywhere. The S&P 500 entered bear territory on Tuesday.  Few assets other than treasuries and the U.S. dollar are doing well, as is typical during a credit crisis.

The big talk on Monday, the first trading day of October, was about the S&P 500 making a new closing low for the year. The intraday low was only slightly lower than the previous one in early August, so peak to trough the index was off 19.8%. The big drop on the opening on Tuesday created a 20% loss, putting the S&P 500 officially in a bear market.

The small cap Russell 2000 already entered bear territory on August 8th. The Russell had another mini-crash on Monday, dropping 5.4% on the day. That was its fourth mini-crash since August. Mini-crashes are common during credit crises, but not at other times.

The selling on Tuesday first showed up in Asia with the Hang Seng in Hong Kong losing 3.4% to close at 16,250 and South Korea's KOPSI dropping 3.6%.  The ugliness then spread to Europe with the German DAX, the French CAC-40 and the UK FTSE down more than 3% during the  trading day. U.S. stocks opened then opened lower with the Dow losing more than 200 points in early trading.

As usual in Europe, banks were at the epicenter of the market quake. Franco-Belgium bank Dexia was down 22% at one point. Deutsche Bank (DB) was down more than 6% in Frankfurt after announcing it would miss its profit target for the current year.  American banks have not avoided the carnage affecting financial stocks elsewhere; just take a look at Bank of America (BAC) and Morgan Stanley (MS), both trading at two-year lows.

While the behavior of banking stocks makes it clear that a credit crisis is taking place, falling commodity prices clearly indicate that the global economy is turning down. Copper prices fell as low as $3.01 a pound early Tuesday. Copper sold for well over $4.00 at its high in February and dropped sharply throughout September. Oil is also indicating weakness, with WTI crude closing at $77.61 on Monday. It traded as low as the $75 range on Tuesday. Oil is heading into a period of seasonal weakness and this is likely to exaggerate any price drops. Next strong support is around $70 a barrel.

Money continues to move into safe haven treasuries. The 10-year yield was as low as 1.725 before selling began in the bond market. The U.S. dollar index traded just under 80 at its high. The euro, which moves opposite to the dollar, hit a low of 1.31.62 Tuesday. Further weakness should be expected until there is some resolution to the debt crises in the EU.

 In bear markets, the bigger trend is down, but this is frequently accompanied by huge volatility. This is what has taken place since August and until there is a good reason that the trend should change, investors should expect that prices will be moving lower.

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.

Is Greece About to Default?

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.

Yields on two-year Greek governments reach 46.84% last Friday. This is roughly comparable to yields on Argentine bonds in early December 2001 -- only a month before the country defaulted on its debt.

Similar interest rates occurred this spring in Greece before the second bailout package was put together. The bailout saved Greece from defaulting back then, but the bailout is now falling apart while the fiscal situation in Greece continues to deteriorate. The risk of default in the near future has returned, but the will to stop it this time around is much weaker than in the past.

Finland and a number of other countries have already demanded collateral from the Greek government for their contribution to the bailout and this reduces the money available that can be used by the Greek government to pay off its debts.  Then talks between the Greek government and the ECB, EU, and IMF broke down last Friday (September 2nd) because Greece admitted it will not meet its deficit reduction and privatization targets for the year. This potentially puts the next $8 billion tranche in bailout payments in jeopardy. The talks are supposed to resume in 10 days. Even more challenges will have to be faced this coming week.

Citizens of the fiscally solvent EU countries are getting tired of paying to support what they see as the profligate spending habits of the EU's weaker economies.  The bailout efforts have been lead by German Chancellor Angela Merkel, but support within her country has never been strong for them. Her ruling party has lost six regional elections this year, including one in her own home state this weekend. Any more pro-bailout efforts will only further weaken her politically.

At the same time that efforts are taking place to undermine the second bailout, more and more money is needed by Greece. Like many other heavily-indebted countries in the past, Greece is dealing with a destructive feedback loop of inexorably escalating interest costs that cause its debt to continue to rise regardless of what efforts it makes to control it. The Greek government claimed a debt to GDP ratio of 120% in 2010 during the first bailout talks. It is now estimated to be as high as 160%. Interest payments on that debt could be as high as 24% of GDP at current rates (the 10-year bond is yielding over 18%). Despite the first bailout and now the second bailout, interest rates keep going higher, the national debt keeps getting bigger and the problem keeps getting worse.  

Since someone elsewhere had to lend all the money that is in danger of not being paid back, Greek debt problems are not isolated to Greece, but are having a major impact on the big banks in France and Germany (the real reason Germany and France are so anxious to bail out Greece). The debt problem moreover is being spread through contagion to Spain and Italy, both of which are much larger economies and which are ultimately "too big to bail". This is casting a wider net of impacted banks. By the last week of August, credit default swaps (insurance on bonds) were rising to crisis levels for the Royal Bank of Scotland, BNP Paribas, Deutsche Bank and Intesa Sanpaolo. The problem seems to be a shortage of liquidity, just as was the case in the fall of 2008.

It has also been reported that many European financial institutions have losses on bond holdings, despite the ECB actively supporting Spanish and Italian bond prices . The global banking system has approximately $2 trillion in exposure to Greek, Irish, Portuguese, Spanish and Italian debt. On Monday, the yield premiums on Italian and Spanish 10-year government bonds over the equivalent German Bund hit their highest in a month. Italian bonds traded at 5.5%, well above the 5% rate at which the ECB has been buying recently. Italy has to roll over 62 billion euros in bonds by the end of the month.

Stocks have of course been negatively impacted by the problems in Greece and this will continue until there is some resolution. The German DAX had another mini-crash on Monday, falling 5.28% or 292 points. The drop in Paris was just under the 5% mark that defines a crash day. London held up somewhat better as it has during the entire crisis so far. U.S. markets were closed.

At this point, the only thing that can prevent a default by Greece is if its entire debt is bailed out by the EU and IMF (this would require a third and even fourth bailout package). This is not going to happen. The second bailout itself is highly unlikely to go through as planned. Without it, Greece will default this fall.  With it, a little more time will be bought before a third bailout is needed - and support for that measure doesn't currently exist and isn't likely to exist. The important question concerning Greek default seems not to be if, but when.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2000s"
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. 

Geithner Talks, Market Drops ... Again

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:

Treasury Secretary Geithner appeared on Face the Nation on Sunday. Stocks in the U.S. are selling off this morning (even though there was a decent rally in Asia last night). Stock selling seems to be the most likely response whenever Geithner speaks and anyone long the market should worry whenever Geithner's mouth is about to open. The interview dealt with the administration's latest imbroglio, the attempt to force GM into bankruptcy and how well the various current bank bailouts are going. Geithner did state, "we want greater lending". He didn't come up with any reason why this might happen.

When Geithner was asked whether the government will force banks to sell their toxic assets to improve conditions for lending, he said that "banks have a large incentive to clean up their balance sheets." A news item released in Europe (please note that this news was not originally published in the U.S.) last Thursday certainly brings that into question. It was reported that a number of large banks including Citigroup, Goldman Sachs, Morgan Stanley, and JP Morgan Chase were considering buying toxic assets to be sold by rivals under the U.S. Treasury’s latest one trillion bailout plan. The purpose of this plan is of course to get toxic assets off the bank's books. Nothing in the law apparently said the banks couldn't participate in the this free money government give away. So of course, they want the goodies too. The result of this congressional oversight could be a huge amount of government spending that results in just moving the toxic assets around the banking system instead of getting them out of it. Geithner also made it very clear in the interview that Treasury's "obligation is to apply the laws passed by Congress".

As for GM, Geithner stated multiple times that "GM is going to be part of this country's future." He followed up with "We want to see a strong automotive industry emerge from this recession," , and added that the government must be sure that GM "can emerge strong enough without having to have government help on an ongoing basis." As to whether GM will have to file for bankruptcy protection, Geithner said "there's a range of options. They've made some progress on restructuring but they're not there yet." What was not stated in the interview is what would the costs be of GM going bankrupt versus it being bailed out.

Bailing out GM will probably be many, many times cheaper than letting it go bankrupt. But hey, when dealing with taxpayer money, why not consider the most expensive option possible. The much higher costs of not bailing out GM are a consequence of the government already having bailed out the banks and the need to increase those bailouts if GM fails. Although the auto companies have been badly managed for years, the idea that the U.S. government knows better about how the auto industry should be run is ridiculous. How they've handled the bank bailouts is a good indication of just how much the government knows about anything to do with business.

NEXT: How to Handle Earnings Season

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.

Oil Yes, Financials No

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:

Suddenly, oil inventories in Cushing, Oklahoma dropped by 200,000 barrels yesterday instead of increasing by 3.5 million barrels that industry 'experts' predicted. While I have predicted that this would happen in this blog and stated so at a class given this Tuesday by the New York Investing meetup, I was a lone voice in the wilderness. Before the news came out, oil ETFs were making new lows as were many financial stocks. While superficially oil and the financials looks like major bargains, only oil should be assumed to be so.

When the 'surprise' (only a surprise to people who get their information from the mass media) news came out that oil stocks had declined, the March contract for Light Sweet Crude jumped $4.86 to close at $39.48. April, which will be the front month after today, closed at $40.18. Anecdotal reports indicate supply is drying up, but you will not see any coverage of this in the American press, other than in relationship to OPEC. For those who are unaware of it (and this presumably includes all reporters on energy topics), every oil and gas lease in the United States contains a term that the producer can stop pumping if the prices aren't high enough. Based on the behavior of the oil futures, which have jumped back to the $40 level over and over again, the market is telling us a price under $40 a barrel just isn't sustainable.

Nevertheless, the coverage in the media today is once again the same old (off-key) song. You will see quotes like, "It was a significant move last night, but there's not much out there that can create a bullish story" . And the reason for this is, "The demand outlook is very weak, and there's nothing to suggest that it will improve in the near term." There is no analysis of the supply side of the equation, despite the news out of Cushing, Oklahoma yesterday. Supply dropping faster than demand is indeed a bullish story. The same reporters who know nothing about how the oil industry functions, also seem to have forgotten to take high school economics. The current coverage of oil is an excellent example of why the average investor who gets his or her (mis)information from the mass media can't make money in the markets.

While oil had a big pop up yesterday, financials hit their lows in many cases and remained at those levels. Citigroup fell to 2.50, Wells Fargo to 11.94 and Amex to 12.74. Bank of America dropped as low as 3.86, only a tinge above its low of 3.77. Collapsing financials led the market down and helped the Dow close at a six-year low. The possibility of a Swedish style bailout of the big banks is becoming more of a reality. This would wipe out the equity holders completely (which include every major pension fund in the United States as well as Wall Street insiders) and has been resisted for that reason. While there is a risk of losing everything if you buy financial stocks, no such risk exists with oil. All commodities have a minimal price which is the cost of production. The minimal price for a troubled stock however is zero.

NEXT: Stocks/Oil Trying to Bottom, Gold at Resistance

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.

Britain Points the Way to U.S. Economic Future

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 of today, Great Britain is officially in recession, joining the U.S., Japan and Germany. Britain's GDP shrank 1.5% in Q4 2008, after shrinking 0.6% in Q3 2008. Those are at least the official figures, it is quite probable that the actual ones are even worse. Notable declines took place in the banking, retail, and manufacturing sectors (just like in the U.S.). The FTSE fell below 4000 and the pound dropped to 1.35 per U.S. dollar, a 23 year low, on the news.

Great Britain was once the premier economy in the world. The British pound was once the world's reserve currency. A rigid class system which guaranteed entitlement to those on top - similar to contemporary Wall Street in the United States - followed by socialist practices that offered entitlement to those on the bottom have over time eroded the country's economic dynamism. Early in the 20th century the capitalist free for all and innovation friendly U.S. began to assume economic preeminence after World War I. U.S. currency dominance was made official at Breton Woods in 1944 toward the end of World War II.

One of the most shocking stories in the history of technology illustrates quite clearly how Britain and U.S. attitudes differed in mid-century and why the U.S. became the post World War II economic powerhouse that it did. Both Britain and the U.S. developed early electronic computers for war time use. At the end of the war, the British government destroyed even the plans for the computers fearing they would fall into the hands of the Russians. The U.S. made the plans publicly available by publishing them, engendering one of the biggest growth industries of all time. The lesson of openness and transparency is currently being lost in the U.S. however with the Federal Reserve and Treasury engaging in significant and frequently secret manipulation of the financial system. In the long term this is only going to prove to be disastrous - although the short term results have been horrendous enough as is.

The response of the British prime minister, Gordon Brown, to the current British recession is that it is a result of global events. In case anyone has forgotten, Gordon Brown was the Chancellor of the Exchequer (equivalent to U.S. Treasury Secretary), who took the decision to sell half of British gold reserves in 1999 , when gold was around $260 an ounce, to buy among other things, U.S. dollars. Brown also has presided over a subprime crisis, 125% housing loans to people who could never pay them back were common, that is much worse than in the U.S. Unfortunately, while Gordon Brown is one of the most economically incompetent officials ever to run a major economy, he has plenty of company on the world stage these days. George Bush is certainly in the running for a close second. Many Japanese leaders in the last 25 years would be up there as well. Because economic idiocracies are common place in the world today, drastic action will be required to fix things. If the U.S. doesn't take appropriate action soon, it will be following Britain down the path of long term economic and currency decline.

NEXT: Unemployment Everywhere

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.

What We Learned From the First Trading Day of 2009

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:

January 2nd was a good year for the markets throughout the world. Volume was low however since many traders took a four day weekend and this almost certainly reduced selling. While we can't look at the results as a complete picture, the first day does provide us with a good sense of what people are buying. While this is very useful information, you need to make sure selling pressure isn't overwhelming the buying interest. Under such circumstances, the areas of the market that were doing the best and worst are most likely to provide useful information.

All the U.S. indices rallied on Friday. The Nasdaq led the way, rising 55.18 points or 3.4%. The S&P was just slightly behind, going up 28.55 points or 3.1%. The Dow with its 258.30 rally was up 2.9%. Noticeably lagging were small cap stocks. The Russell 2000 rose only 6.39 points or 1.2%. Trading volume on the Dow was well below average. Nasdaq volume was low. Low volume was also seen in GLD, which was down slightly on the day. SLV which was slightly up, rose on somewhat above average volume. OIL though won the prize going up 8% on volume that was well above average.

Examining purchasing in individuals stocks, Energy related stocks had the highest percentage of buying interest by far of all industry groups. They were followed by Metals/Steel, Machinery,
Mining, and Aerospace stocks. The list of stocks that investors were scooping up could be best summed up as commodity related and infrastructure plays (the Obama administration is working on a one trillion dollar spending package which will benefit these companies).

And what stocks did investors shun like the plague? At the very top of that list was Savings and Loans. Office products were in essentially just as bad shape. Slightly better were Banks, Semiconductors, Insurance, and Computer Hardware in that order. The industries most lacking in buying interest could best be summed up as financial and those that produce products that are used for business operations - or perhaps, those that are part of the Credit Crisis and those most impacted by recession.

NEXT: Sellers Return for Second Day of Trading

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.

Dr. Evil and Mini Me Loot the U.S. Treasury

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:

On Monday, U.S Treasury Secretary Henry Paulson and his look-alike Interim Assistant Secretary for Financial Stability, Neel Kashkari (both originally from Goldman Sachs and participants in helping to create the credit crisis) came up with a plan to stabilize U.S banks without nationalizing them. The U.S. will be saved from socialism by pilfering its treasury and giving the money to the U.S. banks and brokers that are considered 'too big to fail' the many teetering regional banks will have to wait and if still in business, might get a share of the government's succor sometime in the future). Pilfering was their intent, along with helping out their other well-placed friends from the beginning (Kashkari drafted the Treasury department's three-page constitutionally questionable, unworkable, and politically inept power grab that was the original Wall Street bailout bill). Interestingly, every major American news outlet seems to have missed the real story about what is taking place.

The story universally reported by the U.S. media, frequently in blaring headlines, was that the government was going to distribute funds to banks in exchange for ownership stakes. No such thing is occurring. In reality, the Treasury is injecting liquidity by buying preferred stock. Preferred stock is loan in perpetuity, it does not represent any ownership rights in a company. Preferred stock is supposed to pay interest (if it doesn't, like all other permanent loans it's a gift). No interest rate was cited in the Treasury announcements, although anything less than the 10% that Warren Buffett got on his recently purchased preferred from Goldman Sachs (along with warrants) or Mitsubishi got on its purchase of Morgan Stanley preferred (backed by a U.S. guarantee), is a government subsidy. No major media source seems to have pointed this out. Instead, they all reported that if rescue plan works, the U.S. taxpayer will benefit because these preferred shares will be sold for a profit. Since preferred share prices fluctuate with interest rates and not the fortunes of a company (as long as it's a viable enterprise), they would go down, not up, if higher interest rates result from the government's inflationary policies. No common share price increases, as happens when a company does better, will benefit preferred share holders. It is of course almost 100% certain the government also overpaid substantially for this preferred stock as well (in the case of AIG, the U.S. government paid ten times the market price for the equity it purchased). The U.S. taxpayer is going to lose somewhere between a little and everything on this deal. There is no chance is will be profitable.

This looting of the treasury is also not going to be terribly effective either. With it, the government has officially established a 'too big to fail' policy. Only big banks intitally get any money. These include J.P. Morgan Chase, Bank of America, Citigroup., Wells Fargo, Bank of New York, State Street, Merrill Lynch, Morgan Stanley and Goldman Sachs Group Inc. Citigroup, Wells Fargo, and JP Morgan will get $25 billion each (even though it doesn't appear that JP Morgan, nor Wells Fargo are in trouble and need the money). Another $25 billion will be split between Bank of America, and Merrill Lynch, which are merging. Goldman Sachs and Morgan Stanley will each get $10 billion, while State Street Bank and Bank of New York (which also doesn't appear to need the money) will get roughly $3 billion each.

This latest move by the Treasury will not only help to continue to put another major dent in the U.S. government's stretched finances, but is helping to create a dangerous concentration of banking power. For 200 years, U.S. policy has promoted a large number of small banks, but now we will be getting a small number of large banks. The thinking behind America's historical approach to banking was to prevent the concentration of too much economic power in too few hands, which could threaten the capitalist and democratic systems. Based on what is happening now, these fears were obviously well justified.

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.

Today's Global Stock Market Meltdown

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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A market sell off spread around the globe last night and is about to reach U.S shores as this is being written. This current round of selling was precipitated by a banking crisis in a number of European countries and in Korea over the weekend. Several Eurozone states moved to guarantee bank deposits and large bank bailouts from last week had to be restructured to make them work. The Asian bourses and Israel was the first to open after this news and the pronounced selling took place from the get go, with a number of exchanges recording crash level drops.

The trouble started on Saturday when the a plan for a coordinated bailout of the European banking system fell apart. Sunday, Germany moved to guarantee all bank deposits (Ireland was the first to do so last week). Austria and Denmark quickly followed suit and then so did Sweden . At the same time, Euro governments moved to shore up a number of troubled banks to prevent the problem from spreading. Germany had to restructure the rescue deal for lender Hypo Real Estate (after only one week), BNP Paribas agreed to buy a majority stake in Fortis which had been partially nationalized by Belgium and the Netherlands last Monday, and UniCredit, Italy's second-biggest bank, announced that it needed to raise capital. Tiny Iceland looked like it was about to become the first country with a banking system that completely collapsed. Across the world in Asia, South Korea's finance minister said Korean banks were having trouble securing funds in foreign currencies and that the government would offer loans from its reserves.

When markets resumed trading, the results were ugly. Israel was down 7% at one point, as was Russia. The Hang Seng in Hong Kong and the mainland Shanghai index experienced crash level drops of 5.0% and 5.4% respectively. Indonesia was the worst hit market with a 10% drop. Australia, India, Singapore, South Korea and Thailand were hard hit as well. The Nikkei in Japan was in slightly better shape than China, falling only 4.25% to 10,473 (well below the low of 14,000 plus bottom that it hit in 1992).

Europe, which is still trading as this is being written, followed Asia's lead. The major stock indices - the DAX in Germany, the FTSE in England, and the CAC-40 in France all fell between 4% and 5% after trading opened. Smaller countries were fairing worse with Norway down 6% and Austria down more than 8%. Oil fell to just over $90 a barrel, but gold and silver were rallying as is usually the case during financial crises. As happened last Monday morning, the precious metal rallies were taking place even though the U.S. dollar was up (the euro was down two cents against it).

As has been the case ad nauseum, central banks in Europe were pumping huge amounts of liquidity into the financial system to control the crisis. None of the previous moves have had any lasting effects, nor will this one. The next likely government action is a coordinated global interest rate cut, which we should be seeing soon. When this doesn't work, you should assume that trading bans (such as no short selling at all) will be extended and then no selling at all will be allowed because the stock markets themselves will be closed down for a day or two or even a week or more.

The U.S. markets have just opened with the Dow down almost 300 points and the Nasdaq down more than 50. It should be an interesting day.

NEXT: The New Crash Monday Phenomenon

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 Next Banks and Brokers to Cash Out

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:
http://www.youtube.com/watch?v=qQsTk6SaTJ8
http://www.youtube.com/watch?v=qfpE0wAz-nA
http://www.youtube.com/watch?v=ZIxTlP5FU_Q

The New York Investing meetup first predicted a major broker failure, Bear Stearns, in August 2007. Bear went under in March. The bailout of Fannie Mae and Freddie Mac was predicted in December 2007. They both had to be bailed out this July and then taken over by the government in September. In April 2008, our list of the dirtiest dozen financial companies included AIG, Lehman, Fannie Mae, Freddie Mac, IKB Deutsche Industriebank, Merrill Lynch and Washington Mutual (see 'Night of the Living Fed' at http://investing.meetup.com/21/files). Lehman and Washington Mutual, Merrill Lynch and Wachovia led our list of 'The Banks and Brokers Most Likely to Fail' in September. All of these banks and brokers no longer exist as independent companies, if they exist at all.

While the next wave of failures could include Morgan Stanley (on the April list), it will mostly consist of regional banks. When the market crashed on Monday, regionals were some of the worst hit of all stocks. Many are dependent on the Wall Street bailout bill to keep them in operation. Without it, a number will fail in the near future, with it, they will fail in the not so near future. Top of the list in the next round of the insolvency sweepstakes is National City (NCC), which dropped 63% on Monday after falling 25% on Friday. Management insists everything is fine even though the stock price looks like it could soon be negative and vultures have started circling the branches of the bank. After National City, Sovereign (SOV) and Fifth Third Bancorp (FITB) took some of the biggest hits, dropping 32% and 20% respectively. Fifth Third was on our September list. Sovereign would have been included if we had added one more bank.

The full list of regional banks and brokers that we considered most troubled (we only looked at banks with a market cap over $1 billion) in September is:

•E*Trade (ETFC)
•Corus Bankshares (CORS)
•First Horizon (FHN)
•National City (NCC)
•Provident Bankshares (PBKS)
•Colonial BancGroup (CNB)
•Fifth Third Bancorp (FITB)
•Regions Financial (RF)
•Zions Bancorp (ZION)
•Huntington Bancshares (HBAN)

While these banks are sizeable, they are not 'too big to fail' like a Citibank or UBS. If some form of the Wall Street bailout bill passes then these banks will have a lifeline thrown to them. That lifeline may prove to be fairly short however.

NEXT: Short Selling Democracy - Senate Resurrects Bailout Bill

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.

Credits of Mass Destruction

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.

The New York Investing meetup has made a companion video to this blog entry. You can find it at: http://www.youtube.com/watch?v=qjGoOE2SwhY.

In the week of February 14, 2008, the Auction-Rate Securities market collapsed with almost 1000 auctions failing. Auction-rate bonds were long-term debts that had their interest rates reset in a Dutch Auction every one to 35 days. The market had been created in 1984 and from that time until the end of 2007, only 44 auctions had failed. The market had grown to over $300 billion and was a favorite place to borrow for local governments, hospitals, museums, student-loan agencies and closed-end mutual funds. As long as the auctions worked the rates for these borrowers remained as low as 3%, but if they failed (something no one worried about since this almost never happened), the rates could be punitively high - as much as 20%. Wall Street raised money from some of its best clients to fund these auctions, with promises that these investments were 'as good as cash'. After 24 years without problems, the end came suddenly and without warning. The big banks and brokers withdrew their support and overnight their clients who had invested in these 'good as cash' investments couldn't get their money back. The borrowers suddenly found themselves paying junk bond rates.

At almost the same time, VIEs 0r variable interest entities (also known as conduits or special purpose vehicles) made the news. VIEs are off-balance sheet items for banks (contary to popular belief, the Enron scandal did not do away with off-balance sheet items) and their amounts were revealed to be around $800 billion. The first major news of off-balance sheet items for banks concerned SIVs (structured investment vehicles), which are a type of VIE. This news appeared in the fall of 2007. SIVs were estimated to have an original value of $400 billion and this amount was considered so great that the U.S. Treasury department attempted to arrange an SIV bailout. This effort never got anywhere and was abandoned by December. Only two-months later, the off-balance sheet problem was revealed to be twice as large as originally thought. Furthermore, it was estimated that the VIEs were worth only 27 cents on the dollar. In an SEC filing, Citibank indicated that it had $320 billion in VIEs, which would mean it might have lost approximately $240 billion off-balance sheet. It had only written off $22 billion in losses up to that time.

While problems with the auction-rate securities market and VIEs had not been predicted and appeared seemingly out of nowhere, warnings were being made about the Credit Default Swaps market (CDSs). These were derivatives that were a type of bond insurance and the functioning of this market was threatened on a number of fronts - particularly from bond insurers losing their top credit ratings or a failure of a major counter-party (any large bank or broker). The Fed would have to publicly bail out Bear Stearns in mid-March 2008 to prevent the collapse of this market. The CDS market was so huge at $62 trillion that it was four times the size of the U.S. economy and was effectively a financial nuclear weapon that could wipe out the entire system. If this happened, it would likely be sudden and without warning just like the collapse of the auction-rate security market (and Bear Stearns).

NEXT: Gold, Silver, and Oil - The Basics of Price Movements

Daryl Montgomery
Organizer, New York Investing meetup

For more about us: Please see our web site: http://investing.meetup.com/21.

Central Bankers Gone Wild

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.

The New York Investing meetup has made a companion video to this blog entry. To see it, please go to: http://www.youtube.com/watch?v=y9kzKAzn2Ig

In the hundred years before the Federal Reserve existed, aggregate inflation in the United States was approximately zero. This does not mean that there was never any inflation, inflation did indeed exist, but that the periods of inflation were offset by periods of deflation so that over a long period of time there were essentially no changes in prices. A new era for inflation began when the Fed was created in 1913. Except for the Great Depression in the 1930s, deflation essentially disappeared from the United States economy and there were only periods of lower or higher inflation. This continuing inflation resulted in a 1923% inflation (based on understated official figures) for the first 95 years of the Fed's existence. Conversely, it could be said that the U.S. dollar had lost 95% of its value during this time. And the remaining 5% seemed to be endangered as well.

The beginning of 2008 saw what was probably the biggest injection of liquidity into the U.S. monetary system by the Fed in history. There were two massive rate cuts separated by only 8 days. First there was a 75 basis point cut in the Funds Rate on January 22nd and this was followed by a 50 basis point cut on January 30th. The previous time the Fed had cut rates by 75 basis points was when the Funds rate was at 20%. The January cut took place from a 4.25% level and was the first inter-meeting cut since the 9/11 crisis. Only two months later the Fed would again cut the Funds rate by another 75 basis point, this time from the 3.00% level. Based on the starting levels, the cuts in the Funds Rate was enormous and took place in a very brief span of time.

The cut in the Funds Rate was by no means all the liquidity that the Fed was pumping into the system. The TAF (Term Auction Facility) auctions were raised from $20 billion to $30 billion each by January and would reach $50 billion for each auction in March. Two additional auction facilities were added to the TAF by March - the TSLF and the PDCF. The TSLF (Term Security Lending Facility) was set up to swap $200 billion of treasuries for illiquid securities being held by the banks. The PDCF (Primary Dealer Credit Facility) opened the Fed's credit operations to the 20 firms that bought treasuries directly from it. The Fed had only lent money to commercial banks during its entire history and the PDCF represented a big extension from its traditional scope of operations.

The impact of the Fed's liquidity boosts caused the money supply to explode. MZM (money with zero maturity and therefore available for immediate use) grew by an over 37% annual rate in the first quarter of 2008. This would have been OK if the economy was expanding by around 37% as well, but the economy was contracting instead. The difference between money supply and economic growth was more than enough to create a massive future inflation problem and possibly even hyperinflation. How much inflation would actually take place was something only time would tell.

NEXT: The Fed's Manipulation of the Stock Market

Daryl Montgomery

Organizer, New York Investing meetup

For more about us, please go to our web site: http://investing.meetup.com/21

The Fed's (long) Term Auction Facility

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.

On November 28, 2007 the Federal Reserve started a massive year end injection of liquidity into the financial system. On December 11th, the Fed once again lowered the funds rate a quarter of a point (for a total of 100 basis point drop since the half point cut on September 18th). While neither of these events were extraordinary, what happened the next day was.

On December 12th, the Fed announced the creation of its Term Auction Facility . The TAF program was open to any bank or depository institution, which would be allowed to bid for one-month loans up to the total amount of funds being auctioned off. The winners had a wide-choice of what they could pledge as collateral, including mortgage-backed securities that could not be traded and had no market price. In exchange for their possibly worthless securities, banks and brokers could get cash from the Fed. This new program represented a sea change in Fed operations.

First, the Fed would be offering up sums of money in auctions to banks and depository institutions instead of having them come to the Fed to get a loan. Using the Fed's discount window was usually only done by institutions teetering on insolvency and was carefully avoided by any institution that wanted to preserve its reputation. The Fed finally found a way around this impediment to getting money to struggling banks by offering the money at auction, guaranteeing an injection of liquidity into the system at the amount auctioned off and removing the stigma for those who got the money.

The second major change the TAF introduced was that the Fed was willing to take even worthless paper as collateral for a loan. During its history the Fed usually only accepted treasuries as collateral. With the TAF, it effectively began engaging in subprime lending itself . By doing so, it was bailing out the banks that had foolishly engaged in this practice - and who might have become insolvent if they couldn't get rid of their subprime paper.

When the TAF was announced in December, the original auctions were for $20 billion each. By January 2008, this amount was raised to $30 billion. By March each auction was for $50 billion and two additional Fed lending facilities would be introduced (the TSAF and the PDCF) - breaking even newer ground for Fed operations.

Next: Economic Predictions for 2008

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21

Subprime Freezes Over

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 December of 2007, the Bush administration proposed freezing the rates on adjustable subprime mortgages for 5 years. This program was 'voluntary'. Indeed the U.S. government had no legal authority to void valid contractual commercial transactions between parties, one of the most fundamental underpinnings of our economy. Nevertheless, presidential candidates Hillary Clinton and John Edwards both immediately criticized the proposal as not doing enough and advocated an even longer freeze on rates.

While the alleged purpose of this program was to help the 'struggling homeowner', an examination of the details indicated otherwise. Homeowners with fixed-rate mortgages got no relief. Homeowners with non-subprime variable-rate mortgages got no relief. Why were just sub-prime adjustable-rate mortgage holders singled out? The answer is simple, these mortgages were defaulting and would be defaulting at the highest rates. Many of these had been granted at the end of the mortgage boom and were for a substantial percentage of the house price at the time of sale (up to and even exceeding 100%). Mortgages for 100% of equity, especially when housing prices are falling, are the last thing banks want to take back and have to write off on their books. These are guaranteed losses for the bank since the foreclosed house would likely sell for much less than the amount of the mortgage. Any bank that had a large number of this type of defaulted mortgages could become technically insolvent fairly quickly. Mortgage bond holders, many of them big banks and brokers, who had bought bonds containing these loans would also lose out. It is a much better deal for banks to foreclose on mortgages that have been substantially paid down, since they make a big profit on these. These homeowners were the most deserving and required the least assistance, so they should have been the centerpiece of any mortgage relief program - but they weren't. Helping them would mean hurting bank profits.

The proposed freezing of sub-prime mortgage rates also represented the first attempt at price controls on the part of the government. Price controls are an almost universal response to inflation by the authorities and prices for necessities are the most likely to be controlled. While the rise in mortgage payments was preplanned and the exact amounts were known in advance (rarely the case with most inflation,) this was no different from any other attempts to dampen rising prices by freezing them. it was not surprising that this took place first in housing either since it is one of the most basic of necessities. Unfortunately, price controls always have negative consequences. In the case of the mortgage freeze, anyone offering loans in the future would have to demand higher rates to compensate for the possibility that rates might be frozen. Or lenders seeing higher risk in the market would simply not offer loans at all. In both these scenarios future mortgage rates will be higher than they would have been. The government could then solve this problem that it created by offering subsidies (a common second response to increased prices for necessities), most likely through Fannie Mae and Freddie Mac. These government supported enterprises would then wind up dominating the mortgage market so much that it would effectively be completely socialized. By the end of 2007, it looked like this was already taking place.

NEXT: The Fed's (long) Term Auction Facility

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21

Sovereign Wealth Funds Bail Out the Banks

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.

As the credit crisis unfolded in the fall of 2007, a number of big banks and brokerage houses were desperate for capital - far more desperate than was ever admitted publicly. While they needed large cash infusions to continue operating, a number of sovereign wealth funds in the oil-rich Gulf and the Far East had swollen coffers of dollars that they needed to place somewhere. It was therefore almost inevitable that some of the first bailouts (an insolvent financial institution requires multiple bailouts) of struggling financial institutions would be done by sovereign wealth fund purchases. By the end of 2007, it was estimated that these funds would make at least $37 billion of investments in Western financial companies.

The idea of foreign investment as a means of providing capital was not a completely new one. Prince Alwaleed Bin Talal of Saudi Arabia had purchased 5% of Citibank (then Citigroup) when it was reeling from the Savings and Loan Crisis in the early 1990s. Earlier in 2007, China purchased a $3 billion stake in Blackstone's IPO, which debuted just before the collapse of the private equity bubble and promptly plummeted in price. By November, Abu Dhabi had bought a 4.9% stake in Citibank for $7.5 billion. At the time of the purchase, rumors were circulating on Wall Street that Citi might be insolvent. U.S. government officials admitted being involved in the transaction, which begs the question as to whether or not they would have allowed the deal to go through if it wasn't absolutely necessary for Citibank's survival.

In early December, the Government of Singapore Investment corporation got 9% ownership in UBS for a little less than $10 billion and an unnamed middle eastern investor (thought to be Oman) bought a 2% stake. China then bought a 9.9% stake in Morgan Stanley only days before Christmas. Singapore's Temasek Holdings then helped bail out Merrill Lynch on December 24th. By mid-January, Citibank was already in need of a second bailout by the sovereign wealth funds, only two months after the first one had taken place. The Government of Singapore, the Kuwait Investment Authority and Price Alwaleed were part of a $12.5 billion capital infusion for which they got some ownership of the bank in return. On the same day, only weeks after its first cash infusion from a sovereign wealth fund, Merrill Lynch received an additional $6.6 billion from parties including the Kuwait Investment Authority and the Korean Investment Corp.

None of these deals had to undergo scrutiny by the U.S. Committee on Foreign Investment, which only examines whether acquisitions by overseas buyers compromise national security when their stakes rise above 10%. Given the large number of sovereign wealth funds and wealthy individuals in the Gulf States and Far East, it would be possible for their aggregate ownership to reach 100% without a review ever taking place.

Next: Government Investment Pools Dry Up

Daryl Montgomery

Organizer, New York Investing meetup

For more about the New York Investing meetup, please go to our web site: http://investing.meetup.com/21

Mortgage Insurer Meltdown

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.

Bond insurers (Ambac, MBIA, FGIC, XL Capital, ACA, Security Capital) were only one of the many sectors of the financial industry that had gotten themselves into serious trouble by the fall of 2007. While these companies were not large compared to the banks or broker-dealers, they had an out sized impact because they guaranteed most municipal bonds in the United States and the ratings of those bonds couldn't be any higher than the bond insurance companies own ratings. Lowered ratings on bonds would mean higher interest costs, higher insurance costs, and even the possibility of not being able to borrow money for municipalities throughout the country. As with most of the problems created by the credit bubble, the bill would eventually wind up at the doorstep of the American taxpayer. As bad as this was, it was by no means the full extent of the damage that would be caused if bond insurers lost their financial viability.

Bond insurers are also known as monolines because for most of their existence they only operated in one line of business, the low-risk insurance of municipal bonds. That changed however in 1998 when they persuaded New York State regulators to allow them to underwrite high-risk Credit Default Swaps (a type of derivative that is insurance on a bond) on mortgage securities. Other states promptly followed New York's lead. The bond insurers set up shell companies called 'transformers' because they transformed a traditional bond insurance contract into a Credit Default Swap. These swaps in turn allowed investment banks to move commitments off their balance sheets and book profits up front - an accounting illusion that began to implode when the housing market went into decline.

On December 19, 2007, S&P finally downgraded bond insurer ACA from A to a junk rating of CCC. S&P was apparently one of the last to realize that that the company was no longer creditworthy. The company's stock had already fallen to less than a dollar (the price the market sets when a bankruptcy is expected) and had been delisted from the New York Stock Exchange in November, but apparently even that wasn't enough for S&P to give up the fiction of its A rating on ACA. Nor did S&P explain why ACA suddenly went from a creditworthy rating to junk status overnight when it belatedly downgraded ACA in December. S&P and the other rating agencies were quite aware of what would happen if they gave the bond insurers realistic credit ratings. Shortly after their downgrade of ACA, CIBC World Markets announced that insurance for $3.5 billion in securities it held backed by subprime mortgages was possibly no longer viable. In other words, the big banks and brokerage houses would be on the hook for all the subprime garbage on (and off) their books and would have to acknowledge it if the bond insurers were downgraded. One could safely presume that there was a lot of political pressure from many quarters to prevent this from happening.

Next: Sovereign Wealth Funds Bail Out the Banks

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21

What Banks and Enron Had in Common

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.

The Subprime Crisis began to take a serious toll on bank and broker earnings by the third quarter of 2007. Merrill Lynch led the pack with a $8.4 billion dollar write down. Citibank reduced its earnings by $5.9 billion, UBS by $3.4 billion, and JP Morgan by $3.1 billion. Deutsche Banks had $3.1 billion in write downs, but still amazingly managed to post a rise in earnings (one wonders who did their accounting). There was of course a lot of chatter from the talking heads in the media about whether or not these write downs were the final word in the impact of the Subprime Crisis on financial company earnings. Even the most casual knowledge of stock market history would have provided the answer - 'no they were not!' Whenever earnings in a group of stocks start to fall apart, the first write downs are never the last and usually aren't even the biggest for that matter. This was the pattern when the tech bubble burst only a few years earlier and yet many media commentators couldn't seem to remember even that far back.
Even without a knowledge of history, there was more than enough evidence to indicate that financial company write offs might get much bigger and go on for a long time. SIVs - structured investment vehicles - had already hit the news many weeks before November of 2007. These off-balance sheet items (think Enron) were so obscure that most people on Wall Street had never heard of them. Suddenly, there were an extra $400 billion of possibly bad debt that was not on the balance sheet of the banks, but would be winding up there eventually. Citibank alone had $100 billion in credit exposure to SIVs. This new wrinkle in the Subprime Crisis was viewed as so serious by the U.S. Treasury Secretary that he attempted to organize a bailout (how he had the authority to do so is unclear) by getting a number of large banks and brokers to create a pool that could buy up SIV assets and thereby support their prices. While much ballyhooed by the press, this effort went nowhere and was eventually abandoned by December.

While the Treasury Department's plans for SIVs fell through, the Federal Reserve created an alternative that could help out the big banks. It allowed them to borrow against their (highly questionable) assets, but this necessitated bringing the assets onto the books. In December, Citibank indeed brought $49 billion in SIV assets onto it balance sheet. It is presumed that the other $51 billion the Citi had originally in SIVs had disappeared because of reductions in value. Indeed, it was reported in December that the total value of SIVs was then only $298 billion (it was quite possible that even this was a significant overstatement of their actual worth). If Citi had lost approximate $50 billion in its SIV investments, it was not fully (if at all) reflected in write offs in its first quarter 2008 earnings report.

Although SIVs were considered a serious threat to the stability of the banking system, little did the public know in the fall of 2007, that they were not the sum total of all off-balance sheet items that the banks were holding. After all, why would a company have off-balance sheet items unless it wanted to hide what it was really doing? Since there purpose is secrecy, how does anyone know how many off-balance sheet items a company has, what assets they contain, and how much those assets are really worth? While it would be reasonable to assume that if there was one type of off-balance sheet item on a companies books, there could easily be others, there was little if any speculation on this matter by the financial media. Only in February of 2008 was it reported that SIVs were actually only one type of off-balance sheet items held by the banks - and the possible losses were much greater than had been previously imagined. The accountants who did Enron's book must have been envious.

Next: Mortgage Insurer Meltdown.

Daryl Montgomery
Organizer, New York Investing meetup

For more information about us, please see our web site: http://investing.meetup.com/21.