Is Dexia Bank the Bear Stearns of the Current Credit Crisis?

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

Over the weekend French President Sarkozy and German Chancellor Merkel said they had come to an agreement on recapitalizing EU banks. No details of their mystery plan were released. Plenty of details were forthcoming however on how Dexia bank was going to be bailed out and they indicate that it's time for EU leaders to stop talking and to start acting. 

Before its recent failure, Dexia bank was described as one of the strongest banks in Europe. It had no trouble passing the recent EU stress tests for banks (so much for the accuracy of those tests, which I have maintained for some time are nothing but a meaningless public relations gambit). Its Greek debt exposure was cited by the mainstream media as a primary reason for Dexia's demise. Dexia though had only 5.4 billion euros of Greek debt on its books out of an asset base of 518 billion euros according to Bloomberg. So, Greek debt was a little over 1% of Dexia's loans. Apparently this was enough for wholesale funding for the bank to dry up. Like most banks, consumer deposits were not enough to maintain Dexia's operations, it needed to continually borrow in the interbank market.

Dexia was a Franco-Belgium bank created 15 years ago by a merger of banks from the two countries. It also operates in Luxembourg and owns a 75% stake in Denzibank AS in Turkey, which it purchased in 2006. The Belgium government agreed to buy Dexia for 4 billion euros.  The French and Luxembourg units will be sold. Together, the three European governments will guarantee 90 billion euros of interbank and bond funding for 10 years. Belgium's share will be about 15% of its GDP. Guaranteeing bank debt has its risks and this is why Ireland required an EU bailout. Could Belgium be next?

If Dexia can fail, what EU bank is safe?  Moreover, the failure happened without a default by Greece, so it is clear many more bank failures are possible regardless of the outcome of the Greek debt crisis.
It can also be assumed that default will make the situation much worse. There are reports from German news agency DPA that Eurozone finance ministers are working on a plan involving a 60% reduction in Greek debt (previous reports indicated a 50% reduction).

The recent Dexia failure just like Bear Stearns failure in March 2008 happened because confidence from lenders in the interbank market disappeared. This can happen overnight. The monetary authorities patched things together temporarily after Bear Stearns demise, but the overall situation continued to deteriorate until Lehman Brothers failed six months later. A Greek default is likely to be the Lehman moment for the current credit crisis and Dexia's sudden collapse is similar to Bear Stearns. More bank failures in the EU will be a warning that the current crisis is escalating out of control.

Disclosure: None
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.
 

Credit Crisis Déjà Vu

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.

In September 2008, the markets were in sharp decline because of a bank-centered financial crisis. The authorities took action with bailouts and by buying bonds to prop up the market. Short selling of financial stocks was banned in order to stabilize the markets. Things are certainly different in 2011.  It's not that all of these events aren't happening again, they certainly are. This big difference is that now they are happening in August instead of September.

The geographic epicenter of the crisis has shifted as well. Europe is now dragging down the global financial system, whereas it was the United States that was doing the heavy lifting in 2008. Yet stocks have been down by similar amounts in continental Europe and in the U.S. this month. Whereas the U.S. was dealing with the failure of Lehman Brothers in September 2008, the EU is dealing with a selective default of Greek debt and trying to prevent new crises from arising in Spain and Italy (problems in Ireland and Portugal are on the back burner for now). Greece received its first bailout in May 2010 and then another bailout this July. The original terms of the new bailout require bondholders to take a 21% loss on their holdings. If the bondholders were just in Greece, this would not have major implications. However, French and German banks were major lenders to Greece. The Greek bailout is really a bailout for them.

Rumors have been rife that a number of French banks are in trouble and that S&P was going to downgrade them and France's AAA credit rating. Rumors also dogged Bear Stearns before its failure in March 2008. The company vehemently denied them, especially in the week before it collapsed. The SEC threatened to investigate and find the culprits spreading false rumors about Bear Stearns being in trouble. The SEC's case fell apart though after the company closed its doors. 

Any company, especially any bank, in trouble is going to publically deny it. So French banks denying that they are financially troubled, which they have done, is in and of itself meaningless. In this case, more credence can be given to S&P's statements on the matter. S&P denies it is about to downgrade the credit ratings for France or of the French banks rumored to be in trouble. It would look pretty foolish if it turned around and lowered them in the near future. S&P of course is still smarting from the reaction from its downgrade of U.S. debt from AAA to AA+. Even though the U.S. can't pay its everyday bills without borrowing money and this is as good a definition of insolvency as any, there was incredible outrage that S&P lowered its credit rating. After all, they had given the top rating to securitized mortgage bonds containing subprime loans and some of those borrowers had no income, no assets and no prospect for paying off their debts.

Another government reaction that took place in 2008 that is repeating itself in 2011 is a short selling ban. France, Spain, Italy and Belgium have just banned short selling of select financial stocks. On September 19, 2008, the U.S. banned short-selling on 799 financial stocks. Britain banned short selling on similar stocks the day before. Did it work back then?  No, it didn't. A large number of banks failed and many that didn't remained functioning only because of massive bailouts or because they were nationalized. 

Direct government takeovers were more common in the UK than the U.S. in 2008 and 2009, but just as the land of the free banned short selling, the supposedly capitalistic U.S. took over Fannie Mae, Freddie Mac and eventually GM (it had been lumped in with financial stocks as part of the short selling ban). It's not clear that the bailouts have yet to end either. In August 2011, Fannie Mae paid $500 million to buy servicing rights for 400,000 of Bank of America's worst-performing loans, loans with an unpaid balance of $73 billion. or these instead of Bank of America. Who exactly benefitted from this arrangement? Fannie Mae and Freddie Mac back $5 trillion in loans and many of them are not likely to be paid off. This debt is not counted as part of the $14 trillion plus U.S. national debt, but at least some of it should be.   

In 2011, the ECB (European Central Bank) has established a Securities Market Program to buy government bonds of its troubled members in order to keep interest rates lower than the free market rate. Its first buys were Spanish and Italian bonds on August 8th. The U.S. Fed was a heavy buyer of bonds in September 2008, although it didn't announce its first quantitative easing program until late November of that year. It also denied at the time that it was engaging in quantitative easing. Most of QE 1 had already taken place by the time the Fed announced it. This highly relevant fact remained unmentioned.

So here we are in 2011 and we find events are very similar to what was taking place in 2008. Some of the players are different, the locations are different and the order things are happening may be a little different. But all in all, it looks like the more things change; the more they remain the same.  

Disclosure: None

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


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

U.S Credit Rating Downgrade - A Humpty Dumpty Moment

 

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

As everyone knows by now, S&P downgraded the U.S. sovereign debt rating from AAA to AA+ on Friday. While the extent of the downgrade is minor, the implications are major. As the recent debt ceiling negotiations revealed, the U.S. cannot run its day-to-day operations without borrowing money. It lives on credit (as do most countries in the world today) and anything that impacts its ability to borrow money has serious consequences.

It takes a lot for a credit rating agency to lower the credit rating of a top corporation or country. This is usually only done long after the actual credit worthiness has experienced a significant decline.  The last major Friday afternoon credit downgrade from the credit rating agencies was when they lowered Bear Stearns rating on March 14, 2008. The company didn't open its doors again the following Monday.  The rating agencies were also tardy with lowering the credit ratings of accounting fraud poster child Enron, although they all did finally lower its rating to junk status four days before it declared bankruptcy. Perhaps the best analogy to the current U.S. situation though is the AAA ratings given to a number of securitized bonds that held subprime mortgages. These turned out not to be worthy of a top credit rating after all.

The farcical nature of how the credit agencies determine the rating of U.S. government debt was made clear during the debt ceiling negotiations. Numerous articles in the press reported that failure to come to an agreement, which would allow the U.S. to continue to spend money it didn't have because it could borrow more, would be viewed as fiscally irresponsible! A more rational response would have been, it's quite obvious that the U.S. can't function without borrowing an increasing amount of money and it is therefore insolvent. Under such circumstances its credit rating should be at the junk level - a BB or less - not an AA+. Eventually, this might happen, but as was the case with Enron, this would mean the U.S. would likely be going under a few days later.

The difference between the AA+ credit rating and the BB or lower one is caused by the fantasy factor. The AA+ rating is based on the glorious financial past of the U.S. and ignores the current downward trajectory it is on. Before the debt ceiling problems temporarily curtailed spending for a while, the U.S. was on course for as much as a $1.65 trillion budget deficit. This represents 11% of the current GDP number of $15 trillion (there are many reasons to think GDP is substantially overstated). It is true, that the U.S. is not borrowing money to pay for most of this deficit however - it's printing it. Quantitative Easing 2, a form of money printing, conducted by the Fed covered 70% of the deficit in the first half of the year. A country doing this certainly does not deserve an AAA credit rating, nor does it deserve an AA+ credit rating unless you can make a case that a company engaged in the business of counterfeiting money also deserves a close to top credit rating.

The Obama administration complained that S&P overestimated future U.S. deficits by $2 trillion. What this means is that S&P refused to accept the pie-in-the sky budgets numbers that the government generates. If you look at these, you will see that they assume GDP growth of over 5% a year, each and every year, until 2016. One year of GDP growth over 5% would be good and continual annual GDP growth of over 5% for the U.S. economy just isn't possible. The budget scenario also assumes very low inflation, which would certainly not be the case if the high growth it assumes takes place.  A combined deficit of $20 trillion in the next decade instead of the administration's $7.7 trillion would be more plausible. S&P assuming $2 more is still ridiculously low.

The immediate impact of the U.S. credit downgrade will be to cap the credit rating of companies at AA+. The government of the country has to have the highest credit rating in that country because in theory it has no default risk. Economists say that governments can use their ability to tax to pay off their debts. Although as finances deteriorate it is much more likely governments will print money to pay off their debts. No fiscally solvent government ever engages in excess money printing however. The U.S. Fed had increased its balance sheet (a measure of money printing) by $2 trillion since 2007. It doesn't appear that the credit agencies are taking this into account.

The longer-term implications for the lowered credit rating are far more serious.  More downgrades are likely. Interest rates will go up. Money will leave the United States. The U.S. dollar will lose its reserve currency status and this will lower its value substantially. Higher interest rates and a falling currency will both be inflationary. 

The financial world operates very much on image and reputation. Once that's shattered, it can take years to repair it, if it can be done at all.  When Bear Stearns was downgraded in March 2008, the damage to its ability to operate in the financial markets was terminal. The company imploded like an overinflated balloon that had a pin stuck in it. Fortunately, this is not likely to happen to the U.S. - at least not yet.

Disclosure: None

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

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.

It's De Facto Default for Greece

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 debt crisis in Greece looks like it is finally going to be resolved now that an S&P downgrade of the country's debt to junk status on April 27th has brought the crisis to a head. The eurozone leadership will finally have to stop its denial and provide Greece with funding to roll over its debts. Calm will be then be restored to the markets - at least for a while.

The inept handling of the situation in Greece seems reminiscent of the U.S. government's refusal to bail out Lehman Brothers. That act of political obliviousness led to a crash of the entire world financial system. Greece will have some sort of bailout however, so the more apt analogy would perhaps be the collapse of Bear Stearns. The markets were calmed when the U.S. Fed and Treasury arranged for JP Morgan to buy Bear Stearns at a fire sale price. If they were handling the Greek debt crisis, they probably would have solved it by having Goldman Sachs purchase the country at a 90% discount. Because of the brokered deal by the feds, Bear Stearns never officially went under, although in reality it did because it was no longer capable of independently functioning. If some bailout program is necessary to roll over Greece's government debt or allow it to make interest payments on it, Greece has for all intensive purposes defaulted.

The reaction of the euro zone leadership to Greece's problems seem inexplicable to anyone from the outside. It is definitely a shoot yourself in the foot to punish the other guy approach. A potential bailout for Greece is very unpopular among the electorate in Germany and there will be regional elections there on May 9th. It's the Germans that have been holding up the aid package. German banks have an estimated $45 billion in exposure to Greek debt (France is even higher, holding $75 billion in Greek loans), so an official Greek default would potentially cost Germany more than a bailout. Almost all of Greece's debt is held outside the country and the rest of the eurozone is heavily exposed. It's enough to make you wonder if big banks anywhere in the world ever apply any credit standards to their loans.

The market disaster yesterday seems to have woken the EU from its comatose state of deep denial and fast-tracked handling of a Greek aid package. The euro (FXE) hit a new yearly low of 131.63 and looks like its may have taken out a possible triple bottom. Stocks got hammered on bourses across the continent. Greece itself was down 6.7% and it reacted by instituting a two-month ban on short selling (the U.S. did the same for financial stocks after Lehman collapsed).  Portugal, which had its credit downgraded two notches by S&P, dropped 5.4% and is getting hit hard again today. Italian stocks suffered similar damage. The CAC-40 in France, the Dax in Germany and the FTSE in the UK fell 3.8%, 2.7% and 2.6% respectively. Five-year credit default swaps (CDSs) reached 840 basis points for Greek debt, 430 basis points for Portuguese debt, 270 basis points for Irish debt and 225 points on Spanish debt. The spread between German 10-year governments and equivalent Greek debt rose to 9.63%. Interest rates on two-year Greek governments rose to 18%.

When the EU created the euro currency union, it didn't plan on how to handle debt crises in member states. This was the case even though it allowed some countries with checkered fiscal pasts to become part of the eurozone.  EU leadership (or more appropriately lack thereof) has continued to avoid this issue throughout the entire Greek debt crisis so far. The obvious solution of using dollarization - letting a country continue to use the euro, but not be a part of the credit union - has seemingly not occurred to them. Instead, the tried and true bailout solution will once again by utilized. As became evident in the U.S. during the Credit Crisis, one bailout is never enough. There is already talk about raising the Greek loan guarantees from the EU and IMF from 45 billion euros to 100 to 120 billion euros and extending them over a three-year period. This bailout for Greece will likely just be just one of many and Greece itself will just be the first country to be bailed out.

EFTs that are useful for trading the current crisis in Europe include: EZU (euro monetary union), GUR (emerging Europe), VGK (European stocks), EWI (Italy) and EWP (Spain).

Disclosure: None relevant.

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

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

Moody's Sovereign Debt Assurances Should Concern Investors

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.


According to ratings agency Moody's, credit ratings of the world's four largest Aaa-rated sovereign nations - the U.S., UK, Germany and France - are currently "well positioned despite their stretched finances". The agency does however admit that risks have grown. Based on Moody's past actions, this should give investors little comfort.

In the current Greek debt crisis, Moody's was behind S&P and Fitch in downgrading Greek government debt. As reported in the Wall Street Journal, it took Moody's until December 23rd to make a downgrade of just one notch from A1 to A2. After the elections on October 4th, the Greek government admitted it had lied about its budget deficit and its ratio to GDP would be 12.7%, several times higher than previously reported. Even though the original numbers from the Greek government should have seemed unbelievably rosy, this apparently didn't make the rating's agencies suspicious. Are they likely to be more suspicious of the numbers generated by the politically powerful major countries that get their top ratings?

Prior to the Greek crisis, there was Iceland. According to the Central Bank of Iceland's website, Moody's downgraded Iceland's long-term debt obligations in domestic and foreign currency to A1 (still well within the investment grade range) on October 8, 2008. This was the same day that the Iceland's krona peg to the euro collapsed. Iceland had already nationalized major banks Glitnir and Landsbanki the month before. The Iceland prime minister had stated on October 6th that there had been a real danger of national bankruptcy. That scenario would have justified a rating of C from Moody's, many notches below the October 8th rating.

Investors should also not forget the role of the rating's agencies in giving securitized sub-prime loans top triple A ratings (Aaa in the case of Moody's). Moody's had to downgrade more than 5000 mortgage securities in 2007. The ratings agencies in general blamed mortgage holders that turned out to be 'deadbeats' and not their own practices. They would like us to believe that it was unreasonable for them to have assumed that people with spotty employment, a history of not paying their bills, and who bought houses they couldn't afford would default on their mortgages. If the rating agencies can ignore those problems, investors should ask themselves what problems they are ignoring with U.S., UK, German and French government financing?

How did the rating's agencies do with problem companies? Moody's downgraded Bear Stearns to Baa1 from A2 on March 14th, 2008. The Baa1 rating is an investment grade rating for Moody's (there are five speculative rating's below that level). That downgrade took place on the last day that Bear Stearns' stock traded. Moody's was still maintaining it was an investment quality company. The rating agencies did a little better with Enron, downgrading it to below investment grade four days before it declared bankruptcy. The stock had already lost almost all of its value before the downgrades, so the move was too little too late.

In its current analysis of sovereign finances, Moody's maintains that the major countries will be able to maintain fiscal stability because interest payments are reasonable compared to government revenues. However, government debts are increasing rapidly because of weak economies. If the global economy continues to stay weak, interest payments will go higher , tax receipts lower and debt will continue to pile up. Recovery, on the other hand, will raise interest rates substantially and this could overwhelm tax receipts and create a major debt spiral. The rating agencies are unlikely to consider that the major countries are caught in a lose/lose situation though since they seem to reserve their most speculative ratings for basic logic and common sense.

Disclosure: None

NEXT: The CFTC and Manipulation of the Silver Market

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.

Big Bank Earnings Contradict Economic Recovery Claims

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.


In its recent earnings report, JP Morgan revealed that it had a bigger loss in its retail financial services division in the fourth quarter of 2009, than it did at the height of the Credit Crisis in Q4 2008. Bank of America and Citibank earnings reports for last quarter also indicate that their lending and consumer credit operations remain troubled and that a U.S. economic recovery has yet to take place. The banks are only making money from their investment banking operations and this has offset major losses from lending activities - the core business for any bank.

The loss for JP Morgan in its retail financial services division (which includes mortgages) was $399 million in Q4 2009. The bank lost $306 million in its credit card division and this number would have been even worse if there hadn't been a payment holiday during the quarter. JP Morgan's provision for credit losses was $7.28 billion last quarter. Despite the steep losses in its lending arm, JP Morgan still reported earnings of $3.28 billion or 74 cents a share.

Unlike JP Morgan, Bank of America didn't report positive earnings, but said it lost $5.2 billion or 60 cents a share in the fourth quarter. The bank charged off $8.4 billion in bad loans. While this indicates a severely damaged loan portfolio, it was $1.2 billion lower than in the third quarter. Credit Card losses were $1.03 billion and these were much higher than in the fourth quarter of 2008. Investing banking earnings were up and this kept the reported losses from being much worse.

Citibank also reported a loss in the fourth quarter, 33 cents versus a loss of $3.40 a year ago. Its revenue from trading and investment banking was up 5.9%.  There was a loss of $2.33 billion in it local consumer lending operations. As bad as this was, it was still better than the $4.89 billion loss in the fourth quarter of 2008. Net credit losses for the bank were $7.13 billion versus $7.97 billion from a year earlier. Citibank added $706 million to its loan loss reserves.

Earnings for the big banks indicate that the U.S. economy is still in severe recession. Their lending operations are still experiencing massive losses and in some cases these have gotten worse than during the bleakest days of the Credit Crisis. Earnings have been held up through investing banking operations, which in turn have been helped by changes in accounting rules. Illusions can only work for so long for financial companies however. Investors seem to have quickly forgotten what happened to Bear Stearns in 2008. It was about to report positive first quarter earnings before it went under in March of that year. It had an $18 billion funding reserve and claimed it was solvent right up to the end. Even though the company had a reported book value of around $90 dollar a share (the number was slightly different depending on the source), the U.S. government valued it at $2 a share in the takeover its arranged from JP Morgan. Apparently the real numbers can be much worse than the reported ones for U.S. financial firms and investors should keep this in mind.

Disclosure: None

NEXT: Trouble in Euro Zone Boosts Dollar, Lowers Commodities

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.

CIT DOA; Liquidity Injections Rally Market?

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:

The market had a great rally yesterday with almost all asset classes going up. This started a few days ago with the Goldman Sachs (aka Government Sachs) rally. Morgan Stanley beat expectations this morning. The Goldman rally took place BEFORE the good news was released and if yesterday was at least partially a Morgan Stanley rally, it happened before the news came out also. Don't worry though, the government announced many times last week that it was going to crack down on illicit speculation in the markets. If you had trouble not laughing when reading that last sentence, it's not surprising. There is no need to write parody, when you have the mainstream media reporting news like that.

The lack of memory on the markets part seems to be truly amazing. The no longer in existence Bear Stearns was about to announce good earnings in March 2008. The only thing that prevented it from doing so was the company went under before it could tell the world how much money it was making. This would seem to indicate to anyone with even the most minimal thinking ability that the earnings of these big Wall Street firms are meaningless. But hey, this happened last year. Traders, like government officials, don't let themselves get bogged down with the past. After all, it's not like history repeats itself.

It would not be unreasonable to assume that the market is rallying so much in the last few days because a lot of money is being pumped into the financial system. That the U.S. dollar is going down, while everything else is going up (a common pattern in market rallies since the beginning of June) supports this view. Now what could possibly be behind that? Probably the imminent failure of CIT, a lender to one-million small to medium size businesses. After giving CIT $2.3 billion in TARP funds, the U.S. government has decided to pull the plug. CIT is apparently not too big to fail (meaning that it doesn't have a lot of former alumni in highly placed positions in Washington, D.C.). Treasury Secretary Tim Geithner, part of the tweedledum and tweedledumber team of Geithner and Bernanke, is personally handling the situation.

If there is any historical analogy to CIT's failure it is the Bank of United States, actually a local New York City bank despite the name, failure in December 1930. This bank lent to lots of small and medium size business, but only in the New York metro area, whereas CIT lends nationally. The Fed refused to bail out the Bank of the United States and thought the repercussions would be minimal. Instead, the demise of the Bank of the United States set off the first of three major waves of bank failures that lasted more than two years and which wiped out a large part of the U.S banking system. But that was back in the 1930s when U.S. financial officials didn't have the slightest idea what they were doing. Instead today we have ever on the ball Fed Chair Ben Bernanke who in March 2007 said, "the problems in the subprime market would only reduce somewhat the effective demand for housing” and then followed that up in May 2007 with “given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited”. Bernanke saw no potential ill effects on the broader economy right up until June 2007. A few weeks later everything fell apart.

NEXT: Bank Profits Soar Even Though Business is Bad

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.

Geithner's appointment to Treasury - a Golden Opportunity

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:

The market turnaround last Friday afternoon was reported by the financial media as resulting from the announcement that the head of the New York Fed, Timothy Geithner, would be appointed by President elect Obama as his Treasury Secretary. It would indeed be reasonable for Wall Street to cheer Geithner's appointment and the future team of takover Timothy and bailout Benny. It sent a very clear message that the new administration's policies will be to rescue any and every company needing it. While stocks rallied sharply on this news, the inflation hedges gold and silver rallied even more - and for good reason.

Geithner was the mastermind behind the AIG and Bear Stearns deals. In the case of AIG the company was nationalized by paying 10 times the market price for the U.S. taxpayer's share (if this had been a private deal he would have been sued for malfeasance). Bear Stearns was valued well below market value as a gift to JP Morgan Chase (which has a seat on the New York Fed Board of Directors by the way). Taxpayers just got to guarantee Bear's toxic loans and were left holding the bag. While most news media reported that Geithner was in favor of bailing out Lehman Brothers, this was apparently not the case. People who were on the scene at the negotiations claim otherwise. It is now widely acknowledged that allowing Lehman to fail is what has led to the market turmoil in the last two months. The PR campaign to build up Geithner obviously felt it important to rewrite history and in doing so made it clear that a universal U.S. government bailout policy was in our future.

Despite the momentary trouble that the automakers are having in Washington on getting in on the government gravy train and the failure to bail out Lehman (somewhat similar to the failure of the Fed to bail out the Bank of the United States in 1930, which had disastrous consequences), short of complete nationalization, the U.S. government couldn't do much more to support financial firms other than pump even more money into them (this will indeed be happening). Over the weekend the government guaranteed the most worthless one-sixth of Citigroup's assets. Today, the Fed announced a $600 billion program to support the mortgage market, $100 billion for Fannie Mae and Freddie Mac (two other financial black holes for government money) and $500 billion to purchase mortgage backed securities. Additionally, the Fed will lend up to $200 billion to the holders of securities backed by various types of consumer loans. So that's another $800 billion just for today. The total in the last year is way into the many trillions and you many assume most if not all of that is freshly printed money.

The implications of these moves have not gone unnoticed in the markets. Inflation sensitive silver rallied more than any stock index on both Friday and Monday. Gold, which has not been terribly damaged in the sell off during the last two months, and beaten down oil also had good rallies. The charts for gold and silver are much healthier looking than those for the major stock indices. Sustainable rallies are possible for both, while stocks look like they will need to do more work to get to that point.

NEXT: A Black (Plague) Friday for Retail

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.

Bailout to Bailout - The Collapse and Rescue of Bear Stearns

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

Our video for this posting can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

By March 10, 2008, rumors were flying everywhere on Wall Street that Bear Stearns was in trouble. In an attempt to counter these rumors, Bear's CEO released a statement to the press that the company had a sufficient liquidity cushion to weather the credit crisis. When a company is going under, it has no choice except to make such claims. Instead of being reassuring, this type of statement is an indication of serious trouble. After all, a sound company has no need to assure the public that its financial position is strong - and Bear Stearns was no exception. Insiders, of course, are not fooled by these proclamations, which are meant for the average investor. Indeed examination of options activity during Bear's last days shows heavy put buying that quickly turned into huge profits for those in the know.

According to an SEC report released the following week, Bear Stearns had a cash shortfall starting on March 11th, only one day after the CEO assured the public that Bear had sufficient liquidity. By the evening of March 13th, Bear was no longer a viable business and behind the scenes it was already working out the details of a bailout plan with the Fed. Ironically, if indeed it was a coincidence, earlier that day, S&P released a cheer-leading report heralding the end to subprime crisis write offs, which in turn led to a strong rally in U.S. financial stocks.

On Friday the 14th, Bear Stearns stock went into free fall. It closed at $30 a share, down from a high of over $171 at its peak in January 2007. Depending on the source, the book value for the company's stock was somewhere between $84 and $97 a share. The market obviously didn't agree and it would turn out the Fed's judgment was even more pessimistic. Nevertheless, after the close, the CEO stated in a conference call with investors that the book value was fundamentally unchanged. He also claimed that Bear's 'liquidity position had markedly deteriorated because of market rumors' indicating that management incompetence, the reporting of misleading financial figures, or that Bear actually being insolvent had nothing to do with the loss of faith in the company.

The CEO also announced an emergency 28-day loan from the U.S. Federal Reserve. The Fed had no real legal authority to assist Bear Stearns, so it funnelled the loan through JP Morgan, one of its member institutions. It justified its actions based on an obscure 1930s law that gives the Fed broad ability to grant loans to corporations in crisis conditions. During the weekend, the Fed would became even more proactive and Bear Stearns was no longer be an independent company when the markets opened again on Monday morning.

NEXT: Bailout to Bailout - The Bear Bailout and Its Aftermath

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

From Bailout to Bailout - The Prelude to Bear Stearns Collapse

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 on the material in this post is 'The Bear Stearns Bailout'. It can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

The New York Investing meetup first mentioned in August 2007 that Bear Stearns was likely to fail. Two of Bear's hedge funds had gone under in late July and this helped t0 precipitate a sell off in the U.S. stock market by bringing media attention to the subprime crisis. Even though the subprime crisis had begun by at least December 2006 with the sudden failure of mid-sized mortgage lending company, the financial media failed to recognize its importance until the forced closure of the Bear Stearns funds. The precarious state of Bear Stearns finances that this failure indicated was in turn also missed by the U.S media. As usual, the media took its cues from Wall Street, which remained bullish on Bear Stearns right up to the very end (as was the case for Enron and a number of other major corporate failures).

Furthermore, the September 20, 2007 earnings report indicated everything was fine. Despite the failure of the two hedge funds, Bear Stearns claimed to have earned $1.16 a share. A write off of only $200 million (an insignificant amount for a Wall Street firm) was taken as a charge for closing the funds. Another $700 million of mortgage assets were also written down, also not that great an amount. In the earnings conference call, the CFO stated that he “expect[ed] a return to more favorable conditions next year”, stressed the underlying business was sound, and market dislocations tended to run a quarter or two. The only thing he was correct about was that the market dislocations would only last two more quarters - although he certainly didn't imply that this would be because Bear Stearns would no longer exist after that time.

While the September earnings report was reassuring, Bear Stearns December 20th earnings report was an indication of serious and possibly fatal problems. Suddenly, the company lost $6.90 a share, the first loss in its history (Bear was even profitable in every quarter during the Great Depression). Wall Street analysts were expecting a loss of only $1.79 a share, missing the actual loss by over $5.00 a share. The loss included only $1.9 billion of write downs in subprime mortgage exposure. Despite the indication that analysts had completely missed the extent of Bear Stearns problems, the stock actually went up after the earnings report, instead of sharply falling as it should have. The CEO subsequently 'resigned' - something that usually only takes place when a company is in trouble.

By December 2007, Bear Stearns was hardly unique in suffering losses because of the ever expanding credit crisis. The Federal Reserve attempted to address these system wide problems by creating its first new lending facility, the TAF (term auction facility), which gave it an additional conduit for its money pumping operations. In January 2008, reacting to the further deterioration in the financial system, the Fed cut its funds rate by an additional 1.25%. Bear Stearns, however, could not benefit directly from any of these moves since it was not a commercial bank and was therefore not allowed to borrow money from the Fed, so its situation continued to deteriorate.

Nevertheless, even as late as early March 2008, neither Wall Street, nor the media were ringing any alarm bells that Bear Stearns was about to implode. No Wall Street analyst had a sell recommendation on Bear Stearns stock even though it was about to lose almost all of its value. It apparently didn't bother them that the balance sheet indicated 33 times leverage, an amount that can only be described as enormous and which was greater than any other broker dealer or commercial bank. While the public facade that everything was fine was being maintained by Wall Street, rumors were circulating behind the scenes that Bear Stearns might go under. The big players were quietly getting their money out in what was basically a secret run on the bank.

NEXT: Bailout to Bailout - The Collapse and Rescue of Bear Stearns

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

Economic Predictions for 2008

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

The December 12, 2007 meeting of the New York Investing meetup focused on the likely economic scenarios for the coming year. A video, entitled 'Economic Predictions for 2008' summing up these predictions can be found on You Tube at: http://www.youtube.com/watch?v=bZLsD2DHvLw.

The most important themes cited for 2008 were inflation and recession. Even though inflation is and has been under reported by the U.S. government since the 1980s, it was our opinion the even the manipulated numbers, let alone the real ones, would start to become noticeably higher. We predicted that as inflation was climbing, that the U.S. economy was likely to be gripped by recession (with negative job creation in each of the first 3 months of 2008, it now looks like the U.S. economy was in recession in the first quarter of the year). We also pointed out that it was unlikely the government would be reporting that we were in recession (the government GDP figures are unreliable, just like the inflation figures) until the recession was well under way or even over.

A widening out of the credit crisis with credit card debt, car loans and student loans being impacted was also mentioned in the talk (defaults in all of these loan types were rising significantly in the first quarter of 2008). A big drop in commercial real estate and a continuing weakness in residential real estate were also predicted (foreclosures continue to hit multi-year highs).

Special mention was made of the problems with bond insurers (monolines) and how their condition would continue to deteriorate, but the rating agencies might fail to lower their ratings appropriately because of political pressure (the official lowering of the ratings of these companies could lead to financial chaos). Bond insurer SCA's credit rating was lowered substantially in March 2008, but the rating agencies were still mostly maintaining ratings on the industry leaders MBIA and Ambac.

More bailouts of banks and broker-dealers with the assistance of the Fed was also predicted. The behind the scenes purchase of Country Wide Financial by Bank of America as the secret behest of the Federal Reserve (something denied by Bank of America) was given as an example. The Sovereign Wealth fund purchases of parts of major U.S. financial institutions, certainly with the knowledge and approval of the federal authorities, was also cited as a type of bailout that would continue to take place. Citibank in fact received just such a bailout (for the second time) in mid-January. Of course, the Bear Stearns bailout in mid-March was the most spectacular example of the of the accuracy of this prediction.

Finally it was predicted that the U.S. dollar would continue to drop and this would eventually lead to some form of currency intervention by the G7 countries (most likely late in the year, particularly after the election). Unless the Fed choices to raise rates substantially, this intervention will fail.

NEXT: The First Four Trading Days of 2008

Daryl Montgomery
Organinzer, New York Investing meetup

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

The New York Investing meetup predicts the current bear market in Aug 2007

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.

After having warned its members that the subprime crisis would soon start impacting the stock market in July 2007 (days before it actually happened), the New York Investing meetup followed this up in the August 8, 2007 meeting with a prediction of a crash or Bear Market. By January 23, 2008 both the Nasdaq and the Russell 2000 had fallen over 20% and were officially in Bear markets.

The August meeting emphasized that the Bull Market was over, that earnings wouldn't save the Market (a common claim by the financial media pundits at the time), the hardest hit sectors would be the bubble sectors of the Bull Market, real estate and financials, and short-covering rallies would be the key to profits on the long side in the future. It was even predicted that one or more broker-dealers would fail, with Bear Stearns name mentioned. The most important point made in the talk "Crash or Bear Market" (http://investing.meetup.com/21/files/) was that the Federal Reserve would not be able to save the stock market with its usual liquidity injections into the financial system. It was emphasized quite strongly that the U.S. dollar was in precarious shape and that any attempt to save the U.S. stock market with rate cuts would ultimately fail because of the damage it caused to the dollar. Future events would more than bear out this prediction.

Next: Bernanke Get in His Helicopter and Does His First Money Drop on Wall Street

Daryl Montgomery

For more information about the New York Investing meetup, please see: http://investing.meetup.com/21